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BOOKKEEPING BASICS

  The Three Basic Elements

The three basic elements of accounting are:

• Assets – Anything of value the company owns
• Liabilities – Anything the company owes to creditors
• Owner’s Equity – What the business is worth to the owner.

Examples of assets: Cash on hand or deposited in banks, equipment, money that is owed to the company, real estate, automobiles.

Examples of liabilities: Credit card debts, bills payable, bank loans payable.

The Owner’s Equity is determined by adding up all the assets and subtracting all the liabilities. If the owners sold all their assets and paid-off all their bills, they would have the right to keep the money that is left over.

Here is an example:

Assets:		Cash on hand Typewriter Total Assets		$ 55.00 $145.00 $200.00
Liabilities:		Credit Card Debt Total Liabilities		$150.00 $150.00
Assets $200.00	- -	Liabilities $150.00	= =	Owners Equity $50.00

Owner's Equity is the difference between what is owned (total Assets) and what is owed (total Liabilities).

On a financial report, the above equation is stated as:
Assets = Liabilities + Owner’s Equity. See the Balance Sheet section below.

We can actually say that this business is worth $50.00, because if the owner sold what the business owns and paid off the debts (what the business owes), the owner would have $50.00 left.

  Balance Sheet

The Balance Sheet is a financial report which shows the business assets, liabilities and how much the business is worth (or Owner’s Equity).

Although the Balance Sheet does not itemize all the income and expenses a business had, it will show if the business made a profit or had a loss at the end of the specific period. The profit or loss a business generated will effect how much the business is worth to the owner or owners (Owner’s Equity).

  Revenue & Expenses

Revenue (income) and expenses (costs of running the business) will effect either an asset, a liability or the Owners Equity.

As the business makes money the cash will increase (cash is an asset) and valuable items may be purchased (an example would be equipment which is also an asset). As the business spends money the cash will decrease or the business may have to borrow money to cover all it’s costs (the loan would be a liability). As the assets and liabilities change the owners equity (how much the business is worth) will change.

Expenses occur in the normal operation of every business every day. Examples of usual business expenses are: electricity, telephone, rent, advertising, and office supplies.

It is the accountant's job to provide the owner with a summary of the expenses at the end of each business period. In this way, the owner is kept informed so he can take action if any business expense appears to be unusual or more costly than necessary.

The types of revenue a business has depends on the business activities it conducts. A lawyer would derive most of his revenue from client fees, a doctor would get his revenue from patient fees, and a hardware store would receive its revenue from sales.

  Profit And Loss

How much revenue the business is generating and how much money the business is spending is extremely important to the business manager.

At the end of each month the accountant prepares a financial report called either an Income Statement, a Profit and Loss Statement, or A Report of Earnings. The report is the same regardless of what it is called.

The business manager uses the Income Statement to determine if the company has made a profit or a loss during the last accounting period. The manager can then make business decisions to increase the company’s profits.

The profit (or loss) the business had at the end of the period, the value of the assets and the balance of the liabilities will determine how much the business is worth to the owner or owners.

  Importance of Knowing the Difference

It is important for a manager or owner to understand the difference between the Balance Sheet items (assets, liabilities and owner’s equity) and the Income Statement items (revenues and expenses).

When the business repays a loan it is not a business expense. The loan proceeds were used for business expenses but the loan repayment REDUCES the liability and would effect the Balance Sheet – not Income Statement.

Similarly, buying equipment or property which the business will own and use to generate more income is an asset and will effect the Balance Sheet. The money spent to purchase these items would not effect an Income Statement.

  Accurate Reporting

If the Bookkeeper and manager or owner understand the differences between assets, liabilities, income, expenses and the owner’s equity accounts the reports will be accurate and actions can be taken to make the company more profitable.

Bookkeeping Information    |   Methods of Accounting    |   Financial Reports

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