The accounting equation

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Cambridge O Level Accounting 7707

The Accounting Equation

The big idea: Everything a business owns was paid for either by its owner or by someone it owes. So assets always equal liabilities plus owner’s equity, after every single transaction.

Summary — What This Chapter Covers

Assets are resources owned by the business; liabilities are amounts it owes to others.
Owner’s equity (capital) is what the business owes the owner: assets − liabilities.
The accounting equation: Assets = Liabilities + Owner’s equity. It must balance after every transaction.
Use the equation to find a missing figure and to show the effect of a transaction on each element.

1. Assets, Liabilities and Owner’s Equity

Syllabus 1.2 · Paper 1 & 2

What the business owns and owes

The business is treated as separate from its owner (the business entity principle, Topic 7), so the business can owe money to its own owner.

Term	Meaning	Examples
Assets	Resources owned by the business which have a money value	Premises, machinery, motor vehicles, inventory, trade receivables, bank, cash
Liabilities	Amounts owed by the business to people other than the owner	Trade payables, bank overdraft, bank loan, other payables (accrued expenses)
Owner’s equity (capital)	The owner’s investment in the business: the amount the business owes its owner	Capital introduced, plus profits kept, less drawings

Practice Question 1

Classify each item as an asset or a liability: (a) a delivery van; (b) money owed to a supplier for goods; (c) money owed by a customer; (d) a bank overdraft; (e) inventory of goods for resale.

2. The Equation and Missing Figures

Syllabus 1.2 · Paper 1 & 2

A = L + E, rearranged as needed

The accounting equation Assets = Liabilities + Owner’s equity
Owner’s equity = Assets − Liabilities · Liabilities = Assets − Owner’s equity

Worked Example

On 1 May 2025 a business had equipment $4,500, a motor vehicle $12,000, inventory $2,800 and money in the bank $950. It owed trade payables $3,250 and had a bank loan of $5,000. Calculate the owner’s equity.

Practice Question 2

Complete the gaps: (a) assets $48,000, liabilities $13,500, owner’s equity ? (b) assets ?, liabilities $7,200, owner’s equity $31,800 (c) assets $25,600, liabilities ?, owner’s equity $19,900

3. The Effect of Transactions

Syllabus 1.2 · Paper 1 & 2

Every transaction keeps the equation in balance

Each transaction changes at least two items, so the equation still balances afterwards. Some transactions change only assets (one up, one down), so the totals do not move.

Worked example

Show the totals of assets, liabilities and owner’s equity after each transaction.

Transaction	Assets $	Liabilities $	Owner’s equity $
Owner pays $20,000 into a business bank account	20,000	0	20,000
Buys equipment for $6,000, paying by bank	20,000	0	20,000
Buys inventory $3,000 on credit	23,000	3,000	20,000
Borrows $5,000 from the bank (loan)	28,000	8,000	20,000
Pays the supplier $1,200 by bank	26,800	6,800	20,000

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The accounting equation