The Accounting Equation

Exam code: 7707

Written by: Ashika|Reviewed by: Caroline Carroll|Updated 2 July 2026

The accounting equation

What is the formula for the accounting equation?

The formula for the accounting equation is: Assets = Liabilities + Capital
The equation states that the assets of a business are always equal to the liabilities and capital of the business
You can rearrange the equation so that you can find one of the three values if the other two are known
- Liabilities = Assets - Capital
- Capital = Assets - Liabilities

The accounting equation: Assets equal liabilities plus capital — The accounting equation

Why is the accounting equation important?

The accounting equation may be shown in the form of a statement of financial position
The statement of financial position will be affected every time the business makes changes to the assets, liabilities and capital
Every single transaction will result in at least two changes which balance out
- Both sides of the equation could increase by the same amount
- Both sides of the equation could decrease by the same amount
- Both sides of the equation could stay the same

Case study

Hannah is the owner of a business. Some of her transactions are listed below. After each transaction, the accounting equation still balances.

Transaction	Effects on assets	Effects on liabilities or capital
A credit customer, Peter, pays the amount owed to Hannah by cheque for $1 120	Assets increase by $1 120 because the money in the bank increases Assets decrease by $1 120 because the amount owed by Peter decreases Overall no change to assets	No change in liabilities or capital
Hannah pays the amount owed to a credit supplier, Rizwan, by cheque for $4 200	Assets decrease by $4 200 because the money in the bank decreases	Liabilities decrease by $4 200 because the amount owed to Rizwan decreases
Hannah buys additional fixtures and fittings for $5 500 on credit from FixFit Ltd	Assets increase by $5 500 because the value of Hannah's assets increases	Liabilities increase by $5 500 because the amount owed to FixFit Ltd increases
Hannah takes goods worth $500 from the business for personal use	Assets decrease by $500 because the amount of inventory decreases	Capital decreases by $500 because Hannah takes drawings from the business
Hannah transfers $1 000 from her personal bank account into the business bank account	Assets increase by $1 000 because the money in the bank increases	Capital increases by $1 000 because Hannah invests $1 000 into the business
Hannah makes $20 profit by selling goods which cost $30 for $50 cash	Assets increase by $50 because the amount of cash increases Assets decrease by $30 because the amount of inventory decreases Overall assets increase by $20	Capital increases by $20 because a profit has been made

	$
Premises	8 500
Equipment	7 000
Inventory	1 000
Trade receivables	5 000
Trade payables	4 500
Bank overdraft	1 200

	$
Premises	8 500
Equipment	7 000
Inventory	1 000
Trade receivables	5 000
Total assets	21 500

	$
Trade payables	4 500
Bank overdraft	1 200
Total liabilities	5 700

	Effect on assets	Effect on liabilities
A	Reduce bank	Reduce trade payables
B	Increase bank	Increase trade payables
C	Reduce trade payables	Reduce bank
D	Increase trade payables	Increase bank

The accounting equation

The accounting equation

What is the formula for the accounting equation?

Why is the accounting equation important?

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