Chapter 2
Accounting: a Very Short course
What is accounting?
Most people in business
have some idea, but professional accountants
have to stop and think about an exact
definition of accounting XE "accounting:definition" . In this book, it will be used to mean keeping track of your money: where it came from, where it went, and how much you own. QuickBooks does accounting. A useful structure begins with a foundation. For accounting, computer or manual, that foundation is the understanding of a few fundamental concepts.
Accounting deals first
with ASSETS, which means anything that
someone might want to keep in their
possession. Cash comes to mind, then
furniture, tools, vehicles and the
like. If you have borrowed money from
the bank, your debt is the bank's asset.
Accounts Receivable, the money that
others owe you, for goods and services
delivered, is your asset. The
limitation is that accounting measures in
dollars (or other monetary units.)
Accountants narrow the definitions to include
only assets XE "assets:definition" of definite monetary value.
When you start a business,
you probably contribute some of these
assets. Keeping records of the money
and other assets coming in and going out is
SINGLE ENTRY accounting. DOUBLE ENTRY
accounting XE "double entry:definition" begins by recording assets, and in addition, the claims on those assets. In the very beginning of a business, the assets may consist entirely of things contributed by the owner. No one else has any claim on the assets, so they belong entirely to the owner. This is the simplest sense of EQUITY, the part of a business that the owners own.
But perhaps the owner
borrowed some money, or bought materials on
credit. The owner has an obligation to
pay money to others. That is a
LIABILITY.
Now the owner no longer
owns all of the assets in the business.
In the way of doing business, the creditors
come first, then the “owner.” So now
the owner's equity is the dollar value of all
the assets, minus liabilities XE "liabilities:definition" to creditors. This can be stated as an equation:
Equity XE "equity:definition" = Assets - Liabilities.
These figures can be
assembled into a table called a Statement of
Financial Position, which is more commonly
known by its older name, Balance Sheet.
ASSETS LIABILITIES
Cash $10,000 Loan on truck $4,000
Truck $8,000 Loan from Bank $2,000
Tools $5,000 ------------
Total Liabilities $6,000
EQUITY
Original Investment $17,000
------------
TOTAL EQUITY $17,000
-------------
TOTAL ASSETS $23,000 TOTAL LIABILITIES AND EQUITY $23,000
This is a balance sheet XE "balance sheet:definition" because it shows that the accountants did their arithmetic correctly, and the two sides are in balance. The accounting equation is usually stated in a form corresponding to the balance sheet:
Assets = Liabilities + Equity.
This balance sheet is simple enough, and it should be. The company has done nothing.
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