Accounting Equation and Basics

ExpertsMind.com offers free accounting basics theory and assignments

From large, multi-national corporation down to corner beauty salon, every business transaction will have effect on company’s financial position, The financial position of company îs measured by following items:

Assets (what it owns)

Liabilities (what it owes to others)

Owner’s Equity (the difference between assets & liabilities)

The accounting equation (or basic accounting equation) offers us simple way to understand how these three amounts relate to each other, The accounting equation for sole proprietorship is:

Assets = Liabilities + Owner’s Equity

The accounting equation for corporation is:

Assets = Liabilities + Stockholders’ Equity

Assets are company’s resources—things company owns, Examples of assets include cash, accounts receivable, inventory, prepaid insurance, investments, land, buildings, equipment, & goodwill, From accounting equation, we see that amount of assets must equal combined amount of liabilities plus owner’s (or stockholders’) equity,

Liabilities are company’s obligations—amounts company owes, Examples of liabilities include notes - loans payable, accounts payable, salaries & wages payable, interest payable, & income taxes payable (if company îs regular corporation), Liabilities can be viewed în two ways:

(1) as claims by creditors against company’s assets, and

(2) source—along with owner - stockholder equity—of company’s assets,

Owner’s equity - stockholders’ equity îs amount left over after liabilities are deducted from assets:

Assets – Liabilities = Owner’s (or Stockholders’) Equity,

Owner’s - stockholders’ equity also reports amounts invested into company by owners plus cumulative net income of company that has not been withdrawn - distributed to owners,

If company keeps accurate records, accounting equation will always be “in balance,” meaning left side should always equal right side, The balance îs maintained because every business transaction affects at least two of company’s accounts, For example, when company borrows money from bank, company’s assets will increase & its liabilities will increase by same amount, When company purchases inventory for cash, one asset will increase & one asset will decrease, Because there are two - more accounts affected by every transaction, accounting system îs referred to as double entry accounting,

A company keeps track of all of its transactions by recording them în accounts în company’s general ledger, Each account în general ledger îs designated as to its type: asset, liability, owner’s equity, revenue, expense, gain, - loss account,