Before you begin the quiz, let's quickly review the fundamental concepts of the accounting equation!
The Basic Accounting Equation
The basic accounting equation is the foundation of the double-entry bookkeeping system. It states that:
Assets = Liabilities + Equity
- **Assets:** These are what a business **owns** (e.g., cash, accounts receivable, equipment, buildings). They provide future economic benefits.
- **Liabilities:** These are what a business **owes** to outsiders (e.g., accounts payable, notes payable, salaries payable). They represent obligations to pay or provide services in the future.
- **Equity (Owner's/Stockholder's Equity):** This is the **owners' claim** on the assets of the business after all liabilities have been paid. It's the residual value or net worth of the business.
The Expanded Accounting Equation
The basic equation can be expanded to show how Owner's Equity changes over time. Owner's Equity increases with owner investments and revenues, and decreases with owner withdrawals (dividends) and expenses.
Assets = Liabilities + Owner's Capital (beginning) + Revenues - Expenses - Dividends/Drawings
- **Owner's Capital (beginning):** The initial investment by the owners or the equity at the start of a period.
- **Revenues:** Earnings from the primary activities of the business (e.g., sales revenue, service revenue). Revenues **increase** equity.
- **Expenses:** Costs incurred in the process of earning revenue (e.g., rent expense, salaries expense, utilities expense). Expenses **decrease** equity.
- **Dividends/Drawings:** Payments or withdrawals of assets by the owner(s) from the business. These **decrease** equity.
Understanding these components is key to grasping how business transactions affect the financial position of a company.