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This lecture explores the concept of assets, liabilities, and equity in financial and managerial accounting. Learn how to read balance sheets, understand different types of assets and liabilities, and analyze a company's financial health.
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Discipline: Financial and managerial accountingTheme 2: The object and method of accounting Lecturer: Vornicova Natalia, Master of Economic Sciences Chisinau 2018
Accounting is fundamentally about Assets, Liabilities and Equity.Assets = Liabilities + Equity
Assets are anything of value that is owned by a company, whether fully paid for or not.
Asset is any item of economic value owned by an individual or corporation, especially that which could be converted to cash. Examples: cash, securities, accounts receivable, inventory, office equipment, real estate, car, and other property.
In financial accounting, a liability is defined as the future sacrifices of economic benefits that the entity is obliged to make to other entities as a result of past transactions or other past events, the settlement of which may result in the transfer or use of assets, provision of services or other yielding of economic benefits in the future.
Equity is the value of an ownership interest in property, including shareholders' equity in a business.
A balance sheet also known as the statement of financial position tells about the assets, liabilities and equity of a business at a specific point of time. It is a snapshot of a business. Assets = Liabilities + Equity
A balance sheet is named so because it lists all resources owned by the company and shows that it is equal to the sum of all liabilities and the equity balance.
An account form balance sheet is just like a T-account listing assets on the left side and equity and liabilities on the right side. A report form balance sheet lists assets followed by liabilities and equity in vertical format.
Fixed assets also known as hard assets, fixed assets include real estate, physical plants and facilities, equipment (from office equipment to heavy operating machinery), vehicles, and other assets that can reasonably be assumed to have a life expectancy of several years.
Most fixed assets, with the notable exception of real estate, will lose value over time. This is known as depreciation, and is typically figured into a business's various financial documents.
Fixed assets are among the most important assets that a company holds, for they represent major investments of financial resources. Indeed, fixed assets usually comprise the majority of a business's total assets.
Fixed assets are also very important to small business owners because they are one of the things that are examined most closely by prospective lenders. When a bank or other lending institution is approached by a business owner who is seeking a loan to establish or expand a company, loaning agents will always undertake a close study of the prospective borrower's hard assets. Bankers view these fixed assets as a decisive indicator of a business's financial health.
Current assets also known as soft or liquid assets, current assets include cash, government securities, marketable securities, notes receivable, accounts receivable, inventories, materials and any other item that could be converted to cash in the normal course of business within one year.
Some current assets (or short term assets): • Inventory; • Receivables; • Cash; • Other current assets.
Cash is, of course, the most liquid of assets. But in business circles, the definition of cash is expanded beyond currency (coins and paper money) to include checks and money orders; the balance in current account; and even less liquid assets that are commonly regarded as cash equivalents. These include certificates of deposit with maturities of less than a year and Treasury bills.
A liability is a debt assumed by a business entity as a result of its borrowing activities or other fiscal obligations. Liabilities are paid off under either short-term or long-term arrangements. The amount of time to pay off the liability is typically determined by the size of the debt; large amounts of money usually are borrowed under long-term plans.
Payment of a liability generally involves payment of the total sum of the amount borrowed and the interest.
Current liabilities are short-term financial obligations that are paid off within one year or one current operating cycle, whichever is longer (a normal operating cycle, while it varies from industry to industry, is the time from a company's initial investment in inventory to the time of collection of cash from sales of that inventory or of products created from that inventory).
Typical current liabilities include such accrued expenses as: • wages, • taxes, • interest payments not yet paid; • accounts payable; • cash dividends; • revenues collected in advance of actual delivery of goods or services.
Long-term liabilities are not paid off within a year, or within a business's operating cycle, are known as long-term or noncurrent liabilities. Such liabilities often involve large sums of money necessary to undertake opening of a business, major expansion of a business, replace assets. Such debt typically requires a longer period of time to pay off.
When debt that has been classified as long-term is paid off within the next year, the amount of that paid-off liability should be reported by the company as a current liability in order to reflect the expected drain on current assets.
Expenses are outflows or other using up of assets or incurrence of liabilities (or acombination of both) from delivering or producing goods, rendering services, or carrying outother activities that constitute the entity's ongoing major or central operations.
Expenses represent actual or expected cash outflows (or the equivalent) that have occurredor will eventuate as a result of the entity's ongoing major or central operations. The assets that flow out or are used or the liabilities that are incurred may be of various kinds—for example,units of product delivered or produced, employees' services used, kilowatt hours of electricity used to light an office building, or taxes on current income.
Similarly, the transactions and events from which expenses arise and the expenses them selves are in many forms and are called by various names for example, cost of goods sold, cost of services provided, depreciation, interest, rent, and salaries and wages depending on the kinds of operations involved and the way expenses are recognized.
Revenues are inflows or other enhancements of assets of an entity or settlements of itsliabilities (or a combination of both) from delivering or producing goods, rendering services, orother activities that constitute the entity's ongoing major or central operations. Revenues represent actual or expected cash inflows (or the equivalent) that have occurredor will eventuate as a result of the entity' s ongoing major or central operations.
The assets increased by revenues may be of various kinds for example, cash, claims against customersor clients, other goods or services received, or increased value of a product resulting from production. Similarly, the transactions and events from which revenues arise and the revenues themselves are in many forms and are called by various names for example: output, deliveries, sales, fees, interest, dividends, royalties, and rent depending on the kinds of operations involved and the way revenues are recognized.
An expenseis reported on the income statement. An expense is a cost that has expired, was used up, or was necessary in order to earn the revenues during the time period indicated in the heading of the income statement. For example, the cost of the goods that were sold during the period are considered to be expenses along with other expenses such as advertising, salaries, interest, commissions, rent, and so on.
An expenditure is a payment or disbursement. The expenditure may be for the purchase of an asset, a reduction of a liability, a distribution to the owners, or it could be an expense. For instance, an expenditure to eliminate a liability is not an expense, while expenditures for advertising, salaries, etc. will likely be recorded immediately as expenses.
Here's another example to illustrate the difference between an expense and an expenditure. A company makes anexpenditure ofUSD255,500 to purchase equipment. The expenditure occurs on a single day and the equipment is placed in service. Assuming the equipment will be used for seven years, the cost of the equipment will be reported as depreciation expense of $100 per day for the next 2,555 days (7 years of service with 365 days each year).
Types of Revenue (Income) • Sale of Products-Amounts earned from the sale of merchandise. • Sale Of Services-Amounts earned from performing services. • Rental Income-Amounts earned from renting properties. • Interest Income-Amounts earned from investments.
Types of Expenses • Supplies-Expenditures for incidental materials needed in the conduct of business, such as office supplies. • Salaries-Expenditures for work performed by employees. • Payroll Taxes-Expenditures for taxes based on wages paid to employees. • Advertising-Promotional expenditures, such as newspapers, handbills, television, radio and mail.
Utilities-Expenditures for basic services needed to function, such as water, sewer, gas, electricity and telephone. • Building Rental-Expenditures paid to an owner of property (building) for use of the property. A rental agreement called a lease contains the terms. • Maintenance & Repairs-Expenditures paid to repair and or maintain buildings and/or equipment.
