Accounting Equation

Accounting equation shows that the total assets should be equal to the total liabilities and stockholders’ equity.
The left side of accounting equation represents the resources of an entity.
The right side of accounting equation shows who has claims to the resources.
[Equation 1] Assets = Liabilities + Equity
As an extension to the basic accounting equation, revenues and expenses can be added. Revenues increase the owners’ equity and expenses decrease the owners’ equity.
[Equation 2]  Assets = Liabilities + Equity + Revenues – Expenses
By adding expenses to both sides, the equation 2 can be rearranged to the equation 3 as follows:
[Equation 3]  Assets + Expenses = Liabilities + Equity + Revenues
The equation 2 shows that assets and expenses are on the left side of the equation. Liabilities, equity and revenues are on the right side of the equation.

Review Questions

1. Entity A had the following balances of assets and liabilities at December 31, 20×1.
Asset = $100,000
Liabilities = $60,000
What is the amount of stockholders’ equity at December 31, 20×1?
 Assets = Liabilities + Stockholders’ Equity
$100,000 = $60,000 + Stockholders’ Equity
Stockholders’ Equity = $100,000 – $60,000 = $40,000

2. Entity B had the following balances of assets and stockholders’ equity at December 31, 20×1.
Asset = $200,000
Stockholders’ Equity = $120,000
What is the amount of stockholders’ equity at December 31, 20×1?
 Assets = Liabilities + Stockholders’ Equity
$200,000 = Liabilities + $120,000
Liabilities = $200,000 – $120,000 = $80,000

3. Entity C had the following balances at January 1, 20×1.
Assets = $140,000
Liabilities = $50,000
Stockholders’ Equity = $90,000

At December 31, 20×1, the balances changed to the following amounts.
Assets = $190,000
Liabilities = $70,000
Stockholders’ Equity = to be determined

The only transactions that affected stockholders’ equity during 20×1 were revenues and expenses.
If Entity C recorded $110,000 revenues, what is the amount of expenses during 20×1?

 At January 1, 20×1
Assets = Liabilities + Stockholders’ Equity
$140,000 = $50,000 + $90,000

 At December 31, 20×1
Assets = Liabilities + Stockholders’ Equity
$190,000 = $70,000 + Stockholders’ Equity
Stockholders’ equity at December 31, 20×1 = $190,000 – $70,000 = $120,000

 During 20×1, stockholders’ equity increased $30,000 from $90,000 to $120,000.
Because revenues and expenses are the only transactions that affected stockholders’ equity during 20×1, $30,000 represents net income.
Net income = Revenues – Expenses
$30,000 = $110,000 – Expenses
Expenses = $110,000 – $30,000 = $80,000

 

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