The two basic elements of a business are what it owns and what it owes.
Assets are the resources a business owns. For example, Google has total as-
sets of approximately $18.4 billion. Liabilities and owner’s equity are the
rights or claims against these resources. Thus, Google has $18.4 billion of
claims against its $18.4 billion of assets. Claims of those to whom the company owes money (creditors) are called liabilities. Claims of owners are called owner’s equity. Google has liabilities of $1.4 billion and owners’ equity of $17 billion.
We can express the relationship of assets, liabilities, and owner’s equity as an equation, as shown in Illustration 1-5 (page 12).
STUDY OBJECTIVE 6
State the accounting equation, and define its components.
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12 Chapter 1 Accounting in Action
Illustration 1-5
The basic accounting equation
Assets = Liabilities + Owner’s Equity
This relationship is the basic accounting equation. Assets must equal the sum of liabilities and owner’s equity. Liabilities appear before owner’s equity in the basic accounting equation because they are paid first if a business is liquidated.
The accounting equation applies to all economic entities regardless of size, nature of business, or form of business organization. It applies to a small propri- etorship such as a corner grocery store as well as to a giant corporation such as PepsiCo. The equation provides the underlying framework for recording and sum- marizing economic events.
Let’s look in more detail at the categories in the basic accounting equation.