What is the accounting equation?

The accounting equation is a fundamental principle that serves as the foundation for the double-entry bookkeeping system. It states that the total assets owned by a business are equal to the sum of its liabilities and equity. This equation illustrates that everything the company owns (assets) is financed either by borrowing money (liabilities) or by the owner's own investment (equity).

When a business acquires an asset, it either incurs a liability or increases equity. This relationship is crucial because it ensures that the balance sheet remains balanced and accurately reflects the company's financial position. If either side of the equation changes, the other side must change accordingly to maintain equality.

While other choices may involve concepts related to financial accounting, they do not represent the accounting equation's core relationship. For instance, the equation relating income, expenses, and assets does not capture the fundamental balance between what a business owns and what it owes, which is central to financial reporting and analysis.