Entrepreneurs, who are thinking of going into business, or who are already conducting business, have to start learning about the basic concepts of Accounting because they are the concepts that are used in reporting their business activities to the government come tax time. They must know about one of the most fundamental concepts in accounting.
Accountants process data into documents called financial
statements. It is the accounting equation that is the basis for the entire
accounting system.
So, what is this magical equation?
The Accounting Equation is:
Assets = Liabilities + Owners’ Equity.
In crude definition:
Assets are economic resources of the business that are
expected to bring benefits for the business in the future.
Liabilities are economic resources borrowed by the business
from another person or an organization.
Owners' Equity is the economic resources that was
contributed by the owners of the business to the business.
One way of thinking of this equation is that the left side
is what the business has including its money, equipment, building, land,
furniture, etc... The right side indicates where these assets had come from.
Were they borrowed from parties outside the business, or were they contributed
by the people who own the business?
The other version of this equation, that you might bump into
is the:
Assets- Liabilities = Owners' Equity.
In other words, if the business's assets pay off all its
liabilities, you are left with a figure that indicates the economic resources
that belongs to the business's owner.
It is pretty much the same thing, a concept of transposition
in algebra.
If you take a look at a business's Balance Sheet - or what
is now modernly called as A Statement of Financial Position - you'll notice
that all the items in there are arranged following this accounting equation in
either one of its versions.
Of course, in a Balance Sheet, it is written vertically,
instead of horizontally as it is in the equation.
You'll see the items arranged somewhat as:
Assets XXX Liabilities YYY Owners Equity ZZZ
Where, XXX = YYY + ZZZ.
So, next time you see a balance sheet aka statement of
financial position, take the time to recognize the logic.
Disclaimer:
This article is presented solely as an example and is not meant to replace
qualified financial advice. If you or someone you know require up to date
financial or legal help, seek qualified assistance. No content on this site
should ever be used as a substitute for direct legal counsel from your lawyer
or a qualified attorney
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