Accounting is a language. It is the language through which a business's
story is told. When a business tells its story, it does it
through a book.
What makes up a company's book? And what exactly does the book say?
We can understand what it is that the book tells us through the following analogy:
Let's pretend that a business is an island in the middle of the ocean.
However, this is not an ordinary island. This island is made completely of coconuts.
These are not ordinary coconuts. They are special because if they are planted
on this island of coconuts, they will grow into trees that produce even more coconuts.
This is a good thing, because, there are birds that come and take away the coconuts from
the island.
There is one more catch; a large amount of coconuts that make up this island were borrowed
from another island, and that other island eventually wants to be paid back their coconuts
over time with interest.
The island's coconut supply must be replenished through the growing activities or else the
island will diminish and everyone will eventually drown.
This island represents a business.
The important thing to know about the island is how many coconuts there are or how high
the island is above the water, and whether the island is growing or shrinking.
This is what the books tell us.
How does the book say this?
First, the book tells us the island's position above the water as of a certain point in time.
This is done by drawing a box with a line down the center splitting the box in half.
On the left-hand side, it is told how many coconuts the island has.
On the right-hand side, it is specified where all of the coconuts came from.
There are two categories on the right side: The first category tells how many coconuts
were borrowed. The second category tells how many coconuts
are owned.
To illustrate this, let's say that the island has 100 coconuts.
Let's assume that 30 of them were borrowed, and 70 of them came from the island's owner.
Notice that the totals of the two sides equal each other, they balance.
If the story is told correctly, the left and the right sides will always balance.
They must always balance.
This is how that would be represented in the book.
In summary, this part of the book shows the island's position, or how many coconuts the
island has, and where the coconuts came from.
Whenever there is a change in the total number of coconuts that the island has, the left
and right sides will increase or decrease to reflect the change in the story.
For example: When a coconut is grown, the total number
of coconuts increases. The number on the left side of the box will
increase by one. Now, in order to complete the story, the book
must specify whether the additional coconut is owned by the island, or whether it is borrowed.
When the island produces something, it is owned by the island; therefore, the island
owns the coconut. This increases the number on the right side of the box within the owner
category by one.
When a bird comes and eats a coconut, the total number of coconuts decreases.
The number on left side of the box will decrease by one.
Now, in order to complete the story, the book must specify whether the lost coconut was
a coconut owned by the island, or whether it was a borrowed coconut being returned to
the lender. When the island losses something, the island
is responsible; therefore, the number on the right side of the box within the owner category
is decreased by one.
Now, when the island returns a borrowed coconut to the island that lent them the coconut,
the total number of coconuts decreases. The number on the left side of the box will decrease
by one. Now, in order to complete the story, we must
show that a coconut has been returned to the lender.
We do this by decreasing the number on the right side of the box within the borrowed
category.
When the island decides to borrow one more coconut, the total number of coconuts represented
on the left side of the box will increase by one.
To complete the story, we increase the number on the right side within the borrowed category
by one.
Lets take a moment to make sure that the two sides equal each other
As we notice, on the left, all of the numbers add up to one hundred.
Likewise, on the right, all of the numbers add up to one hundred.
If both sides did not equal each other, then we know that the story is not being told correctly.
When the island must pay the lender a coconut for letting it borrow from them, the total
number of coconuts decreases. The number on the left side of the box will
decrease by one. To complete the story, we decrease the number
on the right side within the owned category by one also.
Now what happens when the island decides to plant two coconuts?
Well, those coconuts are now gone. Therefore, the total number of coconuts has
decreased by two. This is represented by decreasing the number
on the right side within the owner category by two.
Now those two coconuts will eventually grow into a tree.
And let's say that the tree produces five coconuts.
The total number of coconuts on the island has now increased by five.
The story is completed by increasing the number on the right side of the box within the owner
category by five.
At the end of the day, we can look at the left side of the box and see that the island
has 102 coconuts total. By looking at the right side of the box, we can see who has
claim to these 102 coconuts. By looking in the borrowed category, we can
see that the island borrowed 30 of them. By looking at the owner category, we can see
that 72 of them are owned.
When the updated book is compared to the book from the beginning of the day, we can see
that the total number of coconuts on the island has increased by 2.
As a review: Whenever there is a change in the total number
of coconuts that the island has, the left and right side will increase or decrease to
reflect the change in the story.
At the end of the day, we can look at the left side of the box and see that the island
has 102 coconuts total. By looking at the right side of the box, we can see who has
claim to these 102 coconuts. By looking in the borrowed category, we can
see that the island borrowed 30 of them. We can see that the total number of coconuts
on the island has increased by 2.
Now besides focusing on the change in the total number of coconuts that the island has,
the book want to give additional focus to the change in how many coconuts are owned.
To tell this part of the story, there is an additional page in the book.
To do this, another box is drawn, with a simple equation within it.
The equation is additions, minus subtractions, equals total.
The second component of the book tells us how the island has grown or shrunk between
two points in time, in terms of what is owned. First, the amount of coconuts that were grown
are shown as additions to the island. Second, the amount of coconuts that were lost
are shown as subtractions to the island. Finally, the total amount that the island
grew by or shrunk by is calculated.
Between these two parts of the book, we are told how many Coconuts the island has, or
its position above the water, where the coconuts came from, either from lenders, or owners,
and also, it tells us how quickly or slowly the island is shrinking or growing.
We have thus seen how the island has shared its story through its books, through the language
of accounting.
As a review Books tell us what a company has, where it
came from, whether from an owner or a lender, also the book tells us how much the company
grew, or shrunk. A business's objective is to use what it has
to grow the business.
If a business doesn't use its resources well, they will lose them, and it will eventually
go under.
Finally, businesses that use resources efficiently will grow an become successful.