Describe the balance sheet equation and the dual effects of transactions

THE BALANCE SHEET EQUATION AND DUAL EFFECTS OF TRANSACTIONS

The balance sheet equation provides the analytical framework to understand the effects of transactions and events on the financial statements. The balance sheet equation underlies the recording of transactions and events. It captures the financial statement effects of operating, investing, and financing transactions—three key activities of business firms.

The balance sheet equation shows the equality of assets with liabilities plus shareholders' equity. This equation requires that an entity's assets exactly balance, or offset, an equal amount of financing provided by creditors and owners of the corporation. Total liabilities plus shareholders' equity shows the sources of all the firm's financing, and the assets show how the firm holds or has invested those funds. The balance sheet equation maintains this equality by reporting the financial statement effects of each event and transaction in a dual manner, or what are termed the dual effects of transactions. Any single event or transaction will have one of the following four effects or some combination of these effects:

1 . It increases an asset and increases either a liability or shareholders' equity.

2 . It decreases an asset and decreases either a liability or shareholders' equity.

3 . It increases one asset and decreases another asset.

4 . It increases one liability or shareholders' equity and decreases another liability or shareholders' equity.