What is the Accounting Equation?
The accounting equation is a relationship between assets, liabilities, and equity. Assets are what a company owns; liabilities are what the company owes to others; equity is the difference between assets and liabilities. There are two different formulations of the accounting equation - one for sole proprietorships dealing with owner equity and one for corporations dealing with stockholder equity. The accounting equation looks like this:
Assets = Liabilities + Owner’s Equity (sole proprietorships)
Assets = Liabilities + Stockholders’ Equity (corporations)
You can already see that both formulations of the accounting equation can be translated as follows:
Assets - Liabilities = Equity (owner’s or stockholders')
This equation is used everywhere in accounting, from balance sheets to the general ledger. Because of this, the accounting equation will be the key to everything you do in accounting. Here are three easy ways to remember the accounting equation.
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A = L + O
Can you remember this? Some people work better with simplified equations or acronyms and other mnemonic devices to help remember important things. The first step in creating an acronym as a mnemonic device is to break the equation down into its initials, as I have, above. A = L+O. Next, give each letter a new name that is meaningful for you. For example, you might say “Arguments are Loud and Obnoxious.” With acronyms, there are two important things: First, you need to make sure that the words you substitute have meaning for you and two, they should be easy words to remember.
Assets to the Left Please!
If using an acronym doesn’t work for you, perhaps you’re a visually stimulated person. If you tend to remember the last place you put something by trying to visualize where it was that you placed that thing, this might be an easy way to remember the accounting equation for you. Remember that assets are always to the left of the equation. Liabilities are always in the center, and equity is always to the right. Look at the equation, close your eyes, and visualize it. The only thing that changes is when you are trying to determine the equity given the assets and liabilities, in this case, the equal symbol moves to the right, and a minus symbol demonstrates the relation between assets and liabilities.
Work Through Examples
What if you are not very visual, and your attempts to figure out a meaningful mnemonic device are thwarted by over-pronounced left-brainedness? The best way to easily remember the accounting equation is to work through examples. Like with any mathematical equation, experience will bring familiarity and confidence. Work through equations involving assets, liabilities, and equity and the relationship between these three accounting terms. You could look at public balance sheets from companies to practice, or you could perform exercises from a book like Peter J. Eisen’s Accounting the Easy Way, which has a great section on the accounting equation. Whether you choose to use a mnemonic device like an acronym or a visual memory strategy, the easiest way to remember the accounting equation is through using it over and over again in sample problems. This way, when you go to take a bookkeeping exam or create a balance sheet for your own small business, you will have the experience to back up the equation.