The basic accounting equation is: Assets = Liabilities + Stockholders’ Equity. When looking at the balance sheet one can assume that assets must balance out each transaction and balance the claims to the assets (Kimmel, 2010). A balance sheet provides Assets of the company first and foremost, then Liabilities and Stockholders’ Equity and last retained earnings. This shows the companies incoming money, outgoing payments, and the money left or retained at the end of each time period being documented on the balance sheet.
The components of the accounting equation affect each other in many ways. For example, when cash assets are received the company is making profit only as long as it is making more revenue than the liabilities owed. So, when using the Sierra Corporation on pg. 14 from the text the company has to pay the Liabilities: Notes payable, Accounts payable, Salaries payable, Unearned Service revenue, and Interest prior to ever turning a profit above the black. When looking at a balance sheet one needs to know all incoming as well as outgoing money to determine profitability and sustainability of a corporation.
Next, when looking at a balance sheet the liabilities + the stockholder’s Equity have to ALWAYS balance out to amount of assets to ensure all things are accounted for and there are no accounting errors. When done properly the balance sheet can be used to verify the company’s revenue and the financial stability of a company based upon debt to stockholders’ equity.
Kimmel, P. D., Weygandt, J. J., & Kieso, D. E. ( 2010). Financial accounting: Tools for business decision making (6th ed.). Hoboken, NJ: John Wiley & Sons.