What is the relationship between assets, liabilities, and equity in accounting?

The correct answer reflects the fundamental accounting equation, which states that assets are equal to the sum of liabilities and equity. This equation is the cornerstone of double-entry accounting and illustrates how a company's resources (assets) are financed through debts (liabilities) and the owners' stakes (equity).

In a balance sheet, assets represent everything that the company owns, such as cash, inventory, and property. Liabilities represent what the company owes to external parties, while equity represents the residual interest of the owners in the company's assets after all liabilities have been settled. This relationship ensures that the balance sheet is always balanced, as each asset has corresponding claims against it either from creditors or owners.

Understanding this equation is crucial for evaluating a company's financial health, as it provides insight into how well a company can meet its obligations and how much of the company's assets are financed through equity versus debt.