The Accounting Equation

Transcription

1 The Accounting Equation People go into business to make a profit. In order to make a profit, the business requires economic resources as well as human resources. While human resources are the people who work in the business, economic resources are those items which have cash value and are necessary to establish a business. Some examples include cash, office supplies, office equipment, building and land. These represent what the business owns; they are called the Assets of the business. Claims against the assets are called Equities. These claims may be made by creditors or by the owner of the business. Claims of the creditors against the assets are called Liabilities. These are the debts or unpaid obligations of a business. They usually consist of accounts or bills which have fallen due but which are not paid (Accounts Payable). Liabilities are the debts of the business or what the business owes. The owner s equity or interest in the business is called Capital which is the claim of the owner against the assets. This equity is based on what the owner has invested in cash and other assets into the business. If you take what the business owns, and subtract what it owes, the difference will be the owner s interest in the business. Capital is the owner s net worth. Thus we can show: A = L + C is known as the Accounting Equation. What is Owned = What is Owed + Owner s Equity Economic Resources = Creditor s claims + Owner s Claim ASSETS = LIABILITIES + CAPITAL A = L + C

2 Liabilities are listed before the owner s equity on the right side of the equation. The claims of the creditors take precedence over those of the owner. For example--if the business were to be declared bankrupt (incapable of paying its debts)--then in any sale of the assets, the creditors claims on the total assets would have to be satisfied before the claims of the owner. The Balance Sheet One way of determining the profitability of a business is to compare the net worth of the proprietor at the beginning and at the end of a period of time. In order to make such a comparison, it is necessary to produce a statement which shows the financial position of an individual or a business by means of a formal statement called a balance sheet. The balance sheet reports assets, liabilities and owner s equity at a certain date. In addition, a balance sheet is simply the fundamental accounting equation in tabular form. The left-hand total of the balance sheet is always equal to the right-hand side. When the totals of the equation are equal, they are "in balance". An example of a formal balance sheet statement follows: Sunshine Motel Balance Sheet As At December 31, 20 Assets Liabilities Cash $ Accounts Payable: Supplies Acme Plumbing Supplies $ Furniture & Fixtures Bank Loan Payable Equipment Total Liabilities $ Owner s Equity T, SummersCapital Total Assets $ Total Liabilities & Owner s Equity $

3 Accounting Equation Calculations Name: 1. Complete the following chart by finding the missing values. ASSETS LIABILITIES CAPTIAL On April 12 th of this year Jason Brechart opened an accounting office. The following is a list of his assets and liabilities. A/P , Office Equipment , Cash , Bank Loan , Office Furniture Determine Jason s Capital. 3. Tom Jones is the owner and operator of Jones Enterprise, a motivational consulting business. At the end of its accounting period, December 31, 2009, Jones Enterprise has assets of $760,000 and liabilities of 240,000. Use the accounting equation to calculate the answers in each of the following: a) Tom Jones, capital, as of December 31, 2009

4 b) Tom Jones, capital, as of December 31, 2010, assuming that assets increased by $120,000 and liabilities increased by $72,000 during 2010 c) Tom Jones, capital, as of December 31, 2010, assuming that assets decreased by $60,000 and liabilities increased by $21,600 during 2010 d) Tom Jones, capital, as of December 31, 2010, assuming that assets increased by $100,000 and liabilities decreased by $38,400 during 2010 e) Net income during 2010, assuming that as of December 31, 2010, assets were $960,000, liabilities were $156,000, and there were no additional investments or withdrawals.

5 Balance Sheet Activities Use the following balance sheets to complete the textbook activities. 1. Century 21 Page

6 2. Century 21 Page 35 2-M