Accounting equation
One of the most important principle of accounting is the Accounting Equation. It forms the foundation for
the double entry concept, that helps to run and balance the whole transaction from the business. It is the
equity of what the company owns and what the company owes. Therefore, in other words, is the equity of
assents and the sum of liabilities and capital. To understand accurately the accounting equations is
essential to know the items in the equation: assets, liabilities and capital.
Assets are resources owned or controlled by a business that can generate future economic revenue for the
business, for instance, could be converted into cash. An asset could be investments, supplies, land,
buildings, vehicles, etc.
There are three types of assets:
Current assets, all the assets converted into cash within one year. Hence all the short-term resources
owned by a business, for instance: cash & cash equivalents, account receivable or inventory. Although it
can be a Non-current asset, that is long-term resources converted into cash after more than one year.
Finally, intangible assets are assets without physical presence. Such patents, title given by the owner to an
exclusive use of his invention and same time it gives protection. They belong to the same category of
assents: Trademarks (for instance a logo), copyrights (right reserved to the author) and goodwill (positive
image of the company built through a period of excellent service).
A different component of the accounting equation is the liabilities. It is an obligation or a debt to be paid to
a business on something we own from them. The liabilities can be current o non-current.
An example of current liabilities is an overdraft, that is when the business borrows money from a creditor,
and the debt must be paid within one year. This is a simple example of short-term liability.
The non-current liabilities are long-term debts payable over a long period, precisely more than one year.
The owner’s equity, often called capital, represents the money introduced by the business own. It’s the
money that we have in the business, including all the assets and the liabilities, in fact capital is the equity of
assets minus liabilities. The capital may vary depending on various economic transactions, such as:
Expenses, all the purchases that the owner must do for his business, for instance, staff’s salary, telephone
bill, electric bill, wages or rent.
Income, known as revenue or sales revenue, are all the money coming into the business, from an exchange
of goods or also provided service, therefore everything the business earn from own activities.
Drawing, everything removed from the business for personal used, it is not necessary to be money. They
can be assets such as goodwill, vehicle or products.
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