Why Equity + Liability always equal total assets

August 17, 2015


If you study balance sheet of limited company, you will find that, total shareholder equity plus total liability is always equal to total assets calculation. How it is possible ?

The answer is, shareholder’s equity is calculated by Total assets – Total liability.

Total assets is the sum of all the things that can fetch money like bank balance, shop, furniture of company etc. Company can get the money by selling its assets.

If company has taken loan, If company becomes bankrupt, all the assets of the company will be sold. If assets calculation is correct,the money received by company by selling its assets is same as predicted. Now the money received by company will be distributed between creditor ( Who given loan to company) and shareholder (owner).

The first right to claim of the money goes to creditor by law, whatever money left after paying creditor will be distributed to shareholder.

Suppose the Total asset value of company is $1000, i.e. if you sell all the things of company you may get $1000, if calculation is correct. If company is having debt of $800, creditor will get the $800 first from $1000 as per law. After paying creditor, only $200 is left to shareholder, so equity of company is $200.

So even if after selling the company total asset at $1000, ownner (shareholder) of the company will get only $200. So shareholder are more interested to know the equity of company only.

There may be chance that company will have more debt then assets, in this situation, all the ammount received by selling assets goes to creditor only (creditor will also suffer loss), no money will be received by owner. But the interesting thing is that, credit will not cover the loss by asking money from owner (shareholder ) of limited company as per law.

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