Which of the following statements best represents the reason for the fundamental accounting equation?

• A. It is only relevant for companies that use the cash basis of accounting.
• B. It is used to calculate the net income of a business for a specific period.
• C. It determines the amount of cash a company has at the end of the year.
• D. It shows that a company's resources (assets) are financed by creditors and owners (liabilities and equity).

Answer: (D)

Verified step by step guidance

1. Step 1: Understand the fundamental accounting equation, which is expressed as: Assets = Liabilities + Equity. This equation represents the relationship between a company's resources (assets) and the claims on those resources by creditors (liabilities) and owners (equity).
2. Step 2: Recognize that the fundamental accounting equation is the foundation of the double-entry accounting system. It ensures that every transaction affects at least two accounts, maintaining the balance between assets, liabilities, and equity.
3. Step 3: Clarify why the equation is relevant. It is not limited to cash basis accounting, nor is it used to calculate net income or determine year-end cash. Instead, it provides a snapshot of how a company's resources are financed, either through debt (liabilities) or ownership (equity).
4. Step 4: Analyze the correct answer. The statement 'It shows that a company's resources (assets) are financed by creditors and owners (liabilities and equity)' aligns with the purpose of the fundamental accounting equation, as it explains the source of financing for the company's assets.
5. Step 5: Conclude that understanding the fundamental accounting equation is essential for interpreting financial statements, as it reflects the financial position of a company at any given time.