The Fundamentals of accounting

Part 1-The accounting equation

It is important that all organization keep records of their resources, resource uses and claims. These resources are known as assets, and represent the things of value that the company owns.

There are financial assets such as Cash and Account Receivables and non-financial assets, such as machinery and office furniture.

The business assets can be obtained from money contributed to the business by its owners to expand operations. Borrowing from a bank also creates an asset-Cash- and also a liability --note payable. The business also incurs an asset-Inventory- and a liability -Accounts payable or notes payable when merchandise inventory is acquired.

A net increase to assets is obtained when the inventory is sold at a price higher than that at which it is bought, plus the expenses of sale.--resulting in a profit. Profit is the motive of all business-type organizations. This form of organization is distinct from a not-for-profit organization,such as a ccharity or a church.

The difference between assets and liability is called Equity or Capital. Capital can also be introduced to the business when the owner of a LLC or partnership makes a contribution to the business.

We derive the accounting equation from these three elements-asset, liability and equity.
The equation is: Assets = Liability + Equity--meaning that the assets of an entity is equal to the resources of those assets: which is the liability and equity.

Thus, at any given time in a period, a financial statement can be prepared showing the assets on one side and the liabilities and equity on the other side. This statement is called a Balance Sheet, and represents the status of the financial position of a business. Some non-profit organization also refers to this statement as a statement of financial position.

Equity will be changed (increased) when an asset is sold for profit, and will be decreased when an item is sold at a loss. The profit or loss is arrived at by comparing the revenue derived from the sale with the expenses incurred to make the sale.


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-----Our next Accounting article will deal with the accruals concept of accounting------