Intuition behind the accounting equation: Assets= Liabilities + Shareholder’s Equity

Question

Every transaction (exchange of value) has two sides: what I get, and what I give. How this thought leads us to say:

Assets = Liabilities + Shareholder's Equity

All I mean is there any intuition behind the accounting equation.

P.S. I have been thinking about this for two weeks, and finally, I decided to ask the experts themselves. How dual aspect idea leads us to formulate accounting equation?

It's not exactly sure what you're asking here, but it sounds like yours trying to understand the concept of a balance sheet? That's probably off topic as an accounting question — littleadv, Jun 30 '23 at 21:50
I'm not sure what the question is or where that equation came from. It seems like "Capital" is just being used as another term for "net equity" meaning "Assets minus Liabilities". But that's not how I would think of "capital". — D Stanley, Jun 30 '23 at 21:51
And transactions don't always involve both sides of the equation. If I spend $100 on office supplies, One asset account goes down and one goes up. Liabilities and equity are unaffected. — D Stanley, Jun 30 '23 at 21:52
It's off topic and an accounting question. I think if you get a copy of any introductory accounting book, you'll clearly see what's the relationship. A simplified (not completely realistic) example is a house (asset) you bought with 100% mortgage (liability). Net, you have no equity. If the house price increases in market value, your asset goes up. Now you have equity, provided you book your asset at fair value. — AKdemy, Jul 01 '23 at 08:06

score 4 · Accepted Answer · answered Jul 01 '23 at 12:11

So why is is assets = liabilities + owners equity?

Look at a few steps of this example.

I am a business and I borrow $100. Now I have an asset (the $100), and a liability (the $100 is owe).

so the equation is

cash + stuff  = liabilities   + equity  
$100 + $0       = $100        + $0

Now I use the assets to buy $100 worth of products to sell. I just changed the form of the assets. So the result is this:

cash + stuff  = liabilities   + equity  
$0     $100   = $100          + $0

I have a good day, and I sell everything for $250. The result is that now the equation looks like this.

cash + stuff  = liabilities   + equity
$250 + $0     = $100          + $150

I can now use the $250 to buy more stuff or pay back what I owe and then use the equity to buy more stuff. and the cycle continues.

It does get more complex when you are dealing with taxes, depreciation, selling expenses....

The equation has to be structured this way because you can't look at the pile of cash and think you are profitable.

Notice then when banks talk about assets and liabilities the amount deposited into the customer accounts are liabilities, the loans are assets. It gets confusing very fast.

@mhoran_psprep Great, great explanation. When you said, "I am a business", I had euphoria, literally. Last night, I also got to learn about the business entity concept, which means business and business owners should be considered separately. Fine, but I am struggling to view business as a separate thing from a business owner. Can you explain a little bit? I just started with accounting and am very confused. There's no accounting site in StackExchange. — Vinay Sharma, Jul 02 '23 at 07:40

Intuition behind the accounting equation: Assets= Liabilities + Shareholder’s Equity

1 Answers1