Accounting: Assets, Liabilities, and Equity

Accounting: Assets, Liabilities, and Equity

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There are three main account categories: assets, liabilities, and equity.

  • Assets: things the business owns and that it expects to use in the future (examples include Cash, Accounts Receivable, Land, and Office Supplies)

  • Liabilities: things the business owes to its creditors (examples include Accounts Payable, Notes Payable, Utilities Payable)

  • Equity: the claims of the owners (or shareholders) to the assets of a business. Equity has a number of components, which will be explained in more detail below.

The relationship between the three main types of accounts is expressed by the fundamental accounting equation: Assets = Liabilities + Equity. In other words, the value of the business’ assets will be equal to the claims of the business’ creditors and owners. The accounting equation can be rearranged to solve for equity or liabilities:

  • Equity = Assets - Liabilities

  • Liabilities = Assets - Equity

Equity can be a tricky concept for beginning accounting students. It has two primary parts. To begin with, all of the money owners put into a business is referred to as contributed capital. Owners may make a direct contribution, or they may pay money into the business in exchange for stock.

The second main component of equity is retained earnings, which will not be redistributed to shareholders. Retained earnings are increased by revenues, the money the business earns by providing goods or services. Some common revenue accounts are Service Revenue and Sales Revenue. (Note that Unearned Revenue is a liability account, since it represents goods or work that are owed to customers). Retained earnings are decreased by expenses, the amounts the business spends during its operations, and by dividends, the money paid out to shareholders. Dividends are not always paid out in cash, and indeed may not be paid out at all.

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