C. Reviewing the accounting equation

The accounting equation is a fundamental principle of accounting that represents the relationship between a company’s assets, liabilities, and equity. The equation states that:

Assets = Liabilities + Equity

This equation must always remain in balance, meaning that the total value of a company’s assets must equal the total value of its liabilities and equity.

Let’s take a closer look at each component of the accounting equation:

1. Assets:

Assets are the resources that a company owns or has the right to use to generate income. They can be tangible or intangible, and they include things like cash, accounts receivable, inventory, property, plant, and equipment. Assets are recorded on the left side (debit side) of the balance sheet.

2. Liabilities:

Liabilities are the obligations that a company owes to others, such as loans, accounts payable, and accrued expenses. They represent the amount of money that the company owes to creditors or lenders. Liabilities are recorded on the right side (credit side) of the balance sheet.

3. Equity:

Equity represents the residual interest in a company’s assets after all liabilities have been paid off. It includes the initial investment made by owners, as well as any retained earnings. Equity is also recorded on the right side (credit side) of the balance sheet.

By understanding the accounting equation and the relationship between assets, liabilities, and equity, we can gain a deeper understanding of a company’s financial position and make informed decisions about investing or lending. Additionally, accountants use the accounting equation as a basis for preparing financial statements such as the balance sheet, income statement, and cash flow statement.