1. Mathematical Breakdown of the Accounting Equation

The entire double-entry system rests on the foundational equation:

Assets = Liabilities + Equity

To see how operational activities affect capital, we expand this equation by breaking down Equity:

Equity = Contributed Capital + Retained Earnings

Retained Earnings = Beginning Retained Earnings + Revenue − Expenses − Dividends

Thus, the fully expanded accounting equation is:

Assets = Liabilities + Contributed Capital + Beginning Retained Earnings + Revenue − Expenses − Dividends

  1. Deconstructing the 5 Elements of Financial Statements

The Conceptual Framework strictly defines the five components of this equation:




| Element       | Formal Definition Criteria                           | Real-World Example                    |
+---------------+------------------------------------------------------+---------------------------------------+

| Asset         | Present economic resource controlled by the entity   | Patent, Accounts Receivable,          |
|               | as a result of past events.                          | Manufacturing Machinery               |
+---------------+------------------------------------------------------+---------------------------------------+

| Liability     | Present obligation of the entity to transfer an      | Bank Loan, Accounts Payable,          |
|               | economic resource as a result of past events.        | Unearned Revenue                      |
+---------------+------------------------------------------------------+---------------------------------------+

| Equity        | The residual interest in the assets of the entity    | Common Stock, Share Premium,          |
|               | after deducting all its liabilities.                 | Retained Earnings                     |
+---------------+------------------------------------------------------+---------------------------------------+

| Income        | Increases in assets or decreases in liabilities that  | Sales Revenue, Interest Income,       |
|               | result in increases in equity (not from owners).     | Gain on Disposal of Property          |
+---------------+------------------------------------------------------+---------------------------------------+

| Expense       | Decreases in assets or increases in liabilities that  | Salaries, Cost of Goods Sold (COGS),  |
|               | result in decreases in equity (not to owners).       | Depreciation Expense                  |
+---------------+------------------------------------------------------+---------------------------------------+

 
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