All transactions entered into by the business entity have an effect on the accounting equation when the transactions are recorded in the general ledger. The accounting equation represents the relationship that exists between the assets, liabilities and the interest of the owner in the entity.
Assets are owned by the entity as a result of a transaction in the past that has the potential to generate future economic benefits. Examples of assets are inter alia land and buildings, vehicles, machinery, equipment, furniture, investments, debtors and cash.
Liabilities are obligations arising from past transactions concluded which the entity must settle by sacrificing economic resources in the future. Examples of liabilities are inter alia loans and creditors.
Owners’ equity is the interest of an entity after liabilities have been deducted from the assets. Examples of equity are inter alia capital contributions plus profits or minus losses reduced by drawings made by the owner. Owners’ equity is affected by an increase or decrease of capital contributions as well as drawings by the owner. Income increases profits and will therefore increase owners’ equity. Expenses decrease profits and will therefore decrease owners’ equity.