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I have been using quickbooks for some time (less than a year) and today when I was looking at my balance sheet I noticed something that seems really strange to me.

My Total Assets number is $300,000. My total liabilities are $20,000. I then have the equity section which I don't claim to understand at all. It has retained earnings ($250,000), Net Income ($30,000) and total Equity which is $280,000. Then there is the Liabilities and Equity that is $30,000.

What I can't figure out is that I would expect the very bottom figure to be $280,000 (assets - liabilities) but instead it is the same as my assets total!

Can anyone explain to me what is going on?

all numbers given are examples only, not actual figures.

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It's very simple. A traditional balance sheet has two columns which have to balance. The left side, usually marked ASSETS, has to equal the right column, traditionally marked LIABILITIES.

Both columns have to be equal, under all conditions, no matter what.

This confuses people. They say, "oh gosh, I have 20,000 in debt (liabilities) and 300,000 in the bank (assets), so how can assets equal liabilities?"

So to solve this problem, accountants put another number on the right hand side, called EQUITY. It's a made up number... you derive it by taking ASSETS-LIABILITIES.

Thus, ASSETS = LIABILITIES + EQUITY.

And if anyone ever asks what EQUITY means, there are two possible explanations:

  1. What is Equity? It doesn't matter. It's just a made up number that you put in so that the bottom number in the ASSETS column is exactly equal to the bottom number in the LIABILITIES column, because we like to balance the balance sheet.

  2. No, really. What is Equity? It's the amount that the owner of the company owns, by virtue of owning a company with more assets than liabilities.

Now, let's look at your figures.

You said that $300,000 is your total assets. We got that by adding up the value of everything your company owns. Easy.

You said that $20,000 are your liabilities. We got that by adding up the value of everything that your company owes. Also easy.

But! If we only had $20,000 of liabilities, then the balance sheet isn't in balance! Danger Will Robinson!

So we made up a number called Owner's Equity to include in the right hand column, and we made it $280,000, because that makes the whole thing balance, and there are two interpretations of this:

  1. It's an imaginary number there to make the two columns add up, or

  2. It's the "book value" of the company -- the amount that YOUR OWNERSHIP in the company is worth based on the books.

One last thing

QuickBooks does something tricky: they split up the Owner's Equity into two pieces.

  • Net Income ($30,000) is this year's profit, so far. It's the amount that Owner's Equity went up this year.

  • Retained Earnings ($250,000) is all previous year's profit that has never been paid out to the owners as a dividend. It's the amount that Owner's Equity went up before this year minus any money which was taken out as a dividend, which is no longer in the company and no longer on the balance sheet. It's also the owners equity minus this year's profit.

QuickBooks is doing this so you can quickly see this year's profit from the balance sheet, but it's not the most common thing in the world outside of the QuickBooks universe.

  • I believe the equation is EQUITY = ASSETS - LIABILITIES which solves to ASSETS = EQUITY + LIABILITIES which you describe later in your post. There is some guesswork involved in this - particularly on the asset side. Are they valued at the market rate (mark-to-market) or some other method? – Muro Nov 23 '10 at 13:23
  • Thanks Muro, you're absolutely right about the equation; I rewrote my explanation. In QuickBooks there's no guesswork on Assets... QuickBooks takes you at your word when you value an asset. How you should value an asset that is not easily valued is your problem. – Joel Spolsky Nov 23 '10 at 14:35
  • Thanks for the refresher. The thing that actually answered my question was the "one last thing" I have at least a basic understanding of the accounting formula, but it was QuickBook's Net Income/retained earnings deal that had me confused. – Icode4food Nov 23 '10 at 17:59

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