Accounting identity

In accounting, finance and economics, an accounting identity is an equality that must be true regardless of the value of its variables, or a statement that by definition (or construction) must be true. Where an accounting identity applies, any deviation from numerical equality signifies an error in formulation, calculation or measurement.

The term accounting identity may be used to distinguish between propositions that are theories (which may or may not be true, or relationships that may or may not always hold) and statements that are by definition true. Despite the fact that the statements are by definition true, the underlying figures as measured or estimated may not add up due to measurement error, particularly for certain identities in macroeconomics.

The most basic identity in accounting is that the balance sheet must balance, that is, that assets must equal the sum of liabilities (debts) and equity (the value of the firm to the owner). In its most common formulation it is known as the accounting equation:

where debt includes non-financial liabilities. Balance sheets are commonly presented as two parallel columns, each summing to the same total, with the assets on the left, and liabilities and owners' equity on the right. The parallel columns of Assets and Equities are, in effect, two views of the same set of business facts.

The balance of the balance sheet reflects the conventions of double-entry bookkeeping, by which business transactions are recorded. In double-entry bookkeeping, every transaction is recorded by paired entries, and typically a transaction will result in two or more pairs of entries. The sale of product, for example, would record both a receipt of cash (or the creation of a trade receivable in the case of an extension of credit to the buyer) and a reduction in the inventory of goods for sale; the receipt of cash or a trade receivable is an addition to revenue, and the reduction in goods inventory is an addition to expense (an "expense" is the "expending" of an asset, in this case, the inventory). Thus, there are two pairs of entries: an addition to revenue balanced by an addition to cash; a subtraction from inventory balanced by an addition to expense. The cash and inventory accounts are asset accounts; the revenue and expense accounts will close at the end of the accounting period to affect equity.

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