The basis for the accounting process is the accounting equation. It shows the relationship among the firm’s assets, liabilities and owner’s equity.
Assets are the items of value that a firm owns – cash, inventories, land, equipment, buildings, patents, and the like.
Liabilities are the firm’s debts and obligations – what it owes to others.
Owner’s equity is the difference between a firm’s assets and its liabilities – what would be left over for the firm’s owners if its assets were used to pay off its liabilities.
The relationship among these three terms is the following:
Owner’s equity = assets – liabilities
(The owner’s equity is equal to the assets minus the liabilities)
For a sole proprietorship or partnership, the owner’s equity is shown as the difference between assets and liabilities. In a partnership, each partner’s share of the ownership is reported separately by each owner’s name. For a corporation, the owner’s equity is usually referred to as stockholders’ equity or shareholders’ equity. It is shown as the total value of its stock, plus retained earnings that have accumulated to date.
By moving the above three terms algebraically, we obtain the standard form of the accounting equation.
Assets = liabilities + owners’ equity
(The assets are equal to the liabilities plus the owners’ equity)
A balance sheet
A balance sheet (or statement of financial position), is a summary of a firm’s assets, liabilities, and owners’ equity accounts at a particular time, showing the various money amounts that enter into the accounting equation. The balance sheet must demonstrate that the accounting equation does indeed balance. That is, it must show that the firm’s assets are equal to its liabilities plus its owners’ equity. The balance sheet is prepared at least once a year. Most firms also have balance sheets prepared semiannually, quarterly, or monthly.
An income statement
An income statement is a summary of a firm’s revenues and expenses during a specified accounting period. The income statement is sometimes called the statement of income and expenses. It may be prepared monthly, quarterly, semiannually, or annually. An income statement covering the previous year must be included in a corporation’s annual report to its stockholders
The importance of the above two statements
The information contained in these two financial statements becomes more important when it is compared with corresponding information for previous years, for competitors, and for the industry in which the firm operates. A number of financial ratios can also be computed from this information. These ratios provide a picture of the firm’s profitability, its short-term financial position, its activity in the area of accounts receivables and inventory, and its long-term debt financing. Like the information on the firm’s financial statements, the ratios can and should be compared with those of past accounting periods, those of competitors, and those representing the average of industry as a whole.
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Answer the questions:
- What is accounting? Give a short definition.
- It is possible to manage a business operation without accurate and timely accounting information?
- Who needs accounting information? Explain why.
- What is the basis for accounting process?
- State (изложите) the standard form of the accounting equation.
- What is the balance sheet? Give a short definition.
- What must a balance sheet show?
- What is an income statement?
- What can be computed from the information contained in a balance sheet and an income statement?
- Do the ratios computed from this information provide a picture of a firm’s profitability and its financial position?
- Is this information for competitors?
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