4.5 The effect of profit on the accounting equation
In both Week 2 and Week 3 we looked at the accounting equation:
Table 3 The accounting equation
|Assets = Capital + Liabilities|
The three elements (assets, capital and liabilities) are presented in the balance sheet. The profit earned by the business increases capital, and we have already seen that Profit = Income/Revenue – Expenses. The accounting equation can, therefore, be expanded to:
Table 4 The expanded accounting equation
|Assets = Liabilities + Capital + (Revenue – Expenses)|
The income statement (also known as the profit and loss statement) shows in detail the elements of the equation: Revenue – Expenses = Profit or Loss. A deep understanding of the income statement is beyond the scope of this free course. An understanding of such a statement, as well as much other useful material, is included in the Open University module, B124 Fundamentals of accounting.