Introduction
The Basic Accounting equation focuses on the equation that exists between the properties of a business(assets) and the claims on those properties(Owner's equity and Liabilities).
Let's look at these three items involved in the equation:
Assets
Assets are possessions of the business. They are things that add value to the business and will bring it benefits in some form. This can be fixed assets(long-term assets) or current assets(short-term assets). Examples include furniture, machinery, motor van, land and building, cash, debtors etc
Equity
Equity, or owner's equity, is the value of the assets that the owner owns. It is the value of the business assets that the owner can lay claim to.
Liabilities
Liabilities are basically debts. The amount of liabilities represents the value of the business assets that are owed to others. It is the value of the assets that people outside the business can lay claim to.
Basic Accounting Equation
ASSETS = LIABILITIES + OWNER'S EQUITY
Applying Mathematical conversions...
LIABILITIES = ASSETS - OWNER'S EQUITY
OWNER'S EQUITY = ASSETS - LIABILITIES
In a nutshell, the accounting equation above shows us how much of the assets are owned by the owner (equity) and how much are owed to others (liabilities). It's as simple as that.
Practical Application
In preparation of the Balance Sheet in the final accounts of a business at the end of an accounting year, assets are placed on the credit side of the balance sheet, while owner's equity and liabilities are placed on the debit side(assuming you're using the t-square method of drawing a balance sheet).
The implication here is that the addition of owner's equity and liabilities must equal the total assets. If the reverse is the case in your final answer, it means there are errors in entries made along the way, beginning from the ledger entries.
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