Question

State the “accounting equation” and define each of its terms. What is the logic behind this equation? (100 words minimum)

Answer 1

The accounting equation (or basic accounting equation) offers us a simple way to understand how these three amounts relate to each other. The accounting equation for a sole proprietorship is:

Assets = Liabilities + Owner's equity

1. Assets (what it owns)
2. Liabilities (what it owes to others)
3. Owner's Equity (the difference between assets and liabilities)

The accounting equation is a simple way to view the relationship of financial activities across a business. The balance sheet essentially takes care of filling in each of the values in the equation, so the equation is not meant for actual use but is instead a simplified representation of how the financial side of business functions.

Assets = Liabilities + Owner's equity from this equation you can find anyone the one aspect if you have available two variables.

Example

An example of how the three values relate: If a business wishes to purchase a new asset, such as computer equipment that costs £300, the purchase can be made using cash (an asset), with owner equity (earnings or funds) or with a liability (such as borrowed money). If a liability is used for the purchase, the £300 can then be paid off using assets or with the use of a new liability, such as a bank loan.