An asset is something that is owned. A liability is something owed. Equity is the difference between the two.
Think of things you own. A car, a bank account, a house, a pen or pencil… they are all assets. An asset is usually something of value. This doesn’t mean an asset has great value, just that is has a value. A pen might be worth $1 while a building might be worth $100,000. There is a big difference in their values but they still are both assets.
Assets are generally recorded on your balance sheet or in your accounting records at cost, meaning the price you paid for them.
The market value of your assets might change over time. Except in special accounting circumstances, the recorded cost of your assets on your balance sheet generally won’t change as their market value goes up or down. However, some assets can decrease in their recorded value as they are used in a business to produce income. For example, if you buy a machine for $50,000 and you expect it to last for five years, you would decrease or “write-off” the cost of the machine by $10,000 as you use it in your business. This is called depreciation.
Think of things you owe. A car loan, your electric bill, a mortgage… these are all liabilities. Liabilities will change in value as you either make payments on them or borrow more money.
For companies, other items such as payroll that needs to be paid to employees but the pay date has not yet arrived and accrued expenses are also liabilities.
Equity can be a complex and confusing concept. The easiest way to describe equity is the difference between ones assets and their liabilities – or, what is left over for the owner.
Equity can be good – meaning that you own more than you owe or, it can be bad – meaning that you owe more than you own.
Think of a house. If a house is worth $100,000 and there is a mortgage of $25,000 on it, one would say there is positive equity of $75,000. However, if that same house worth $100,000 had a mortgage of $125,000 on it, there would be negative equity of $25,000 – some would call this the house being “under water”.
Equity is much more complicated that this and takes into account the earnings of a company over time as well as money that an owner puts in and take out of a company; however, the house example give you a good basic idea of the concept of equity being the difference between what you own and what you owe.