Basic Accounting Equition

The basic accounting equation is:

Assets = Liabilities + Owner's Equity

Assets are resources owned by a business.

The common characteristic possessed by all assets is the capacity to provide future services or benefits to the entities that use them. In a business enterprise, that future economic benefit eventually results in cash inflows to the enterprise.

Liabilities are creditorship claims on total assets (existing debts and/or obligation).

In the event of nonpayment, creditors may legally force the liquidation of a business. In that case, the law requires that creditors claims be paid before ownership claims. Most claims of creditors attach to total enterprise assets rather than to the specific assets provided by the creditor.

Owner's Equity is the ownership claim on total assets.

The assets of a business are suplied or claimed by either creditors or owners. To determine what belongs to owners, we therefore subtract creditors' claims (the liabilities) from assets. The remainder (owner's equity) is the owner's claim on the assets of the business.