{"id":65,"date":"2024-09-06T16:46:05","date_gmt":"2024-09-06T16:46:05","guid":{"rendered":"https:\/\/content.one.lumenlearning.com\/financialaccounting\/chapter\/the-accounting-equation\/"},"modified":"2024-09-11T17:14:48","modified_gmt":"2024-09-11T17:14:48","slug":"the-accounting-equation","status":"publish","type":"chapter","link":"https:\/\/content.one.lumenlearning.com\/financialaccounting\/chapter\/the-accounting-equation\/","title":{"raw":"The Accounting Equation","rendered":"The Accounting Equation"},"content":{"raw":"<section class=\"textbox learningGoals\" aria-label=\"Learning Goals\">\r\n<ul>\r\n \t<li>Explain the basic accounting equation<\/li>\r\n<\/ul>\r\n<\/section>&nbsp;\r\n\r\nOne of the cornerstones of financial accounting is the accounting equation, which in its simplest form, looks like this:\r\n<p style=\"padding-left: 30px;\">[latex]\\text{A}=\\text{L}+\\text{OE}[\/latex]<\/p>\r\nThis equation has to always stay in balance.\r\n\r\n<section class=\"textbox example\" aria-label=\"Example\">\r\n<h3>Balancing a New Business<\/h3>\r\nAn owner registers their new company with the state department of business licensing. They take their business license down to the bank and transfer $20,000 of their own money into a new business account. They have now \u201ccapitalized\u201d their business, which means they made a contribution to capital, which increases owner\u2019s equity.\r\n\r\nAt the same time, they have increased the balance in their checking account. From a bookkeeping perspective, you have to make two entries for this one business transaction, and these two entries balance each other out.\r\n<p style=\"padding-left: 30px;\">[latex]\\text{A}=\\text{L}+\\text{OE}[\/latex]<\/p>\r\n<p style=\"padding-left: 30px;\">[latex]\\$20,000=\\$0+\\$20,000[\/latex]<\/p>\r\n<img class=\"aligncenter wp-image-2803\" src=\"https:\/\/s3-us-west-2.amazonaws.com\/courses-images\/wp-content\/uploads\/sites\/5107\/2020\/08\/04211119\/Scales20.png\" alt=\"balanced scales with $20,000 on each side\" width=\"401\" height=\"399\" \/>\r\n\r\nNow, suppose the owner also borrows $5,000 from the bank, which is then deposited into their account. A loan will not increase their equity. It is not a capital contribution. It is debt, which is a liability.\r\n\r\nNow, the equation looks like this:\r\n<p style=\"padding-left: 30px;\">[latex]\\text{A}=\\text{L}+\\text{OE}[\/latex]<\/p>\r\n<p style=\"padding-left: 30px;\">[latex]\\$25,000\\left(\\text{cash}\\right)=\\$5,000\\left(\\text{bank loan}\\right)+\\$20,000\\left(\\text{original capital contribution}\\right)[\/latex]<\/p>\r\n<img class=\"aligncenter wp-image-2804\" src=\"https:\/\/s3-us-west-2.amazonaws.com\/courses-images\/wp-content\/uploads\/sites\/5107\/2020\/08\/04211553\/Scales25.png\" alt=\"balanced scales with $25,000 on each side\" width=\"400\" height=\"397\" \/>\r\n\r\nAssets are what the business owns. Liabilities are what it owes, and equity is the amount of the company that belongs to the business owner.\r\n\r\n<\/section><section class=\"textbox connectIt\" aria-label=\"Connect It\">\r\n<h3>Balance in a Home Loan<\/h3>\r\nThink of the equation in terms of a house. Say the house costs $250,000 and you owe $200,000 to the bank. Your equity in the home is $50,000.\r\n\r\n[latex]\\text{A}=\\text{L}+\\text{OE}[\/latex]\r\n\r\ncan also be stated as:\r\n\r\n[latex]\\text{A}-\\text{L}=\\text{OE}[\/latex]\r\n\r\n[latex]\\text{Assets}-\\text{Liabilities}=\\text{Owner's Equity}[\/latex]\r\n\r\nIn the case of the house cited above, the equation is [latex]\\$250,000 - \\$200,000 = \\$50,000[\/latex].\r\n\r\n<\/section><section class=\"textbox keyTakeaway\" aria-label=\"Key Takeaway\">\r\n<h3>Accounting Equation<\/h3>\r\nCommit this important accounting concept to memory: Assets = Liabilities + Owner\u2019s Equity\r\n\r\n<\/section>&nbsp;\r\n\r\n&nbsp;\r\n\r\n<section class=\"textbox tryIt\" aria-label=\"Try It\">[ohm2_question hide_question_numbers=1]25094[\/ohm2_question]<\/section>","rendered":"<section class=\"textbox learningGoals\" aria-label=\"Learning Goals\">\n<ul>\n<li>Explain the basic accounting equation<\/li>\n<\/ul>\n<\/section>\n<p>&nbsp;<\/p>\n<p>One of the cornerstones of financial accounting is the accounting equation, which in its simplest form, looks like this:<\/p>\n<p style=\"padding-left: 30px;\">[latex]\\text{A}=\\text{L}+\\text{OE}[\/latex]<\/p>\n<p>This equation has to always stay in balance.<\/p>\n<section class=\"textbox example\" aria-label=\"Example\">\n<h3>Balancing a New Business<\/h3>\n<p>An owner registers their new company with the state department of business licensing. They take their business license down to the bank and transfer $20,000 of their own money into a new business account. They have now \u201ccapitalized\u201d their business, which means they made a contribution to capital, which increases owner\u2019s equity.<\/p>\n<p>At the same time, they have increased the balance in their checking account. From a bookkeeping perspective, you have to make two entries for this one business transaction, and these two entries balance each other out.<\/p>\n<p style=\"padding-left: 30px;\">[latex]\\text{A}=\\text{L}+\\text{OE}[\/latex]<\/p>\n<p style=\"padding-left: 30px;\">[latex]\\$20,000=\\$0+\\$20,000[\/latex]<\/p>\n<p><img loading=\"lazy\" decoding=\"async\" class=\"aligncenter wp-image-2803\" src=\"https:\/\/s3-us-west-2.amazonaws.com\/courses-images\/wp-content\/uploads\/sites\/5107\/2020\/08\/04211119\/Scales20.png\" alt=\"balanced scales with $20,000 on each side\" width=\"401\" height=\"399\" \/><\/p>\n<p>Now, suppose the owner also borrows $5,000 from the bank, which is then deposited into their account. A loan will not increase their equity. It is not a capital contribution. It is debt, which is a liability.<\/p>\n<p>Now, the equation looks like this:<\/p>\n<p style=\"padding-left: 30px;\">[latex]\\text{A}=\\text{L}+\\text{OE}[\/latex]<\/p>\n<p style=\"padding-left: 30px;\">[latex]\\$25,000\\left(\\text{cash}\\right)=\\$5,000\\left(\\text{bank loan}\\right)+\\$20,000\\left(\\text{original capital contribution}\\right)[\/latex]<\/p>\n<p><img loading=\"lazy\" decoding=\"async\" class=\"aligncenter wp-image-2804\" src=\"https:\/\/s3-us-west-2.amazonaws.com\/courses-images\/wp-content\/uploads\/sites\/5107\/2020\/08\/04211553\/Scales25.png\" alt=\"balanced scales with $25,000 on each side\" width=\"400\" height=\"397\" \/><\/p>\n<p>Assets are what the business owns. Liabilities are what it owes, and equity is the amount of the company that belongs to the business owner.<\/p>\n<\/section>\n<section class=\"textbox connectIt\" aria-label=\"Connect It\">\n<h3>Balance in a Home Loan<\/h3>\n<p>Think of the equation in terms of a house. Say the house costs $250,000 and you owe $200,000 to the bank. Your equity in the home is $50,000.<\/p>\n<p>[latex]\\text{A}=\\text{L}+\\text{OE}[\/latex]<\/p>\n<p>can also be stated as:<\/p>\n<p>[latex]\\text{A}-\\text{L}=\\text{OE}[\/latex]<\/p>\n<p>[latex]\\text{Assets}-\\text{Liabilities}=\\text{Owner's Equity}[\/latex]<\/p>\n<p>In the case of the house cited above, the equation is [latex]\\$250,000 - \\$200,000 = \\$50,000[\/latex].<\/p>\n<\/section>\n<section class=\"textbox keyTakeaway\" aria-label=\"Key Takeaway\">\n<h3>Accounting Equation<\/h3>\n<p>Commit this important accounting concept to memory: Assets = Liabilities + Owner\u2019s Equity<\/p>\n<\/section>\n<p>&nbsp;<\/p>\n<p>&nbsp;<\/p>\n<section class=\"textbox tryIt\" aria-label=\"Try It\"><iframe loading=\"lazy\" id=\"ohm25094\" class=\"resizable\" src=\"https:\/\/ohm.one.lumenlearning.com\/multiembedq.php?id=25094&theme=lumen&iframe_resize_id=ohm25094&source=tnh\" width=\"100%\" height=\"150\"><\/iframe><\/section>\n","protected":false},"author":6,"menu_order":10,"template":"","meta":{"_candela_citation":"[{\"type\":\"original\",\"description\":\"The Accounting Equation\",\"author\":\"Joseph Cooke\",\"organization\":\"Lumen Learning\",\"url\":\"\",\"project\":\"\",\"license\":\"cc-by\",\"license_terms\":\"\"}]","pb_show_title":"on","pb_short_title":"","pb_subtitle":"","pb_authors":[],"pb_section_license":""},"chapter-type":[],"contributor":[],"license":[],"part":55,"module-header":"- Select Header -","content_attributions":[{"type":"original","description":"The Accounting Equation","author":"Joseph Cooke","organization":"Lumen Learning","url":"","project":"","license":"cc-by","license_terms":""}],"internal_book_links":[],"video_content":null,"cc_video_embed_content":{"cc_scripts":"","media_targets":[]},"try_it_collection":null,"_links":{"self":[{"href":"https:\/\/content.one.lumenlearning.com\/financialaccounting\/wp-json\/pressbooks\/v2\/chapters\/65"}],"collection":[{"href":"https:\/\/content.one.lumenlearning.com\/financialaccounting\/wp-json\/pressbooks\/v2\/chapters"}],"about":[{"href":"https:\/\/content.one.lumenlearning.com\/financialaccounting\/wp-json\/wp\/v2\/types\/chapter"}],"author":[{"embeddable":true,"href":"https:\/\/content.one.lumenlearning.com\/financialaccounting\/wp-json\/wp\/v2\/users\/6"}],"version-history":[{"count":3,"href":"https:\/\/content.one.lumenlearning.com\/financialaccounting\/wp-json\/pressbooks\/v2\/chapters\/65\/revisions"}],"predecessor-version":[{"id":858,"href":"https:\/\/content.one.lumenlearning.com\/financialaccounting\/wp-json\/pressbooks\/v2\/chapters\/65\/revisions\/858"}],"part":[{"href":"https:\/\/content.one.lumenlearning.com\/financialaccounting\/wp-json\/pressbooks\/v2\/parts\/55"}],"metadata":[{"href":"https:\/\/content.one.lumenlearning.com\/financialaccounting\/wp-json\/pressbooks\/v2\/chapters\/65\/metadata\/"}],"wp:attachment":[{"href":"https:\/\/content.one.lumenlearning.com\/financialaccounting\/wp-json\/wp\/v2\/media?parent=65"}],"wp:term":[{"taxonomy":"chapter-type","embeddable":true,"href":"https:\/\/content.one.lumenlearning.com\/financialaccounting\/wp-json\/pressbooks\/v2\/chapter-type?post=65"},{"taxonomy":"contributor","embeddable":true,"href":"https:\/\/content.one.lumenlearning.com\/financialaccounting\/wp-json\/wp\/v2\/contributor?post=65"},{"taxonomy":"license","embeddable":true,"href":"https:\/\/content.one.lumenlearning.com\/financialaccounting\/wp-json\/wp\/v2\/license?post=65"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}