Accounting Equation Example
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Details of an Accounting Equation Example
An accounting equation example is typically presented in a table format, which records numerous transactions within a business over time. These extensive documents and balance sheets include all of the capital and liability added or deducted over a particular financial period. However, more abbreviated narrative examples, like the ones below, can also serve to illuminate the process of calculating assets with the accounting equation.
Hypothetical Accounting Equation Example
A company owner invests a certain sum of money into a business, which increases company assets but decreases owner equity. The company also takes out a loan, which increases both assets and liabilities, but a year later this loan is repaid, causing assets and liabilities to simultaneously decrease. The company also purchases merchandise with cash in an even exchange that balances assets. Anytime revenue is incurred, owner equity goes up along with the assets. At the end of a certain period of time, all of these assets and liabilities are added or subtracted, respectively, to balance accounts.
Narrative Example #1
Now consider how this hypothetical scenario might apply to a specific situation. For example, say that Mark purchases a laptop for $1,000.He had to borrow $500 from his parents to purchase this computer, and used $500 from his own savings to cover the rest. As a result, Mark’s assets are worth $1000, and both his equity and liability each amount to $500.The accounting equation for this transaction would be as follows: 1000 (assets)=500 (liabilities)+500 (equity).
Narrative Example #2
As an alternate example, imagine that Maria opens her own business by gathering funds from outside investors, amounting to $40,000.Her company then starts with a liability that matches the assets, and she would hold no equity as owner ($40,000=$40,000+0).If, however, Maria is able to immediately generate revenue for her company, she can pay back the loan with the assets she gains in cash, and her liability will decrease and equity will increase. A similar balance will be calculated should Maria opt to purchase any equipment for her company with cash she generates.
Tables and Balance Sheets
Both Mark and Maria would need to keep track of all of these transactions, and record them in their respective ledgers. When transferred to balance sheets, all of the assets would be listed in the left hand column (e.g. Mark would list $1000 for the computer he purchased here), while the liabilities and equity/capital would be added in the right hand column. In Marks’s case, he would add both $500 sums to this section, thus balancing his accounts. The numbers in these accounting ledgers will always be balanced—if they are uneven, it means that something has been miscalculated.
These are some of the most basic examples of what an accounting equation might look like. These also serve as the foundation for further transaction analyses, which include considerations of retained earnings and net income. This in-depth analysis would then lead to what is termed an expanded accounting model, which further breaks down the equity involved in the formula.
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