2 Assets and Liabilities

The basis of accounting is an equation. This fundamental accounting equationAccounting Equation:
Sometimes called the Fundamental Accounting Equation and defined as Assets = Liabilities + Equity. It ensures that our accounts balance, that errors are caught, and accounts are complete. is necessary for accounting to do all the amazing things we discussed in the previous chapter. It ensures that our accounts balance, that errors are caught, and accounts are complete. Here’s the equation:

AssetsAsset:
What is owned. An asset is (1) a resource controlled by an entity (2) as a result of past events and (3) from which future economic benefits are expected to flow to the entity. = LiabilitiesLiability:
What is owed. A liability is (1) a present obligation of the entity (2) arising from past events, (3) the settlement of which is expected to result in an outflow of the entity’s resources. + EquityEquity:
The residual interest in the assets of an entity after deducting all of its liabilities. Equity = Assets – Liabilities. Shareholders own this residual interest.

Assets and liabilities are the main building blocks of accounting. We call them elements of accounting. Let’s define each element in turn and then discuss how the elements relate to each other.