# Accounting Equation Example – Explanation with different Transaction

The accounting equation is the base of the “Double Entry Book Keeping System.” The definition of accounting equation with the principle of “equality” duly finds its effect on the balance sheet with the “Asset Side” being a sum total of “Liabilities and Shareholder’s Equity. This is a clear indication of the “two-fold effect” as in the double-entry system stating that “For every debit, there is an equal amount of credit.” The accounting equation is the primary concept for preparing all financial statements based on journal entries.

The accounting equation formula is expressed in the algebraic form as:

A – L = C
Or
A – L = S

Where,

A = Assets of the Entity (What the business owns)

L = Liabilities of the entity (Outsider’s Claims, i.e., what the business owes to outsiders)

C or S = Capital of the Entity (Owner’s/Shareholder’s Claims, i.e., Capital + Net Profit/Loss – Dividends)

The accounting equation indicates that the total assets of the business are being financed from either borrowed money (liabilities) or from owner’s funds/shareholder’s money (Capital + Retained Earnings), or by reduction of existing assets.

This basic accounting equation can also be expressed as:

Liabilities = Assets – Shareholder Equity
And
Shareholder Equity = Assets – Liabilities

## Accounting Equation Example

The accounting equation shows that “Asset” can be purchased from “assets” or from “Liabilities,” i.e., outside borrowing or from “Owner’s Equity / Shareholder’s Equity,” i.e., For purchasing a machine of \$3000, one can use cash (Asset) or buy it from borrowing the money from someone (Liability) or from owner’s funds (Capital/Shareholder’s Equity).

Similarly, to pay a liability of \$2000, one can use some other debt (Liability) or can, use some Asset (Cash or Stock), or pay it off from retained profits (Owner’s Equity).

The below table would help in explaining the basic accounting equation clearly:

The above examples highlight that the accounting equation holds and remains true for every transaction. Here, we have used the plus sign for indication addition and the minus sign for showing the reduction; however, in the double-entry system of book-keeping, the reduction and increase are shown by recording debits and credits.