Accounting Dictionary

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Basic Accounting Formula

Definition: The basic accounting formula is as follows:

Assets = Liabilities + Shareholders' Equity

The three components of the basic accounting formula are:

• Assets. These are the tangible and intangible assets of a business, such as cash, accounts receivable, inventory, and fixed assets.
• Liabilities. These are the obligations of a business to pay its creditors, such as for accounts payable, accrued wages, and loans.
• Shareholders' equity. This is funds obtained from investors, as well as accumulated profits that have not been distributed to the investors.

In essence, a business uses liabilities and shareholders' equity to obtain sufficient funding for the assets its needs to operate.

The basic accounting formula must balance at all times. If not, then a journal entry was entered incorrectly, and must be corrected before financial statements can be issued. This balancing requirement is most easily seen in the balance sheet (also known as the statement of financial position), where the total of all assets must equal the combination of all liabilities and all shareholders' equity.

The basic accounting formula is one of the fundamental underpinnings of accounting, since it forms the basis for the recordation of all accounting transactions.

The following table shows how a number of typical accounting transactions are recorded within the framework of the accounting equation: