How are equity and liabilities related in the balance sheet?

In a balance sheet, the foundational accounting equation states that assets equal liabilities plus equity. This relationship illustrates that the resources owned by a company (assets) are financed by both external (liabilities) and internal (equity) sources.

When we say that assets are equal to equity and liabilities combined, it reflects this core principle. Equity represents the ownership interest in the company after all liabilities have been settled, while liabilities reflect obligations or debts that the company must repay. Therefore, understanding that assets must be financed either by borrowing (liabilities) or by investors (equity) reinforces this relationship.

Option A is incorrect because equity does not equal total liabilities; rather, equity represents the net worth of the company after covering its liabilities. Option B misinterprets their relationship by suggesting that liabilities are subtracted from equity, which disrupts the structure of the accounting equation. Option D is also inaccurate since equity is not inherently greater than liabilities; the relative amounts can vary considerably depending on the company's financial structure and position. Thus, the relationship highlighted in the correct answer provides clarity on how these financial components interact on a balance sheet.