The accounting equation, also known as the balance sheet equation, is a fundamental concept in accounting that represents the relationship between a company’s assets, liabilities, and equity. It is expressed as:

Assets = Liabilities + Equity

Here’s a breakdown of each component:

1. Assets: Assets are resources owned or controlled by the business that have economic value and are expected to provide future benefits. Examples of assets include cash, accounts receivable, inventory, property, plant, and equipment.
2. Liabilities: Liabilities are obligations or debts that the business owes to external parties. These obligations arise from past transactions and must be settled in the future by transferring assets, providing goods or services, or other actions. Examples of liabilities include accounts payable, loans payable, and bonds payable.
3. Equity: Equity, also referred to as owner’s equity, shareholders’ equity, or net assets, represents the residual interest in the assets of the business after deducting its liabilities. It reflects the ownership interest of the company’s shareholders. Equity can be further broken down into contributed capital (such as common stock) and retained earnings (accumulated profits or losses retained in the business).

The accounting equation must always remain in balance, meaning that the total value of assets must equal the total value of liabilities and equity. This principle is based on the concept of double-entry bookkeeping, where every transaction affects at least two accounts and maintains the equality of the accounting equation.

The accounting equation serves as the foundation for preparing financial statements, particularly the balance sheet, which provides a snapshot of a company’s financial position at a specific point in time by listing its assets, liabilities, and equity. It is a fundamental tool for analyzing the financial health and performance of a business.