accounting equation and Basic Elements of Financial Position

<br /><div style="text-align: center;"><b><span style="font-size: large;">Classification of accounts</span></b></div><div style="text-align: center;"><b><span style="font-size: large;">( Basic Elements of Financial Position )</span></b></div><div style="text-align: center;"><a href="http://bookkeeping-course.blogspot.com/search/label/Basic%20Concepts">Basic Concepts</a> of  Financial Accounting<br /><br /></div><div style="text-align: left;"><b>Two types of accounts: </b><b><span style="color: #666666;">The financial condition or position of a business enterprise is represent­</span></b><b><span style="color: #666666;">ed by the relationship of assets to liabilities and capital.</span>  </b></div><div style="text-align: left;"><br /></div><div style="text-align: left;"><b><span style="color: red;">First:</span></b> Accounts belong to the <b>Balance Sheet</b> and represent the basic accounting equation. </div>These accounts are:<br /><br /><br /><div style="text-align: center;">1. Assets       2. Liabilities          3.Owners Equity </div><div style="text-align: center;"><br /></div><div style="text-align: left;"><b></b></div><b>These three basic elements are connected by a fundamental rela­</b><b><b><b>tionship called  the accounting equation. This equation expresses the </b></b></b><b><b><b>equality of the assets on one side with the claims of the creditors and </b></b></b><b><b><b>owners on the other side: </b></b></b><br /><b><b><b></b></b><br /></b><br /><br /><div class="separator" style="clear: both; text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgW7Gq9RibZ0KcJzaP2F_-9CMyE8QQfapTGzndYovPoivpLfpPEskJhxENnpf0quW6TAufHtx-FmK3wpV33OLKc7fPLkQMgqFRmEQ-Ow-3zQrsUyZlrmZ6CUU6txMjtfbSj9XwrFkA7Lfo/s1600/Accounting+Equation.JPG" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="110" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgW7Gq9RibZ0KcJzaP2F_-9CMyE8QQfapTGzndYovPoivpLfpPEskJhxENnpf0quW6TAufHtx-FmK3wpV33OLKc7fPLkQMgqFRmEQ-Ow-3zQrsUyZlrmZ6CUU6txMjtfbSj9XwrFkA7Lfo/s400/Accounting+Equation.JPG" width="400" /></a></div><div class="separator" style="clear: both; text-align: center;"><br /></div><div style="text-align: center;">( <b>Remember</b> <b>:</b> Assets must be equal to the sum of Liabilities and Owners equity) </div><div style="text-align: center;">It should balance after every <a href="http://bookkeeping-course.blogspot.com/2012/06/accounting-transaction-double-entry.html">transaction</a>. </div><div style="text-align: center;"><br /><div style="text-align: left;">This relationship - which is called the accounting identity or basic accounting equation, is expressed in equation form as:</div><br /><b>A = L + E</b><br /><b>A<span style="color: #444444;">ssets</span> = L<span style="color: #444444;">iabilities</span> + <span style="color: #444444;">Owners</span> E<span style="color: #444444;">quity</span></b><br /><b><span style="color: #444444;"> </span> </b><br /><div style="text-align: left;">where A = Total assets, L = Total liabilities, and E = Equity. Because creditor claims are paid before equity claims if a healthcare organization is liquidated - liabilities are shown before equity both on the balance sheet and in the basic accounting equation.</div><br /><span style="color: red;">Note</span> that the accounting identity can be rearranged as follows:<br /><br /><b>E = A − L</b><br /><div style="text-align: left;">This format reinforces the concept that equity represents a residual claim against the total assets of the business and the fact that equity can be negative.<br />If a business writes down (decreases) the value of its assets, its liabilities are unaffected because these amounts are still owed to creditors and others. If total assets are written down so much that their value drops below that of total liabilities - then the equity reported on the balance sheet becomes a negative<br />amount.</div><br /><br /></div><div class="separator" style="clear: both; text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiZChZMpIeB3YRt_snPo-NRRmLMZgPcD-OZoK6GGo8g88YCCgPDjF1ghArWdljR20V2KGxAvl0UR9oy-ds_UcpUhbxQBKsmbUjsYaox_kJEETzzNuom0YQM52-34C6Hd1WrqFvPVDKfMgo/s1600/Accounting+Equation2.JPG" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="285" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiZChZMpIeB3YRt_snPo-NRRmLMZgPcD-OZoK6GGo8g88YCCgPDjF1ghArWdljR20V2KGxAvl0UR9oy-ds_UcpUhbxQBKsmbUjsYaox_kJEETzzNuom0YQM52-34C6Hd1WrqFvPVDKfMgo/s320/Accounting+Equation2.JPG" width="320" /></a></div><div style="text-align: center;">The basic accounting equation is simply an algebraic form of the balance sheet.</div><b><br /></b><br /><b>1. Assets</b> <br />  Assets are the cash and non cash resources owned by a business and have economic value, and<br />  used in carrying out future services or benefits to the entity using them. <br /><br /><b>Classification of assets:</b><br />-  <b>Current assets</b><br />   Current assets are cash and other types of assets that are reasonably expected<br />   to be converted into cash, sold, or used up during the normal operating year. <br /><br />Examples of current assets include:<br />  Cash, Bank, Goods, Accounts Receivable, Prepaid expenses, Inventory and<br />  Marketable securities etc.<br /><br />-  <b>Fixed assets</b><br />   Fixed assets are those assets that are used in the normal operations of the<br />  entity to produce and sell goods or perform services for customers.  Fixed assets<br />  are expected to service for a number of years are not for re-sell. <br /><br />Examples of fixed assets include:<br />  Lands, cars, buildings, equipments, and furniture etc.<br /><br />-  <b>Intangible assets</b><br /><br />  Intangible assets are those assets that have no physical substance but they<br />  are expected to provide benefits to the entity for several years. <br /><br />Examples of intangible assets include:<br />  Patents, trade marks, copyrights, goodwill, franchise fees, and trade name.<br /><br /><br /><br /><br /><b>2.  Liabilities  </b><br />Liabilities are claims against assets, Amounts owed to outsiders, such as notes payable, accounts<br />payable, bonds payable.<br />  <br /><b>Classification of Liabilities: </b><br /><b>-  Short-term Liabilities   </b><br />   Short-term liabilities are obligations of the entity that are reasonably<br />   expected to be paid or settled in the next year or the normal operating cycle. <br /><br />Examples of short-term liabilities include:<br />  Short-term notes payable, accounts payable, salaries and wages payable and<br />  other types of accrued liabilities for services received but not yet paid for.<br /><br /><b>-  Long-term Liabilities </b><br />   Long-term liabilities are those obligations that do not require payment within<br />   the next year or the normal operating cycle.  In other words, liabilities not classified<br />   as short-term are reported in the Long-term liabilities section of the balance sheet. <br /><br />Examples of long-term liabilities include: <br />  Loan, bonds, and any other obligation that mature in a period more than one<br />  year beyond the balance sheet date is reported as long-term.<br /><br /><br /><b>3.  Owner’s Equity </b><br />  Owner’s equity represents the owner’s interest in the assets of the entity. <br />  It is equal to total assets minus total liabilities, also known as Capital.<br /><br />There are two main sources of owner’s equity:<br />(١)  Amounts contributed by  the owner (Capital)<br />(٢) Amount earned by the entity but not yet taken by the owner.<br /><br /><br /><b><span style="color: red;">Second:</span></b>  Accounts belong to the Income Statement and involve in the determination of<br />net income or net loss of a business entity for a specific period of time. These accounts<br />are:<br /><div style="text-align: center;">1. Expenses                         2. Revenues<br /><br /><div style="text-align: left;"><b>1.  Expenses </b><br />  Expenses are the cost of assets consumed or services used in the process of earning revenue in other words; expenses are outflows or other uses of assets resulting from the sale or delivery of goods or the provision of services by the entity during specific time period.   <br /><br />Examples of expenses include:   <br />Utility expenses (electric and water), telephone bill expense, rent expense, wages and salaries expense and depreciation expense etc.  </div></div><br /><b>2.  Revenues </b><br />  Revenues are cash in-flow result from the sale of goods or the rendered of services. <br /><br />To illustrate the affect (increase & decrease) of a financial transaction on the above classified accounts, study the following chart: <br />  <br /><br /><b>Basic Accounting Equation </b><br /><br /><div class="separator" style="clear: both; text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiaHnuDm9OEzeCsO-a8bxhhseW_Q8Flyh_UFQGczbXHPSdeU25bTVXRL8XTMnLmo4TMquJUlzeAjTGjz2puUi0_9jhBLtejRS-7xqbGr2Peek-OXb5VkOVvkwG45qBxzt-fyi8qRlNl1Zw/s1600/Basic+Accounting+Equation.JPG" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="226" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiaHnuDm9OEzeCsO-a8bxhhseW_Q8Flyh_UFQGczbXHPSdeU25bTVXRL8XTMnLmo4TMquJUlzeAjTGjz2puUi0_9jhBLtejRS-7xqbGr2Peek-OXb5VkOVvkwG45qBxzt-fyi8qRlNl1Zw/s640/Basic+Accounting+Equation.JPG" width="640" /></a></div><br />  You have already learned the basic accounting equation. However, in the above illustration note the expansion of the basic accounting equation to show the accounts that comprise owner’s equity besides expenses and revenues with their effect (increase, decrease) of the <a href="http://bookkeeping-course.blogspot.com/2012/06/accounting-transaction-double-entry.html"><b>debit /credit</b></a> rules on each type of account. <br /><br /><br /><b style="color: red;">To student </b><br />  Please study the above diagram carefully; it will help you understand the fundamentals of the <a href="http://bookkeeping-course.blogspot.com/2012/06/accounting-transaction-double-entry.html"><b>double-entry system</b></a>. <br /><br /><br /><div style="text-align: center;"><b>------------------------------- Example -------------------------------</b></div><div style="text-align: center;"><br /></div><br /><br />During the month of January, Mr. Tom Banana, lawyer,<br />1.  Invested $6,000 to open his law practice.<br />2.  Bought office supplies on account, $500.<br />3.  Received $3,000 in fees earned during the month.<br />4.  Paid $100 on the account for the office supplies.<br />5.  Withdrew $500 for personal use.<br /><br /><div style="text-align: center;">These <a href="http://bookkeeping-course.blogspot.com/2012/06/accounting-transaction-double-entry.html">transactions</a> could be analyzed and recorded as follows: </div><div style="text-align: center;"><br /></div><div style="text-align: center;"></div><div style="text-align: left;">                                  Assets  =        Liabilities         +           Capital </div><div style="text-align: left;"><br /></div><div style="text-align: left;">                                   Cash<span class="Apple-tab-span" style="white-space: pre;"> </span>                                             Tom, Capital </div><div style="text-align: left;">                        1.  + $6,000  =<span class="Apple-tab-span" style="white-space: pre;"> </span>                                             + $6,000</div><div style="text-align: left;"><br /></div><div style="text-align: left;">                               Supplies         Accounts Payable </div><div style="text-align: left;">                        2.  + $500     =          + $500 </div><div style="text-align: left;"><br /></div><div style="text-align: left;">                                  Cash </div><div style="text-align: left;">                       3.   + $3,000  =                                              Fees Income </div><div style="text-align: left;">                                                                                              + $3,000 </div><div style="text-align: left;"><br /></div><div style="text-align: left;">                                  Cash</div><div style="text-align: left;">                       4.    − $100     =  Accounts Payable </div><div style="text-align: left;">                                                       − $100</div><div style="text-align: left;"><br /></div><div style="text-align: left;">                                  Cash </div><div style="text-align: left;">                       5.    − $500     =                                               Tom, Capital </div><div style="text-align: left;">                                                                                                − $500 </div><br /><div style="text-align: center;"><br /></div><br /><b>Notice</b> that for every transaction, <a href="http://bookkeeping-course.blogspot.com/2012/06/accounting-transaction-double-entry.html">two entries are made</a>. After every <a href="http://bookkeeping-course.blogspot.com/2012/06/accounting-transaction-double-entry.html">trans­action</a>, the accounting equation remains balanced.<br /><br /><br /><b>Notice</b> that for Preparing a new equation A = L + C after each trans­action would be cumbersome and costly, especially when there are a great many transactions in an ac­counting period. Also, information for a specific item such as cash would be lost as successive transactions were recorded. This information could be obtained by going back and summarizing the trans­actions, but that would be very time-consuming. Thus we begin with the account, Account which records the <a href="http://bookkeeping-course.blogspot.com/2012/06/accounting-transaction-double-entry.html">accounting transactions</a> so you must know what the accounting transactions and how to post accounting transaction (<a href="http://bookkeeping-course.blogspot.com/2012/06/accounting-transaction-double-entry.html">Double-entry bookkeeping system</a>)<br /><br /><br /><b>Quiz -Tested yourself</b><br /><br />1.  The accounting equation is _______ = ________ + ________.<br />2.  Items owned by a business that have monetary value are ______.<br />3.  _________ is the interest of the owners in a business.<br />4.  Money owed to an outsider is a(n) _________.<br />5.  The difference between assets and liabilities is ___________.<br />6.  An investment in the business increases _______ and ________.<br />7.  To purchase “on account” is to create a ___________.<br /><br /><br /><br />Answers: 1. Assets, liabilities, capital; 2. Assets; 3. Capital; 4. Liability;<br />5. Capital; 6. Assets, capital; 7. Liability<br /><br /><br /><br /><br /><br /><div style="text-align: center;"><br /></div><div style="text-align: center;">------------------------------------------------------------------------------------------------------</div><div style="text-align: center;"><span style="color: #666666; font-size: x-small;">bookkeeping and financial accounting training</span><span style="color: #666666; font-size: x-small;"> course</span></div><br /><br /><br />

accounting equation and Basic Elements of Financial Position

Classification of accounts ( Basic Elements of Financial Position ) Basic Concepts of  Financial Accounting Two types of accounts:  The fina...

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