Accounting – 1.2 The accounting equation | e-Consult

The Accounting Equation states that Assets = Liabilities + Equity. This equation represents the fundamental relationship between a business's resources (assets), its obligations to others (liabilities), and the owners' stake in the business (equity).

Importance to Financial Statements: The accounting equation is the foundation upon which all financial statements are built. It ensures that the accounting records are balanced. Every transaction affects at least two elements of the equation, maintaining the overall balance. It's crucial for ensuring accuracy and reliability of financial reporting.

Example: If a business purchases equipment for £5,000 with cash, this transaction increases assets (equipment) by £5,000 and decreases assets (cash) by £5,000. Since the total assets remain the same, the equation remains balanced. The transaction does not directly affect liabilities or equity.