It is important that all organizations keep records of their resources, resource uses and claims against the organization. These resources are known as assets, and represent the things of value that the company owns.
There are financial assets such as Cash in the bank and Account Receivables (amounts owed to the company). There are also non-financial assets, such as machinery and office furniture. Also there are Intangible assets defined as identifiable non-monetary assets that cannot be seen, touched or physically measured, which are created through time such as Goodwill.
ASSET AND LIABILITY
The business assets can be obtained from money contributed to the business by its owners to expand operations. Borrowing from a bank also creates an asset (Cash) and also a liability (note payable). The business also incurs an asset (Inventory) and a liability (Accounts payable or notes payable) when merchandise inventory is acquired.
A net increase to assets is obtained assets such as inventory is sold at a price higher than that at which it is bought, including the expenses to sell.–resulting in a profit. Note that the overall profit for any given period is derived by subtracting all the expenses of operation from the revenue generated. It should also be noted that the total expenses used in the computation depends on whether the company is using the CASH BASIS or the ACCRUAL BASIS of accounting.
CASH AND ACCRUAL BASIS
The cash method is more commonly used in small businesses. Under the cash method, income is not counted until payment is actually received, and expenses are not counted until they are actually paid.
Under the accrual method, transactions are counted when the goods or services are ordered, the item is delivered, or the services received, regardless of when the money for them is actually received or paid.
Profit is the motive of all business-type organizations. This form of organization is distinct from a non-profit organization, such as a charity or a church.
The difference between assets and liability is called Equity or Capital. Capital can also be introduced to the business when the owner or shareholder makes a contribution to the business.
We derive the accounting equation from these three elements-asset, liability and equity. The equation is: Assets = Liability + Equity – meaning that the assets of an entity are equal to the resources of those assets: which is the liability and equity.
Thus, at any given time in a period, a financial statement can be prepared showing the assets on one side of a balance Sheet and the liabilities and equity on the other side. This statement is called a Balance Sheet, and represents the status of the financial position of a business. Some non-profit organization also refers to this statement as a statement of financial position.
Equity will be changed (increased) when an asset is sold for profit, and will be decreased when an item is sold at a loss.
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