The Basic Accounting Equation (eBook excerpt chapter 2.02)

A free sample from chapter 2 Accounting Fundamentals of our Landlord Accounting in QuickBooks guide. Section 2.02 The Basic Accounting Equation.

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There is one equation that always holds true in Accounting: Assets = Liabilities + Equity. Assets, Liabilities, and Equity are the three most fundamental types of accounts. If the Assets side of the equation increases, then the Liability + Equity side also must increase by the same amount. Many sub-accounts exist within these three types of accounts (like cash or that mortgage you keep paying).

Assets are things that your company owns which have intrinsic monetary value. These include houses, cash, prepaid insurance, power tools, land and accounts receivable (money people or companies will pay you in the future). Put more formally, an asset is anything owned which can produce future economic benefit, whether in possession or by right to take possession, the measurement of which can be expressed in monetary terms. Assets are listed on the balance sheet. It increases with a debit.

Liabilities involve owing something to someone or something. These include loans on property, security deposits you are holding and will likely return eventually; a tenant’s prepaid rent; or accounts payable (money you will have to soon pay to suppliers, vendors, etc.) It is said, “assets put cash in your pocket, and liabilities take cash out of your pocket.” Liabilities are classified as current (expected to be liquidated within a year) and non-current (expected to be paid off in over one year).

Equity is the leftovers of all assets minus the claims on them (liabilities.) Equity includes the money owners have invested in a company (contributed capital) as well as money the company earned and has kept (retained earnings). A real estate example: owner’s equity in a property is the difference between the market price of a property and the owner’s mortgage debt.

Accounting Equation is: Assets = Liabilities + Equity. For every transaction, the equation must balance.
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