Assets = Equity + Liabilities
The accounting equation is the basis of all the accounting. This equation says Assets equal Equity plus Liabilities. In other words, What I have is equal to what I owe plus what I own.
One of the financial statements – a Balance Sheet – is prepared based on this principle. The reason for calling it balance sheet is that always the left-hand side equals the right-hand side – they are balanced.
It is actually simple logic. Whatever you want to buy (What I have), either you can use your own money (What I own) or you can take a loan to buy it (What I owe).
Let’s take an example of a food processing company buying the spray drying machine worth $10,000 for its operations. The bank has sanctioned the loan of $5,000 to the company for buying this machine. Another $5000, is invested by the owner of the company. Now how does this particular transaction reflect in the company’s balance sheet based on the accounting equation?
Depending on the size and nature of the business, many such transactions will happen on a daily basis and will be recorded.