The relationship

The basic accounting equation is Assets = Liabilities + Owner’s equity. Assets are resources controlled by the business. Liabilities are obligations to others. Owner’s equity is the owner’s residual interest after liabilities are deducted.

Start a small business

An owner contributes LKR 100,000 cash. Assets increase by LKR 100,000 and equity increases by LKR 100,000. If the business then borrows LKR 40,000, assets become LKR 140,000 and liabilities become LKR 40,000. Equity remains LKR 100,000. The equation stays balanced.

Buying an asset is not always an expense

If the business uses LKR 20,000 cash to buy equipment, one asset decreases and another increases. The total value of assets is unchanged at that moment, assuming no other costs. Recognising later expenses such as depreciation is a separate step.

Check both effects

For each transaction, identify what the business receives and what changes in return. A balanced equation is a useful check, although balance alone does not prove that every item has been classified correctly.

Practice question and worked answer

A business repays LKR 5,000 of loan principal using cash. Assets decrease by LKR 5,000 and liabilities decrease by LKR 5,000. Owner’s equity does not change from this principal repayment alone. Interest, if any, is a separate item.

Source & credits

Original content: Science With Jasseeth

Visit original source sciencewithjasseeth.site