Accounting Equation


Transactions that affect Liabilities and Equity of the entity

These transactions result in the increase in Liabilities which is offset by an equal decrease in Equity and vice versa.

Diagram illustrating transaction effecting both Liability and Equity of the Company

Any increase in liability will be matched by an equal decrease in equity and vice versa causing the Accounting Equation to balance after the transactions are incorporated.

Example 1

ABC LTD incurs utility expense of $500 which remains unpaid at the period end.

Before Transaction: Assets $10,000 - Liabilities $5,000 = Equity $5,000

After Transaction: Assets $10,000 - Liabilities $5,500* = Equity $4,500*

*Liability $5,500 = $5,000 Plus $500 (Accrued Liability)

*Equity $4,500 = $5,000 Less $500 (Accrued Expense)

Example 2

ABC LTD recognizes rent income for the period of $500 which it received in advance in the last accounting period.

Before Transaction: Assets $10,000 - Liabilities $5,000 = Equity $5,000

After Transaction: Assets $10,000 - Liabilities $4,500* = Equity $5,500*

*Liabilities $4,500 = $5,000 Less $500 (Accrued Income)

*Equity $5,500 = $5,000 Plus $500 (Rent Income)