What is the accounting equation?

The accounting equation, which is fundamental to the double-entry bookkeeping system, asserts that the total assets of a business must equal the sum of its liabilities and equity. This relationship illustrates how resources are financed: either through borrowing (liabilities) or through the owners’ contributions (equity).

When we say that assets equal liabilities plus equity, it signifies that what the business owns (assets) is funded by what it owes (liabilities) and what the owners have invested (equity). This balance is crucial for maintaining the integrity of financial statements.

Understanding this equation is essential for analyzing a company’s financial health. Any modifications in either assets, liabilities, or equity will automatically affect the other components to keep the equation balanced. Thus, the choice that states "Assets = Liabilities + Equity" captures this critical principle effectively.

The other statements do not reflect the accurate relationship defined by the accounting equation or misrepresent the relationship between the components, thus failing to establish the foundational balance necessary for understanding business financials.