The Accounting Formula – The Foundation of Everything

In Article 1 of the Accounting Series, we introduced accounting as a system for understanding how money, resources, and obligations flow through the university. Now it’s time to explore the foundation of all accounting, the accounting formula. 

If you’ve never studied accounting, it can sound intimidating, full of numbers, rules, and complicated reports. But at its heart, accounting is built on one quite simple idea, called the accounting formula (also known as the accounting equation). 

Once you understand this formula, you understand the foundation of all accounting. Just like knowing a recipe is the first step in making a great meal.

In the world of private business, the familiar accounting equation is Assets = Liabilities + Owner’s Equity, where Owner’s Equity represents the owners’ residual claim on the organization’s resources after debts are paid. Public universities operate differently because they do not have owners or shareholders. Instead, their resources are held and managed on behalf of the public and are often restricted for specific purposes such as instruction, research, or student services. For that reason, governmental and public-sector accounting replaces Owner’s Equity with Fund Balance, creating the equation:

Assets = Liabilities + Fund Balance

Fund Balance represents the net resources available within specific funds after liabilities are satisfied, reflecting how much remains to support the institution’s mission rather than to provide a return to owners. This shift in terminology helps align the accounting formula with the stewardship and accountability focus of public universities. 

At its core, this formula shows that everything a university owns (assets) comes from obligations (liabilities) or net resources (fund balance). So, what does this mean in practice for a university’s financial health? Think of it as a recipe for managing resources; assets, liabilities, and fund balance are all essential ingredients that must work together to create financial stability.

What the Formula Means in a Public University 

Think of the accounting formula as the recipe for running a university’s finances. Just as a recipe tells a chef what ingredients they have and how they are balanced, the accounting formula shows how resources are sourced and used. Here’s how it breaks down:

• Assets: These are the university’s "ingredients," the resources it controls and can use, like cash, buildings, or equipment. In a kitchen, it’s like a stockpile of ingredients you have ready for your next dish. The more ingredients you have, the more you can cook (or the more the university can achieve its mission).
• Liabilities: What the university owes to others. For instance, accounts payable (what the university owes to suppliers) or deferred revenue (money collected but not yet earned, like tuition payments that cover future semesters). 
• Fund Balance: Fund balance is the difference between assets and liabilities, organized by purpose or restrictions. In a public university, fund balance represents the net resources remaining after liabilities have been paid within a particular fund. Think of this as the leftover ingredients you can freely use after all debts have been paid off. To help understand these resources, we break them down by level of restriction and whether the resources can be spent. 

Breaking Down the Formula 

Let’s take a closer look at what each of these "ingredients" in the formula represents for the university.

Assets (The Ingredients)

Assets answer the question, “What does the university have to achieve its mission?” Think of this as your kitchen pantry and where you keep everything you need to cook a delicious meal. Examples include:

• Cash: Tuition collected from students, state appropriations, or grants and contracts - cash gives you the ability to purchase ingredients
• Accounts Receivable: Tuition billed but not yet paid, or external grants receivable where work has been completed, the sponsor has been billed and has yet to pay. Think of this as an IOU from a supplier promising to deliver your ingredients at a future date
• Buildings and Equipment: Land, buildings, laboratories, and equipment. These are the big-ticket items in your kitchen like stoves, refrigerators, ovens, etc. 
• Investments or Endowments: Funds invested in scholarships, capital projects, or programs (purposes vary by university). Imagine you have a special collection of rare ingredients that you plan to use for a big future event, but you’re letting them grow in value (like aging wine) before using them

Liabilities 

Liabilities show claims on university resources by external parties as well as deferred revenues. Examples include: 

• Accounts Payable: Money owed to vendors for supplies and services, travel, or maintenance 
• Deferred Revenue: Tuition or grant money received but not yet earned. Think of this as when a customer pays you in advance for a future event or meal that hasn’t happened yet. Until the event occurs, you owe them the service, just like the university owes something for the tuition it collects
• Long-Term Debt: Debt issued for construction of a new building or a major renovation of an existing building, money you have borrowed from a bank
• Payroll and Benefits Payable: Salaries owed to faculty and staff or taxes withheld and payable to federal, state, or local taxing authorities

Fund Balance (Net Resources) – The Leftover Ingredients

Fund balance is the difference between assets and liabilities, organized by purpose or restrictions. In a public university, fund balance represents the net resources remaining after liabilities have been paid within a particular fund. Because universities manage resources on behalf of the public and various stakeholders, these balances are often subject to different types of restrictions on how they may be used. Two helpful ways to understand fund balance are by looking at the level of restriction on the resources and whether the resources can be spent.

Restricted vs. Committed
Some fund balances are restricted, meaning the use of the funds is limited by an external party. These restrictions might come from donors, granting agencies, or legislation. For example, a grant may specify that money can only support a specific research project, or the state might allocate funds for a particular purpose, such as deferred maintenance. Think of this as receiving ingredients for a specific recipe, like a gift of truffles that you must use for a gourmet dish only.

Other fund balances are committed, meaning the university has set the funds aside for a specific purpose. These commitments are typically made through official actions, like decisions by the board of trustees or senior administration. For example, the university might commit funds for a future building project or for technology upgrades. This is like a chef setting aside special ingredients, knowing they’ll be used for a future, carefully planned dish.

Expendable vs. Non-expendable
Fund balances can also be classified based on whether the principal may be spent. Expendable funds can be used to support university operations, programs or student aid. Consider these ingredients you can use in any recipe like potatoes or carrots.

Non-expendable funds, on the other hand, must be maintained in perpetuity (indefinitely). Typically, only the earnings generated from the invested principal may be used. This structure is common for permanent endowments where a donor requires the original gift to remain intact while investment income supports scholarships, professorships, or other activities. This is like allowing a good wine to age because you are saving it for a special, future event.

Putting it together
In practice, a university’s fund balance may combine these characteristics. For example, a scholarship endowment might be restricted and non-expendable (the principal cannot be spent and must support scholarships), while funds set aside by the institution for a future project might be committed and expendable. Understanding these distinctions helps to see not just how much funding the university has, but how those resources are allowed to be used. 

Why the Formula Always Balances 

Every financial transaction in a university affects at least two accounts so that: 

Assets = Liabilities + Fund Balance 

University Example: Tuition and Grants 

Let’s look at a simplified scenario: 

1. The university collects $5 million in tuition and receives a $2 million federal research grant. 
2. It owes $1 million in accounts payable for supplies and services. 

Calculating the fund balance: 

Assets: $7 million cash and receivables ($5M in tuition + $2M in federal research grant)
Liabilities: $1 million (for supplies and services payable to suppliers)
Fund Balance: $7 million − $1 million = $6 million 

The $6 million fund balance reflects the net resources available. Part of it may be restricted for the federal grant, while the rest may be available for general operations. 

No matter what happens, the total assets still equal liabilities plus fund balance, keeping the formula in balance.  

 How Fund Balance Relates to Accountability 

In a public university, fund balance is not about profit, it’s about responsible stewardship. Administrators and boards use fund balance to: 

• Ensure grant funds are spent according to restrictions (like using truffles for only a special recipe)
• Plan for future operations or emergencies (setting aside the rare spices for special occasions)
• Track which resources are available for instruction, research, or scholarships (just like tracking ingredients for future recipes)

The Most Important Thing to Remember

The most important thing about the accounting formula is that it shows where the university’s resources come from. Every dollar the university has (assets) must come from one of two places:

1. Borrowed or deferred money (liabilities)
2. Net resources that belong to the university (fund balance)

Everything the university owns is either owed to someone else or belongs to the institution to support its mission. The accounting formula keeps these two sources in balance. Just like a chef ensures the right ingredients are used in the right amounts to create a delicious dish. 

What Comes Next?

Now that you’ve got the basics down, keep exploring how different accounts work together to create the financial framework of a university. Like mastering a recipe, the more you understand, the better you’ll be at putting the pieces together in university accounting. There are five basic types of accounts: 

• Assets
• Liabilities 
• Fund Balance 
• Revenue
• Expenses 

By learning these concepts one by one, you’ll gain confidence in understanding university accounting. Just like mastering a recipe ensures success in your kitchen.