Study: Accounting Equation: Computing Ending Balances
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Welcome to Introduction to Accounting Preparing for a User’s Perspective.
Accounting Equation: Computing Ending Balances
As you can see here, I have put up the accounting equation.
Assets equal liabilities plus equity.
The accounting equation, also known as the balance sheet equation
Links to an external site., shows resources a company has, and who, or what, has claim to those resources. Resources are either claimed by the lenders and creditors, who provided resources, or [they are] claimed by the owners because they are left over. You take all the assets and deduct the liabilities what’s left over belongs to the owners and that’s called net assets.
So let’s do these three problems as quickly as we can.
Question 1: Assets are $50, Liabilities are $20. What is Equity?
In this case, we have been given our assets which are $50, so let’s put in the $50 assets which have been given. We put in the $20 liabilities we’ve been given and we recognize that we don’t know our equity Links to an external site.. In order to solve this algebraically, we’re going to remove the $20 from both sides. You’ve got to keep this equation in balance so if you do one thing to one side you’ve got to do it to the other side.
So, what this effectively represents, is if you take all your assets and deduct the liabilities, you have $30 in net assets remaining which belong to the owners and that is their equity in the business. $30 is the answer as the equity of the business also known as net assets.
Slide 3: Let’s do the next problem.
Question 2: Assets are $90, Equity is $40. What are Liabilities?
In this problem, once again they have given us the assets, so let’s put down the assets. But instead of giving us the liabilities as in question 1, they’ve given us the equity. So let’s put in the equity. So they know how much belongs to the owners, so the question is “How much has been funded by lenders and creditors?”
So once again, we don’t know this [Liabilities], we’re going to solve for the unknown by deducting $40 from both sides so that liabilities can be on that side, all by itself.
That means $50. And this is now $0. So, our liabilities equal $50. Pretty easy. So, in other words, if you take all your assets and deduct what belongs to the owners, the difference must have been funded by the lenders and creditors.
Slide 4: Let’s do the next problem.
Question 3: Assets are $70, Liabilities are $10. What are Net Assets?
On this final question 3, in this case, they’ve given us the assets of $70. They’ve given us the liabilities of $10 and then they say “What are the Net Assets?” Well, if you didn’t know that net assets and equity mean the same thing, this could be confusing but you know that already because you learned that in question 1.
So, we are trying to figure out what equity is, because that is the same thing as net assets. Net assets effectively says, “Take all your assets, deduct what belongs to the creditors and what’s net left over, belongs to the owners.” So, by deducting liabilities from both sides, we get net assets on this side of $60, which means that is equal to our equity, which is the same thing as our net assets.
So, it doesn’t get any harder than this when dealing with a question on the accounting equation, so I am going to give you a few quiz questions. Have you test this idea and make sure you have it solid and then we will move on to the next level. Where what we will do is we’ll take this equity, we’ll say “Well, what are the sources of Equity?” Well, owners can either contribute equity, which is contributed capital, or the company can earn equity [for the owners] by being profitable and [the] profits belong to the owners.
So we are going to break this owners’ equity piece out into two pieces, the contributed equity, as well as the earned equity that’s been retained [by the owners] in the business. It’s either contributed or it’s internally generated and when we expand this piece, it is called the expanded accounting equation. What do we expand? We expand equity.
Hope that helps and [I wish you] good luck.