Accounting Equation

The accounting cycle is built around a very simple concept called the basic accounting equation. The equation states:

Assets = Liabilities + Stockholders’ (or Owner’s) Equity

An asset is something the company owns — cash, buildings, equipment, and so forth. A liability is a debt the company owes to someone else. The stockholders' equity, or owner's equity for a non-corporation, is the difference between what the company owns and what it owes. Another term for this equity is net assets."

Steps of the accounting cycle

1st Step

The first step in the accounting cycle:

Analyze each transaction when it happens.

First, you look at the beginning account balance for each account. Then, you look at the transactions that have taken place during the past period. What did the business spend money on? What accounts are affected by these transactions? Are these transactions related to assets, liabilities, or stockholders’ (owner’s) equity?

Journal Entry

Remember that an asset is anything your company owns, including cash. Even if the building your company owns has a mortgage on it, the building itself is still considered to be an asset. A liability is anything your company owes to someone outside of the business owner. Stockholders’ or owners’ equity is the same thing as net worth. It’s the difference between what the company owes and what it owns.

Once you answer these questions for any given entry, you’ll make a journal entry

Do each of these transactions increase or decrease the business's assets and equity?

Three days after opening, The Green Team receives its first big landscaping job. The project, landscaping for a local apartment complex's clubhouse and courtyard, pays $9,000. It takes Mr. Sanders and his crew 22 hours to complete. He hires two foremen and four laborers for the job. The total cost of this labor was $2,068. The Green Team spends $1,530 on bushes, flowers, and mulch for the job.

Did you make money or lose money?

The $9,000 received for the job increased cash (asset) and revenue (equity) by $9,000:

Cash ($9,000) = Liabilities ($0) + Equity ($9,000)

When the workers were paid, cash (asset) was decreased by the amount of their pay, which was $2,068, as well as equity:

Cash ($-2,068) = Liabilities ($0) + Equity ($-2,068)

The $1,530 spent on bushes, flowers, and mulch is an expense, which decreases equity, and also decreases cash (asset) by that amount:

Cash ($-1,530) = Liabilities ($0) + Equity ($-1,530)