A Look at the
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| Assets = Liabilities + Owner's Equity |
The formula can be restated as:
| Assets - Liabilities = Owner's Equity |
This formula applies to every transaction in financial accounting and affects each of the financial statements.
For example, if Sunny acquired a building for $100,000 for his retail store, the Balance Sheet would show:
| NonCurrent Assets: | |
| Building | $100,000 |
| Owner's Equity: | |
| Owner's Investment | $100,000 |
The Owner's Investment account represents assets purchased by the owner(s) of the business, or money put into the bank. If Sunny deposits the money into a business account setup for Sunny Sunglasses Shop to start his business, the Balance Sheet would show an asset for $100,000 in the form of cash, and $100,000 for Owner's Equity:
| Current Assets: | |
| Cash | $100,000 |
| Owner's Equity: | |
| Owner's Investment | $100,000 |
Both events have the same effect on the accounting formula:
| Assets $100,000 = Liabilities $0 + Owner's Equity $100,000 |
In the above example, cash is a Current Asset, and the building is a Noncurrent Asset. To review the difference between the two, click here to navigate to Accounting Terms.
If Sunny did not have cash to purchase a building, or simply wanted to conserve his cash for other business uses, he could take out a mortgage to fund the building. Sunny puts down $20,000 of his own money as a down payment, and takes out a mortgage for $80,000.
The balance sheet and the accounting formula would now include a liability for the mortgage as follows:
| Assets: | |
| Building | $100,000 |
| Liabilities: | |
| Mortgage Payable | $80,000 |
| Owner's Equity: | |
| Owner's Investment | $20,000 |
The effect on the accounting equation looks like this:
| Assets $100,000 = Liabilities $80,000 + Owner's Equity $20,000 |
or
| Assets $100,000 - Liabilities $80,000 = Owner's Equity $20,000 |
Book Value
The equity of a company is called Book Value, and is the first sign of a healthy or weak Balance Sheet. For publicly traded companies, Book Value is expressed on a per-share basis.Negative Book Value results when liabilities are greater than assets. Increasing Book Value is one of the key indicators of business success, since Book Value directly impacts the intrinsic value of the company, and if publicly traded, the share price.
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