The accounting equation is the basic framework for recording financial transactions.
It is assets equal liabilities plus equity.
Remember that this is the accounting equation not the accounting suggestion, so it must always be in balance.
The asset side must always equal the liabilities and equities side.
Assets are the economic resources of the business.
They are items that have value and will provide benefit into the future.
You can see on this slide a list of some common assets.
Liabilities are claims against the assets from outside parties, commonly known as creditors.
You might also think of liabilities as debts.
Again, you can see some examples from the slide.
Owner's equity is the owne'rs claim on the assets.
Owners always have secondary claims behind creditors.
Sometimes owner's equity is known as net worth for net assets.
Owner's equity is increased
by owner investment and net income.
It is decreased by owner withdrawal and
net loss.
Let's recall that net income is revenues minus expenses
when revenues are greater than expenses.
Net loss is revenues minus expenses when expenses are greater than revenues.
So another way to think about the impact of net income or loss on the accounting equation
is that revenues increase owner's equity
and expenses decrease owner's equity.
Owner withdrawal is a reduction of owner's equity.
It occurs when an owner withdraws cash or other assets from a business.
If an owner works in the business and earns a salary,
the salary is a withdrawal and not an expense.
Revenues are inflows that result from business activities entered into for the purpose of earning income.
So if a company performs service for customer, it earns service revenue.
If it sells goods to a customer than it earns sales revenue.
You can see from slides some common examples of revenue.
Expenses are the cost of assets used up
or the result of liabilities incurred in the process of earning revenues.
I like to think of expenses is the cost of doing business.
You can see some common examples of
expenses on the slide.
Finally, let's look at a basic example of the accounting equation.
Let's say a home is worth $200,000.
This house is an asset because it has value and provides benefit into the future.
However, there is also a home loan which we call a mortgage.
Let's say the amount of that mortgage is $150,000.
A mortgage is a liability because it's a claim against the asset from an outside party,
which in this case is a bank.
At this point the accounting equation is not in balance because 200,000 does not equal 150,000.
The remainder is equity.
The owner has $50,000 of equity in the home.
Equity represents the owner's claims on the asset.
And that concludes this brief overview of the accounting euqation.