Category : Databases and related files
Archive   : FINEVAL.ZIP
Filename : ACCTEQU.HLP

PART 1: THE ACCOUNTING EQUATION
-------------------------------

An entity's financial position is reflected by the relationship between
its assets and its liabilities and capital (equity).

The ACCOUNTING EQUATION reflects these elements by expressing the
equality of assets to the claims of creditors and owners' equity as
follows:

ASSETS = LIABILITIES + CAPITAL

There are two other forms this equation can take to show the
relationship among the three components. For example:

ASSETS - CAPITAL = LIABILITIES

and,

ASSETS - LIABILITIES = CAPITAL

The accounting equation is the basis for DOUBLE ENTRY ACCOUNTING. This
means that each transaction has a dual effect. A transaction affects
either (a) both sides of the equation by the same amount, or (b) one
side of the equation only, by both increasing and decreasing it by
identical amounts and thus netting to zero.

For example: If a business has assets of $500,000, obligations of
$300,000, and owners' equity of $200,000, the accounting equation is:

ASSETS = LIABILITIES + CAPITAL
------ ----------- --------
$500,000 = $300,000 + $200,000

If at the end of the reporting period, the business derived net income
of $50,000, the accounting equation becomes:

ASSETS = LIABILITIES + CAPITAL
------ ----------- --------
$550,000 = $300,000 + $250,000

If $10,000 was then used to pay creditors, the accounting equation
becomes:

ASSETS = LIABILITIES + CAPITAL
------ ----------- --------
$540,000 = $290,000 + $250,000

In the next example, let's illustrate how the TRANSACTIONS of a typical
business are recorded and what effect they have on the accounting
equation.

Mr. Smith, an entepreneur, has a small consulting business and
experienced the following events in the month of September, 1987:

1. Started his business with a cash investment of $10,000
and office equipment worth $5,000.
2. Purchased office supplies of $800 by paying cash
3. Bought a typewriter for $500 on account from IBM
4. Paid $400 in salary to his employees
5. Received an electric bill for $300
6. Earned professional fees of $20,000, of which $12,000
was received in cash and $8,000 was owed by clients
7. Paid $300 to IBM
8. Withdrew $100 from the business for personal use
9. Received $1,000 from one of the clients who owed him
money
10. The worth of his office supplies on hand at the end of
September was $600

The table below provides an analysis of the above ten transactions:

SUMMARY OF TRANSACTIONS
September 1987

A = L + C

Cash Equip Supl AR Payables
-------------------------------- --------
10,000 5,000 15,000 1.
(800) 800 2.
-------------------------------- -------- --------
9,200 5,000 800 0 0 15,000
500 500 3.
-------------------------------- -------- --------
9,200 5,500 800 0 500 15,000
(400) (400) 4.
-------------------------------- -------- --------
8,800 5,500 800 0 500 14,600
300 (300) 5.
-------------------------------- -------- --------
8,800 5,500 800 0 800 14,300
12,000 8,000 20,000 6.
-------------------------------- -------- --------
20,800 5,500 800 8,000 800 34,300
(300) (300) 7.
-------------------------------- -------- --------
20,500 5,500 800 8,000 500 34,300
(100) (100) 8.
-------------------------------- -------- --------
20,400 5,500 800 8,000 500 34,200
1,000 (1,000) 9.
-------------------------------- -------- --------
21,400 5,500 800 7,000 500 34,200
(200) (200) 10.
-------------------------------- -------- --------
21,400 5,500 600 7,000 500 34,000
================================ ======== ========
$21,400 $5,500 $600 $7,000 $500 $34,000

A = L + C

By looking at the capital column, we can determine the firm's NET
INCOME, which is equal to revenue less expenses.

For example:

INCOME STATEMENT


Professional Fee Revenue $20,000
Less: Expenses
Wages $400
Utilities 300
Office Supplies 200
----
Total Expenses 900
-------
Net Income $19,100
=======

NOTE: The "drawing" account is not an expense, but rather a with-
drawal of money for personal use by the owner and is, there-
fore, a disinvestment in the business.


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