What is the accounting equation?

The accounting equation represents the fundamental relationship between a company’s assets, liabilities, and equity. It states that the total assets owned by a business are financed either through debt (liabilities) or through the investment of the owners (equity).

This foundational principle ensures that a company remains in balance; every financial transaction affects at least two of these accounts, maintaining the equation's integrity. The equation is often stated as "Assets = Liabilities + Equity," which signifies that everything a business owns (assets) is either owed to creditors (liabilities) or invested by owners (equity).

Understanding this relationship is crucial for financial analysis and maintaining accurate financial records. Other formulations, while they may rearrange the components or present the equation in different ways, do not accurately reflect the underlying principle that assets must equal the sum of liabilities and equity.