Question

1. What is the importance of the following equation: ASSETS = LIABILITIES + OWNERS' EQUITY.

Group of answer choices

a. it shows the two groups, creditors and owners, who have provided resources to the company

b. if it is in balance it proves that no financial fraud has taken place

c. if it is not in balance the data processing system must have been corrupted.

d. if it is not in balance it shows financial fraud must have taken place

2. The stockholder equity section on the balance sheet of a corporate entity reveals net worth from what two sources?

Group of answer choices

a. profitable operations, current assets

b. owner investment, profitable operations

c. owner investment, borrowing

d. cash, owner investment

Answer 1

Here in question 1, (c)option is more accurate because accounting equation ensures that credit and debit balances should be equal.So if it is not equal it may be due to any data processing errors such as errors in machines, errors of persons entering data,inputs entered etc.It does not necessarily require the firm to work in a fair and fraudless way if its balances are equal.For example the firm may try to increase profit by decreasing depreciation or resort to the practice of bribery like charity fraud etc.This could still be grouped under the term financial frauds.Thus option b is ruled out.Similarly if it is in balance it does not guarantee absence of frauds.Thus option (d) is not right too. Option (a) also is not entirely correct because equation when considering a non profit organization does not record any shareholders equity.There owners equity is replaced by 'Net Assets'. Thus option (c) is correct.

In question 2 option (a) is obviously wrong as shareholders equity does not contain current assets which comes under the category 'assets'.But equity is a liability of the business as it needs to be repaid to the owner (as per business entity concept).in option(c),borrowings do not form a part of shareholders equity as it is an item of liability.Thus it is not correct.In option(d),the item cash denotes current asset which comes under the head 'assets' and not equity.But in option (b),both the items owners investment and profitable operations are part of shareholders equity.Here owners equity refers to capital contributed by the owner and profitable operations shows net income(which is usually added to retained earnings).In short, a shareholders equity consist of the following-share capital,net income and dividends,retained earnings.