Accounting Equation

Question 1

The basic accounting equation is: ________ = ________ + ________

1. Assets = Liabilities + Equity
2. Equity = Assets + Liabilities

Answer 1

1. Assets = Liabilities + Equity

Question 2

Assets are the stuff that a business owes.

True or False?

Answer 2

False.

Assets are stuff that a business owns.

In accounting speak: “Assets are probable future economic benefits obtained or controlled by a particular entity as the result of past transactions or events.”

Question 3

Liabilities are the stuff that a business owns.

True or False?

Answer 3

False.

Liabilities are the stuff that a business owes to third parties. A more wordy definition is:

“Liabilities are probable future sacrifices of economic benefits arising from present obligations of a particular entity to transfer assets or provide services to other entities in the future as a result of past transactions or events.”

Question 4

Equity is the owner’s claim on the net assets of a business.

True or False?

Answer 4

True.

Indeed this is true. Equity is the stuff that a business owes to its owners.

You could also say: “Equity represents the net funds invested into a business by it’s owners.” or “Equity is the residual value of an entity’s assets after deducting all of it’s liabilities.”

Question 5

The balance sheet gives us a snapshot of a business’s assets, liabilities equity at a point in time?

True or False?

Question 6

What are the two main components of equity?

Capital contributions
Revenue
Expenses
Retained Earnings

Question 7

What are retained earnings?

1. Net profit
2. Accumulated profits held for future use

Answer 7

2. Accumulated profits held for future use

Retained earnings are the profits a business has held onto since it was born. It excludes any withdrawals distributed back to the owners.

Retained earnings = accumulated profits - withdrawals

Depending on the business structure, withdrawals are also called drawings or dividends.

Question 8

Can a business have negative retained earnings?

Yes or No

Question 9

The income statement flows into the accounting equation through ________.

1. Assets
2. Liabilities
3. Equity

Question 10

When a customer buys a product “on account”, they agree to pay the supplier at _______ date.

1. an earlier
2. a later

Question 11

An owner makes a $1,000 initial investment into their business. What is the impact on the accounting equation?

1. Assets and equity go up
2. Assets and liabilities go up

Question 12

A business borrows $5,000 from the bank. What is the impact on the accounting equation?

1. Assets and equity go up
2. Assets and liabilities go up

Question 13

An owner withdraws $500 cash from their business for personal use. What is the impact on the accounting equation?

1. Assets go up and equity goes down
2. Assets and equity go down

Question 14

A business buys a car for $10,000. The payment is made in cash. Is the car an asset or a liability?

1. Asset
2. Liability
3. Both

Question 15

A business finances a new vehicle with a bank. Does the business record an asset or a liability?

1. Asset
2. Liability
3. Both

Question 16

A business has liabilities of $25,000 and equity of $5,000. How many assets does it have?

1. $30,000
2. $20,000

Question 17

A business has assets of $90,000 and liabilities of $50,000. How much equity does it have?

1. $140,000
2. $40,000

Question 18

A business takes out a loan to buy a machine. What is the effect on the accounting equation?

1. Assets and liabilities go up
2. Assets and equity go down

Question 19

A business collects cash from a customer. The balance was initially recorded in accounts receivable. What is the impact on equity?

1. Increases
2. Decreases
3. No impact

Question 20

A business pays out cash to a supplier. The balance was initially recorded in accounts payable. What is the impact on liabilities?

1. Increases
2. Decreases
3. No impact

Question 21

A business makes a net profit during a financial year. What impact does this have on equity?

1. Increases
2. Decreases
3. No impact

Question 22

A business makes a net loss during a financial year. What impact does this have on equity?

1. Increases
2. Decreases
3. No impact

Question 23

At the end of a financial year, a business has a total assets of $150,000 and total equity of $70,000. What were the business’s total liabilities?

1. $220,000
2. $80,000

Question 24

A business sells a product “on account” and earns a profit. What is the impact on the accounting equation?

1. Assets and equity go up
2. Assets and liabilities go up

Question 25

A business receives a payment from a customer in advance for a service. The service is to be carried out in the future. What is the impact on the accounting equation?

1. Assets and equity go up
2. Assets and liabilities go up

Answer 25

2. Assets and liabilities go up

Cash increases because the business has received a payment. Cash is a type of asset so total assets also goes up.

Deferred Revenue also increases. This is because the business has received an advance payment for a service that hasn’t yet been provided. Deferred Revenue is a liability account. So total liabilities also go up.

The journal entry is:
Dr Cash
Cr Deferred Revenue