The accounting equation is an important formula in accounting that entails critical components found in the Balance Sheet. It comprises the following: Assets = Liabilities + Owners’ Equity The assets comprise the resources of the organization that are utilized in the operations of the company to provide a product/service and/or generate profits. Assets are normally classified between non-current and current assets. Liabilities are the financial obligations of the company that result from past transactions. They are also classified between long-term and current liabilities.
Owners’ equity as it name stands are the elements accountable to the owners of the organization. They mainly comprise the investment of the owners in form of capital and the accumulated profits/losses generated from operations. Impact of Fraud Activities: 1. If merchandise is stolen the inventory under the assets section will diminish. This will result in an imbalance in the accounting equation, because no sale took place to enhance profits. As a result an expense will be recorded to decrease the owners’ equity and put again the equation in balance. 2. A fake invoice will result to a fake increase in liability.
If undetected it will not be written off and will lead to a decrease in cash (assets) due to its payment. 3. This will result to an understatement of assets (inventory) since the receipt of inventory was not recorded. If the culprit is not found and the inventory is not taken back this will lead to another expenditure resulting in a fall in owners’ equity. 4. Such omission will not affect the accounting equation because nothing is recorded. However, cash and owners’ equity will be understated due to such fraud. 5. This action is normally allowable provided drawings are properly taken into account.
In such a stance a fall in cash and owners’ equity will result. However, if this is done fraudulently a mismatch in the equation will arise, because the assets side will be lower than the other side of the formula. 6. Per se such fraud will not directly affect the equation. However, this will result in lower productivity, which may in turn lead to lower profits. As a result the profit figure in the owners’ equity will be lower than it should be. This will in turn lead to lower assets held by the company. Reference: Wood F. ; Sangster A. (2002). Business Accounting 1. Ninth Edition. Essex: Pearson Education Limited.