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Chapter 2

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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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Last modified: May 21, 2004