The accounting equation and its key component.
According to the principle of accounting, the fundamental accounting equation is :
Assets = Liabilities + Owners’ Equity
Assets are basically the economic resources owned by the entity, such as cash, accounts receivable, inventories, land, buildings, equipment, and even intangible assets like patents and other legal rights.
Liabilities, in short, are obligations and duty, which are amounts owed to others. Loans, extensions of credit. It's basically the existing obligation to pay or perform some duty.
Owners’ equity also called net assets since it is equivalent to assets minus liabilities, and depends on the legal form of the entity, the owner is different. For instance, a business can run by sole proprietorships, partnerships, and corporations. A sole proprietorship is a business owned by one person and typically consists of a single owner’s capital account. A partnership is a business owned by more than one person, with a separate capital account for each partner. A corporation is ownership interest being represented by divisible shares of stock, generally corresponding to the owner investments in the capital stock and additional amounts generated through earnings that have not been paid out to shareholders as dividends.
Generally accepted accounting principles
According to the principle of accounting, financial reports prepared under the generally accepted accounting principles (GAAP), intended to be general-purpose, not prepared especially for owners, or creditors, or any other particular user group. Instead, they are intended to be equally useful for all user groups. As such, attempts are made to keep them free from bias (neutral). Standard-setting bodies are guided by concepts that are aimed at production of relevant and representationally faithful reports
Key principles
- Not prepared especially for owners, or creditors, or any other particular user group.
- Equally useful for all user groups
- Keep free from bias and neutral
- Relevant and representationally faithful
The basic financial statements and their purpose
As we have learned from the textbook, the income statement, statement of retained earnings, statement of cash flows and balance sheet are the four core financial statements.
The income statement, a summary of an entity’s results of operation for a specified period, in short, is operations, revenues, and expenses, partly similar to our daily life(We get paychecks and we spend it).
Statement of retained earnings provide dividends, net income or loss information.
The balance sheet is an overall summary of total assets, liabilities, and equity. The balance sheet portrays financial position while other statements reflect the results of operations.
Statement Of Cash Flows provide the details of an entity's cash flows, in other words, why we spend, received and how much the amounts of these flows.
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