Golden Formula of Accounting
The "golden formula" of accounting refers to the fundamental accounting equation, also known as the balance sheet equation. This equation represents the basic structure of a company's financial position and is expressed as:
Assets = Liabilities + Equity
Here's a brief explanation of each component:
Assets: These are the economic resources owned by a business that have measurable value. Assets can include cash, accounts receivable, inventory, property, and equipment.
Liabilities: These represent the obligations or debts of a business. Liabilities can include loans, accounts payable, and other financial obligations.
Equity: Also known as net assets or shareholders' equity, this represents the residual interest in the assets of the entity after deducting liabilities. Equity is the ownership interest of the shareholders in a company.
The equation must always balance, meaning that the total value of assets must equal the total value of liabilities and equity. This principle is fundamental to double-entry bookkeeping, the system of recording financial transactions in which every transaction affects at least two accounts.
The golden formula provides a snapshot of a company's financial position at a specific point in time and is crucial for preparing financial statements such as the balance sheet.
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