PSIA Accounting Practice Test

Assets must equal liabilities plus equity because every resource a business owns is funded either by amounts owed to others (liabilities) or by the owners’ claims (equity). This balance is at the heart of double-entry bookkeeping: every time something of value is acquired, there’s a corresponding change in either what is owed or in the owners’ stake, so the total assets always reflect both sources of financing. For example, if you purchase equipment with cash financed by a loan, assets rise (equipment) and liabilities rise (loan), keeping the equation in balance. If the purchase is financed by the owner's investment, assets rise (cash or equipment) and equity rises correspondingly, again maintaining balance. Revenue affects equity through retained earnings, so it can indirectly influence the equation as assets increase and equity increases, preserving the balance. The other statements don’t represent the fundamental funding relationship. Revenue minus expenses is a measure of net income, which is an income statement concept, not the balance of what the assets are funded by. An equation that subtracts equity from liabilities misstates the relationship, since equity is a funding source alongside liabilities, not something to be subtracted from them. Saying equity equals liabilities plus revenue mixes components in a way that doesn’t reflect how assets are financed and how accounting is structured.