The Accounting Equation

Double entry accounting allows the users of the data to accurately track how the financial resources of the firm are being used. For example, think how hard it is to figure precisely how much you spend on electronic purchases over a period of time just by using your check register. Some things you paid with cash money won't show up, Some things you charged will also not show up. Double entry accounting allows you to track your money down to the penny.

In order to do this, we start with a basic rule called the accounting equation which is shown directly below.

ASSETS = LIABILITIES + OWNER'S EQUITY

What this equation means is that value of all the property under the control of the firm must equal the same value as what is owed by the firm to others and the residual net value that actually belongs to the owners of the firm.

For example: If you buy a house (an asset) for $100,000 with 20% down and an $80,000 mortgage (a liability) you will have at the time of settlement $20,000 in Owner's Equity (O/E).

$100,000 = 80,000 + (20% x 100,000)

If after a year the current market value of the house is $125,000 and you have reduced the principle through payments by $1500 then your Owner's Equity grew. Part through paying off the liability and part from the economic appreciation of the asset.

$125,000 = ($80,000-$1,500) + ?

The question mark represents the owner's equity. In this case the O/E is $46,500

Check for yourself $125,000 = (78,500 + 46,500)