The Accounting Equation

The accounting equation must always balance because every business transaction affects two or more accounts. It involves at least a double entry which means that the right side must always be equal to the left side (Accounting Equation , n.d). A transaction will be recorded in at least two different accounts.

Owner’s equity is decreased by withdrawals where the owner withdraws funds directly from the equity account. Withdrawals reduce cash asset account and equity balance. Increasing a company’s assets without a corresponding expense leads to an increase in business equity. Similarly, decreasing an asset by making a payment say an advertising campaign payment, then the cash account is reduced that in turn reduces the equity balance. An increase in liabilities reduces the equity of a business since a payment has been made (Kimball, n.d). Net income increases owner’s capital in return increases owner’s equity while net loss decreases owner’s capital that decreases owner’s equity. Net loss means that more money was given out than what was received. This means that extra money was obtained from the company’s retained earnings decreasing owner’s equity (Merritt, n.d).

Example

A business owes $40,000 and investors have invested $120,000 by buying the company’s stock. The assets the business owns will be calculated using the equation;

Assets = liabilities + owner’s equity

= $40,000 + $120,000

= $160,000

References Accounting Equation. (n.d). Retrieved from Accounting Coach: https://www.accountingcoach.com/accounting-equation/explanation Kimball, T. (n.d). Types of Transactions That Affect the Equity of the Company. Retrieved from Chron: http://smallbusiness.chron.com/types-transactions-affect-equity-company-41730.html Merritt, C. (n.d). Net Income’s Effects on Stockholders’ Equity. Retrieved from Chron: http://smallbusiness.chron.com/net-incomes-effects-stockholders-equity-60092.html