The Accounting Equation is the underlying concept for double entry accounting. It shows the relationship between a company’s assets, liabilities, and owners’ equity:
Assets = Liabilities + Equity
The accounting equation ensures that the balance sheet remains “balanced,” and each entry made on the debit side should have a corresponding entry on the credit side. This is extremely important: if your assets don’t equal your liabilities + equity, then something is wrong with your figures!
Definitions of terms:
Assets are the resources a company owns; things like cash, inventory/supplies, equipment, and real estate/land, but also items such as accounts receivable (which is money that others owe the company, because the company provided goods/services on credit), prepaid insurance (and other accounts of that nature, because the company already paid for it), and intangible items (such as patents, copyrights, 'goodwill', brand recognition, etc.)
Liabilities are debts the company owes (these are usually all the accounts ending in ‘payable,’ e.g. notes payable, accounts payable, salaries/wages payable, interest payable, etc.)
Equity (also called owners’ equity, owners’ capital, shareholders’ equity, stockholders' equity, etc.—people like to call it a lot of different names and it gets confusing) is the difference between all the assets and all the liabilities; basically, it’s everything the company owners would have left if they sold off every asset and paid every outstanding debt
