Accounting equation
The accounting equation, Assets = Liabilities + Equity, is the rule that keeps your books balanced.
Published Friday 24 July 2026
Table of contents
Key takeaways
- The accounting equation states that assets equal liabilities plus equity, and it must always balance.
- It sits behind double-entry bookkeeping, where every transaction touches at least two accounts so the books stay balanced.
- The expanded version brings in income, expenses and owner drawings to show how equity moves over time.
- The same equation forms the structure of your balance sheet and offers a quick read on whether your business is solvent.
What is the accounting equation?
Before you dig into your reports, it helps to know the one rule that holds them together. The accounting equation is the foundation of all your bookkeeping.
The accounting equation is: Assets = Liabilities + Equity. It shows that everything your business owns is funded either by money you owe to others or by money the owners have put in and kept in the business.
The parts of the accounting equation
The equation has three parts, and each one describes a different side of your finances. Here's what each part covers.
- Assets: what your business owns, such as cash, stock, equipment and money customers owe you
- Liabilities: what your business owes, such as loans, unpaid bills and tax due
- Equity: what's left for the owners once you subtract liabilities from assets
How the accounting equation and double-entry bookkeeping work together
The accounting equation is the reason your books balance, and it works hand in hand with a method called double-entry bookkeeping. This is worth understanding because it's how most accounting software records your transactions.
With double-entry bookkeeping, every transaction affects at least two accounts. When you buy equipment with cash, one asset goes up and another goes down, so the two sides of the equation stay equal.
If you take out a loan, your cash rises and your liabilities rise by the same amount. Because each entry has an equal and opposite effect, the accounting equation always balances.
The expanded accounting equation
The basic equation shows a snapshot in time, but your equity changes as you trade. The expanded accounting equation breaks equity down so you can see what drives those changes.
The expanded version reads: Assets = Liabilities + Equity + Income − Expenses − Owner drawings. Income and owner contributions push equity up, while expenses and owner drawings pull it down.
This view is useful when you want to understand your profit rather than just your position. To go deeper on the equity side, read about owner's equity.
Accounting equation example
A worked example makes the equation easier to picture. Say you add up everything a small business owns and everything it owes.
The assets come to R75,000: R15,000 in equipment, R16,000 in inventory, R20,000 in cash and R24,000 owed by customers. The liabilities come to R50,000: R37,000 in loans, R7,000 in taxes and R6,000 in unpaid bills.
To find equity, you rearrange the equation to Assets − Liabilities = Equity. So R75,000 minus R50,000 leaves R25,000 in equity for the owners.
The accounting equation and the balance sheet
The accounting equation isn't just theory, it's the structure of a report you'll use often. Your balance sheet, also called the statement of financial position, is the equation laid out in full.
A balance sheet lists your assets on one side and your liabilities and equity on the other, and the two sides always match. That's the accounting equation at work.
You can check the figures behind it with a trial balance, which confirms that your debits and credits agree before you finalise the report.
Solvency and the accounting equation
The equation also gives you a quick health check on your business. When you rearrange it to Assets − Liabilities = Equity, the result tells you where you stand.
If your assets are worth more than your liabilities, your equity is positive and your business is solvent. If your liabilities outgrow your assets, equity turns negative, which can be a sign of insolvency.
Keeping an eye on this balance helps you spot trouble early and take action while you still have options.
Simplify your small business accounting with Xero
When your bookkeeping runs on double-entry behind the scenes, your accounting equation stays balanced without the manual maths. That frees you up to focus on running your business rather than checking your figures line by line.
Xero keeps your assets, liabilities and equity up to date in real time, so your balance sheet is ready whenever you need it. See how it fits your business and get one month free.
FAQs on the accounting equation
Here are answers to some frequently asked questions about the accounting equation to clear up the finer points.
Is the accounting equation the same as the balance sheet equation?
Yes, they describe the same relationship between assets, liabilities and equity. The balance sheet simply presents that equation as a formal report.
Why must the accounting equation always balance?
Every transaction is recorded in at least two places under double-entry bookkeeping, with equal and opposite effects. That built-in check keeps the two sides of the equation equal.
What is the expanded accounting equation?
It adds income, expenses and owner drawings to the equity side of the basic equation. This shows how trading activity and owner decisions change equity over time.
Can equity be negative?
Yes, equity turns negative when your liabilities are greater than your assets. This can point to insolvency and is worth acting on quickly.
Related terms
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Disclaimer
This glossary is for small business owners. The definitions are written with their requirements in mind. More detailed definitions can be found in accounting textbooks or from an accounting professional. Xero does not provide accounting, tax, business or legal advice.