The equation: holdings equal claims
Introduced| English | Meaning |
|---|---|
| asset/ˈæset/ | Resources owned or controlled by a person or organisation that are expected to provide value or future benefits. |
| liability/ˌlaɪəˈbɪlɪti/ | A present obligation to transfer an economic resource. |
| equity/ˈekwɪti/ | The owners' residual interest in a business's assets after liabilities are deducted. |
| income/ˈɪŋkʌm/ | Money received by a person or organisation over a period. |
| expense | Decreases in economic benefit that shrink equity. |
| accounting equation | Assets = Liabilities + Equity: holdings always equal claims. |
| double effect | Every transaction moves two elements of the equation. |
£35,000 arrives: whose money is it?
- Nimbus Bakery Ltd starts with £20,000 from its founders and a £15,000 bank loan. The company now has £35,000 in the bank.
- It also owes £35,000: £15,000 to the bank and £20,000 to the founders. Accounting records both sides of every amount, and this lesson shows why they always match.
Five elements, defined precisely
- An asset 资产 is a resource the business controls because of a past event: cash, the oven, the flour in the store. A liability 负债 is something it must hand over later: the loan, the supplier not yet paid.
- Equity 所有者权益 is what is left for the owners: assets minus liabilities. Income 收入 makes equity grow and an expense 费用 makes it shrink, so profit (income − expenses) ends up in equity.
Which element is it?
Sort each item from Nimbus's first week. An asset is controlled because of a past event, a liability must be handed over later, and equity is the owners' claim. Some things matter to the business but are not recorded at all.
The founders pay £20,000 into Nimbus for shares. That £20,000 is
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Issuing shares raises cash (an asset) and share capital (equity). Calling it income is the classic slip; funders invest, customers buy.
Nimbus's head baker has an excellent local reputation, so Nimbus records the reputation as an asset.
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An asset must be controlled and come from a past event. Nimbus did not buy or build the reputation, and it cannot control it, so it is not recorded.
One equation that never breaks
- The accounting equation 会计等式 says $\text{Assets} = \text{Liabilities} + \text{Equity}$. The left side is what the business holds; the right side is who has a claim on it.
- Every transaction has a double effect 双重影响: it changes at least two amounts, in a way that keeps the two sides equal. That is not a convention; it is the only way the equation can stay true.
Four patterns cover almost everything
- Both sides up: issuing shares (cash and equity rise) or borrowing (cash and a liability rise). A swap: buying an oven for cash changes two assets and no total.
- Buying on credit: inventory and payables both rise. A sale: cash rises, the stock used falls, and the difference (the profit) lands in equity.
Match each transaction to its double effect.
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In each case the equation stays balanced. Only the swap leaves both totals unchanged.
Nimbus sells bread for £3,000 cash. The bread used £1,200 of flour. What is the double effect?
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Cash comes in (3,000), the flour goes out (1,200), and the profit of 1,800 lands in equity. Assets rise by 1,800, exactly as much as equity.
Nimbus's first week, line by line
- Check the equation after each line. Line 3 changes no total; line 5 is the only line that changes equity through profit.
- Issue shares: cash +20,000, equity +20,000.
- Bank loan: cash +15,000, loan +15,000.
- Buy the oven for cash: equipment +6,000, cash −6,000.
- Flour on credit: inventory +4,000, payables +4,000.
- Sell bread for cash: cash +3,000, inventory −1,200, equity +1,800.
| # | Assets | Liabilities | Equity |
|---|---|---|---|
| 1 | 20,000 | 0 | 20,000 |
| 2 | 35,000 | 15,000 | 20,000 |
| 3 | 35,000 | 15,000 | 20,000 |
| 4 | 39,000 | 19,000 | 20,000 |
| 5 | 40,800 | 19,000 | 21,800 |
Using the five lines of the first week, how much cash does Nimbus hold at the end, in £?
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$20\,000 + 15\,000 - 6\,000 + 3\,000 = 32\,000$. Line 4 brings in flour on credit, so no cash moves.
One number, read two ways
- Holdings: cash £32,000 + equipment £6,000 + inventory £2,800 = £40,800. Claims: loan £15,000 + payables £4,000 = £19,000, and equity £20,000 + £1,800 = £21,800.
- The founders' stake grew from £20,000 to £21,800 in one week, and the growth is exactly the week's profit. The balance sheet is two lists of the same company.
At the end of the week, assets are £40,800 and liabilities are £19,000. Equity must be
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Equity is what is left: $40\,800 - 19\,000 = 21\,800$, which is £20,000 of share capital plus £1,800 of profit. The equation leaves no freedom.
Next Monday Nimbus pays the flour supplier £2,500 from the bank. What are total assets now, in £?
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Cash falls by 2,500 and payables fall by 2,500: $40\,800 - 2\,500 = 38\,300$. Liabilities become £16,500 and equity stays £21,800, so $16\,500 + 21\,800 = 38\,300$.
Three common slips
- The founders' £20,000 is not income. It is a capital contribution: equity, not revenue. Customers buy; funders invest.
- "Asset" does not mean "valuable". A baker's fine reputation is not yet an asset, because nothing controlled was bought or built in a past event.
- The equation cannot go wrong by itself. If the two sides differ, a transaction was posted wrongly, and that is exactly how errors are found.
Which of these change Nimbus's equity? Select all that apply.
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Profit and new share capital change the owners' claim. A cash purchase swaps one asset for another, and a loan adds an asset and a liability together.
Recap
- Five elements: asset, liability, equity, income, expense.
- $\text{Assets} = \text{Liabilities} + \text{Equity}$, after every transaction.
- Each transaction has a double effect; profit ends up in equity.