Assessment Description:
Briefly describe each element of the accounting equation. Explain why it is necessary for the equation to remain in balance.
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SOLUTION to ACC 240: Fundamentals of Accounting- Topic 3 DQ 2.
Hello class,
According to Weygandt et al. (2019), the accounting equation is a fundamental tool that equates the assets of a company to the claims against those assets. This equation is made up of three elements which include; assets, liabilities, and the owner's equity. Cade et al. (2019) refer to assets as economic resources owned or controlled by a business that are expected to provide future benefits. They include both long-term tangible goods as well as short-term liquid holdings. Conversely, liabilities refer to debts or obligations that must be settled by sacrificing assets or incurring expenses in the future (Cade et al., 2019). Common liabilities are accounts payable, accrued expenses, notes payable, and long-term debt.
The final component of the equation is owner’s equity, which may be defined as the owner’s investment in the company, together with the retained earnings, minus any current liabilities. Equity makes sure that assets are sufficient to cover all the liabilities. Apart from understanding what each element entails, it is crucial to note that for the equation to remain balanced, the following must always be true:
Assets = Liabilities + Owner's Equity
This equation is important because it checks the mathematical accuracy of the books of account and provides evidence for the source of financing of reported assets. This means that an unbalanced equation suggests that journalizing was done improperly or mathematical errors were made or that the account balances have not been totaled to show all increases or decreases in value over the period. Additionally, remaining in equilibrium confirms the "dual aspect" concept that for every financial transaction, both an asset or expense and either an equity or revenue account are affected (Barth et al., 2023). This gives stakeholders faith in the ability of the company to apply accounting principles uniformly and avoid errors or intentional manipulation that compromise the integrity of reported data.
References
Barth, M. E., Li, K., & McClure, C. G. (2023). Evolution in value relevance of accounting information. The Accounting Review, 98(1), 1-28. https://doi.org/10.2308/TAR-2019-0521
Cade, N. L., Koonce, L., Mendoza, K. I., Rees, L., & Tokar, M. B. (2019). Assets and liabilities: When do they exist?. Contemporary Accounting Research, 36(2), 553-587. https://doi.org/10.1111/1911-3846.12479
Weygandt, J. J., Kimmel, P. D., & Kieso, D. E. (2019). Financial Accounting. John Wiley & Sons.