1. Foundations

Equation and Elements

Use the accounting equation as a model and a control

Equation and Elements

The model

\text{Assets} = \text{Liabilities} + \text{Equity}

The equation is a description of claims on resources, not a debit-and-credit mnemonic.

Element	Plain-language question	Northstar example
Asset	What present economic resource does Northstar control?	Cash, receivables, inventory, equipment
Liability	What present obligation must Northstar transfer?	Supplier payable, loan, contract liability
Equity	What residual remains after liabilities?	Share capital and retained earnings
Income	What increase in assets or decrease in liabilities raises equity, excluding owner contributions?	Revenue from delivered bikes
Expense	What decrease in assets or increase in liabilities lowers equity, excluding distributions?	Components consumed, wages, depreciation

Five events, one equation

Northstar begins operations:

Event	Assets	Liabilities	Equity
Owners contribute £100,000 cash	+100,000	—	+100,000
Bank lends £60,000	+60,000	+60,000	—
Equipment bought for £70,000 cash	Cash −70,000; PPE +70,000	—	—
Components bought on credit for £24,000	Inventory +24,000	Payables +24,000	—
Components costing £8,000 are used in bikes sold for £15,000 cash	Cash +15,000; inventory −8,000	—	Revenue +15,000; expense −8,000

Closing totals:

Assets	£	Claims	£
Cash	105,000	Bank loan	60,000
Inventory	16,000	Trade payables	24,000
Equipment	70,000	Equity: contributions	100,000
		Equity: profit	7,000
Total	191,000	Total	191,000

The £7,000 profit is £15,000 revenue less £8,000 expense. Owner contributions are not revenue; borrowing is not revenue; equipment purchase is not immediately a £70,000 expense.

Why balance is necessary but insufficient

This wrong entry balances:

Dr Equipment expense   £70,000
    Cr Cash                         £70,000

It misclassifies an asset purchase as an immediate expense. The equation still balances because expense reduces equity. Arithmetic control cannot replace economic analysis.

A reliable event test

Name the resource, obligation or owner claim.
State whether it increased or decreased.
Separate owner transactions from income and expenses.
Check the period.
Only then assign debit and credit.

If receivables rise by £20,000, possible causes include credit sales, acquisition of a receivable or a reclassification. It does not prove revenue rose by £20,000. Accounting analysis moves both from events to statements and from statement changes back to plausible events.