1.5 Fundamental Accounting Equation

The accounting equation may be expressed in three different forms:

1. Assets = Liabilities + Owner's Equity

2. Liabilities = Assets - Owner's Equity

3. Owner's Equity = Assets - Liabilities

The first format is the fundamental accounting equation used in financial reporting. Accountants used the second and third format for analysis purposes. The most important thing to remember is that the equation must be in balance at any given time.

In the Accounting Equation, the Owner's Equity section is expanded to include the Revenue and Expense accounts. The Owner's Equity is increased by the Revenue accounts and decreased by the Expense accounts.

Basis of Accounting:

1. Cash Basis – is a basis in accounting wherein revenues earned are accounted for when cash is received, and expenses incurred are accounted for when cash is paid.

2. Accrual Basis – is a basis in accounting wherein revenues are accounted for in the period they are earned regardless of when cash was received, and expenses are accounted for in the period they are incurred regardless of when cash payment is made. Accrual basis clearly reflects the matching principle in accounting in which revenues and expenses are assigned to the same period they have been earned and incurred.

Understanding the cash and accrual basis of accounting at this early stage is important because QuickBooks Pro has structured the presentation of the financial statements based on whether the company uses the cash or accrual basis of accounting at the set-up option.