Multiple Choice
Which of the following statements best explains how the fundamental accounting equation applies to businesses?
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1. Introduction to Accounting
Fundamental Accounting Equation
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Which statement is true about the relationship between total assets and total liabilities according to the fundamental accounting equation?
A
Total assets are always greater than total liabilities.
B
Total liabilities equal total assets minus owner's equity.
C
Total assets equal the sum of total liabilities and owner's equity.
D
Total assets are calculated by subtracting owner's equity from total liabilities.
Verified step by step guidance1
Step 1: Begin by recalling the fundamental accounting equation, which is: Total Assets = Total Liabilities + Owner's Equity. This equation is the foundation of financial accounting and represents the balance sheet structure.
Step 2: Analyze the options provided in the problem. The first option, 'Total assets are always greater than total liabilities,' is incorrect because total assets can be equal to or greater than total liabilities depending on the owner's equity.
Step 3: Evaluate the second option, 'Total liabilities equal total assets minus owner's equity.' This is correct because rearranging the fundamental accounting equation gives: Total Liabilities = Total Assets - Owner's Equity.
Step 4: Assess the third option, 'Total assets equal the sum of total liabilities and owner's equity.' This is correct and directly aligns with the fundamental accounting equation: Total Assets = Total Liabilities + Owner's Equity.
Step 5: Review the fourth option, 'Total assets are calculated by subtracting owner's equity from total liabilities.' This is incorrect because it contradicts the fundamental accounting equation. Total assets are calculated by adding total liabilities and owner's equity, not subtracting owner's equity from liabilities.
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