Define the accounting equation & discuss how it is related to the four financial statements. Required to show the inter-relationships between four financial statements and with the aid of examples, how the transactions impact the accounting equation.
The accounting equation consists of three company`s accounts including assets, liabilities and owner`s equity. The accounting equation can be summarized as :
Assets = Liabilities + Owner`s Equity
Based on the equation, assets are the total of liabilities and owner`s equity. Assets are a company’s resources—things the company owns. Examples of assets include cash, accounts receivable, inventory, prepaid insurance, investments, land, buildings, equipment, and goodwill.
Liabilities are the amounts of the company owes. Examples of liabilities include notes or loans payable, accounts payable, salaries and wages payable, and interest payable.
Owner’s equity or stockholders’ equity is the amount left over after liabilities are deducted from assets:
Assets – Liabilities = Owner’s Equity.
Owner's Equity is applicable when the company is a sole proprietorship. If the company is a corporation, the words Stockholders' Equity is used. Owner’s or stockholders’ equity also reports the amounts invested into the company by the owners plus the cumulative net income of the company that has not been withdrawn or distributed to the owners.
The accounting balance will balance if the records are accurate. The balance is maintained because every business transaction impact at least two accounts. For example, when a company borrows money from a bank, the company’s assets will increase and its liabilities will increase by the same amount. When a company purchases inventory for cash, one asset will increase and one asset will decrease. Because there are two or more accounts affected by every transaction. Company`s general…...