explain the meaning of assets, liabilities and owner''s equity

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1.2 The Accounting Equation - IGCSE Accounting

1.2 The Accounting Equation

Introduction

The accounting equation is the fundamental principle of double-entry bookkeeping. It shows the relationship between a business's assets, liabilities, and owner's equity. This equation must always remain in balance.

Key Terms

Assets

Assets are resources controlled by the business as a result of past events and from which future economic benefits are expected. They represent what the business owns.

Examples of Assets:

  • Cash
  • Inventory
  • Debtors (money owed to the business by customers)
  • Buildings
  • Equipment
  • Land

Liabilities

Liabilities are obligations of the business to external parties. They represent what the business owes to others.

Examples of Liabilities:

  • Creditors (money the business owes to suppliers)
  • Loans from banks
  • Salaries payable
  • Tax payable

Owner's Equity (or Capital)

Owner's Equity represents the owner's stake in the business. It is the residual interest in the assets of the business after deducting liabilities.

For a limited company, this is often referred to as Equity. For a sole trader or partnership, it's called Capital.

Examples of Owner's Equity:

  • Capital (for sole traders and partnerships)
  • Share Capital (for limited companies)
  • Retained Earnings (accumulated profits kept within the business)

The Accounting Equation

The accounting equation is expressed as:

$$Assets = Liabilities + Owner's Equity$$

This equation always holds true. Any change in the equation must be balanced by a corresponding change in another part of the equation.

Component Definition Example
Assets What the business owns. Cash, Inventory, Equipment
Liabilities What the business owes to others. Loans, Creditors, Salaries Payable
Owner's Equity The owner's stake in the business. Capital, Retained Earnings, Share Capital

Illustration: Consider a small business with:

  • Cash: $10,000
  • Equipment: $20,000
  • Creditors: $5,000
  • Capital: $15,000

Applying the accounting equation:

$10,000 + $20,000 = $5,000 + $15,000$

$30,000 = $20,000$

The equation balances.

Suggested diagram: A simple visual representation of the accounting equation with boxes for Assets, Liabilities, and Owner's Equity, connected by equals signs.