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   1. What’s the basic accounting equation?

Assets equal to Capital plus liabilities of a business

Assets = Capital + Liabilities

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   2. What’s capital?

Also known as Equity, Shareholders’ Equity, paid in capital.

Capital represents the investment in business by the owner or owners (more than one owner as in partnership and corporate business) to run the business and earn return on it. Capital may show the total book value of assets an entity owns (if the company has no liabilities). In other words capital or equity shows the owner’s interest in business

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   3. What are the liabilities?

These are the obligations of a business arisen by the past transaction or event

Liabilities can also be explained as investment in business by other people that are not the owners of the business. Therefore, business has to repay its debts which is a kind of obligation for the business

Examples of liabilities
A/C Payable or creditor notes or bills payable, accrued interest and commission, bank loan, mortgage loan, issued bonds, unearned income, accrued tax etc.

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   4. Define the elements of accounting equation?

There are three main elements of an accounting equation

Assets = Capital + Liabilities

Capital
Capital represents the amount of investment in business made by the owner of business

Liabilities
Liabilities are amount of investment in business made by the people who are not the owners of the business. Therefore, liabilities are obligations and business has to repay them.

Assets
Assets are tangible or intangible resources of the business

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   5. What are the circumstances under which the value of capital declines?

Since Asset=Capital + Liabilities, if liabilities remain the same and there is a decrease in assets, the capital of a business would definitely decrease

For example a business makes a loss, the loss will cause the business’s assets to reduce holding same amount of liabilities; business’s capital has to reduce

If the owner of business draws some cash or goods from business for their personal use, it decreases the assets (cash or goods). So, the capital will reduce to match the decrease of assets

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   6. How does the value of business capital increase?

A business can increase its capital by:

- Injecting fresh capital in the form of cash, inventory, fixed assets etc.
- Making profit

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   7. Can capital be negative?

Yes, capital might be negative under the following situation

If a business constantly making losses over time, it can have a negative figure of capital. For example, a person started business with $10,000 cash and suffered a loss of $12,000 in the first year of operation. Net capital of the business would be $10,000-$12,000=-$2000 which means the business has a negative capital of -$2000

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   8. What are retained earnings?

Retained earnings are the accumulated amount of net incomes that are kept aside for the future growth and expansion of a company since the beginning of company

Generally, companies don't distribute all earnings to their shareholders in the form of dividends and retain a portion of their earnings as retained earnings to meet the adverse financial situations and to enlarge their operations

If you subtract accumulated amount of dividends from the amount of all incomes of a company since its formation, you would come up with the figure of retained earnings. Accumulated net incomes – Accumulated dividends = Retained earnings

Positive retained earnings is added to the equity or capital in balance sheet and negative retained earnings (known as accumulated deficit) is subtracted from capital which reduce the amount of capital of a company

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   9. How do expenses affect the accounting equation?

Expense can affect accounting equation in three ways (since there are three main elements of an accounting equation Assets=Capital + Liabilities)

Expense decrease assets
Consider the situation when we have to pay off expenses in the form of cash. Don’t we decrease cash of the business which is an asset? For example purchase of goods for cash in which purchases are expense of the business

Expenses increase liabilities
Expenses can increase the liabilities of a business when we incur expenses but not pay them at that point in time. These expenses are still unpaid means we have to pay them in future. So, these expenses are liabilities or obligations of a business and these kinds of expenses are known as accrued expense. Therefore, when we incur accrued expense we, in fact, increase our liabilities.

Expenses decrease the equity or capital of a business
Expenses are deductions in the income statement which implies that they decrease value of net income or increase value of net loss. Because net income is an addition to capital and net loss is a subtraction from capital, expenses do decrease the amount of business capital

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   10. How do revenues or incomes affect the accounting equation?

Revenues can affect accounting equation in three ways (since there are three main elements of an accounting equation Assets=Capital + Liabilities)

Revenues increase assets
Consider the situation wherein we receive revenue in the form of cash. Don’t we increase cash of the business which is an asset? For example sale of goods for cash in which sale is a revenue of the business

Revenues decrease liabilities
Revenues can decrease the liabilities of a business when we earn revenue that we have received in advance in form of money. Therefore, previously unearned revenues which is a liability are now decreased

Revenues increase the equity or capital of a business
Revenues are additions in the income statement which implies that they increase the value of net income or decrease the value of net loss. Because net income is an addition to capital and net loss is a subtraction from capital, revenues do increase the amount of business capital

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   11. Are liabilities of a business good or bad for the business?

Liability can be good and they might be bad as well

Every business entity needs to increase the size of its operations or enlarge its size of business to magnify its earnings. This can be done by investing in assets and asset can be financed either by equity or liabilities which means either owner has to arrange money or resources to invest in assets or owner has to ask someone to lend him/her money or resources

A general rule is the more liabilities, the higher risk of business’s liquidation. Liabilities increase business profits as well as chances of losses. Therefore, liabilities are good till business seems safe and not having optimum level of risk

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   12. What are assets?

Assets are tangible or intangible resources or things that are controlled by an entity and possess the future economic benefits for the entity. Assets are presented in balance sheet at their book value or carrying value. Examples of assets include building, vehicle, machinery, cash, copyrights, trademarks, investments etc

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   13. What are expenses?

Expenses are costs expired during an accounting period or gross outflow of economic benefits which can be measured in money for getting services or goods. Technically, expenses are events by which assets are decreased or liabilities are increased

Examples of expenses
Purchase of goods or services, rent expense, employee wages or salaries, factory lease and depreciation expenses, heating and electricity expenses, repair and renewal of machinery and plant, freight and demurrage expenses etc

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