Skills Development:

Financial Statement Introduction part 1 of 3

"If done accurately and timely, [accounting] is a very useful tool to tell us where we have been and where we are going."

Assets - Liabilities = Owner's Equity

by Willard Boone, CPA - With experience in the petroleum industry and serving small to medium sized companies through his own practice, Mr. Boone has gained a broad range of experience. He utilizes this experience to assist in the development of others as he has been training for the Becker CPA Review Course for more than 30 years. At present, in addition to various consulting engagements, he continues to be Becker's lead instructor in Oklahoma City, OK and an on-line instructor of the CPA preparatory course.

Accounting is the universal language of business. It is defined as 1. the system, science, or art of keeping, analyzing, and explaining commercial accounts. 2. a statement of debits and credits. 3. a settling or balancing of accounts. Accounting is something we use in many areas every day of our lives. If done accurately and timely, it is a very useful tool to tell us where we have been and where we are going. Some distinction between tax and management purposes is of significance in this context as Russian bookkeeping is entirely tax oriented.

The financial information provided by an accounting system is needed by management to help them plan and control activities of the economic entity. Financial information is also needed by outsiders-owners, creditors, investors, the government, and the public-who have supplied money to the business or who have some other interest that will be served by information about its financial position and operating results.

To create accounting information in a form which can be useful to the people who use the information, the classified information is summarized in financial reports, called financial statements. Financial statements show the financial position of the business at the time of the report and the operating results by which it arrived at this position.

The ultimate objective of accounting is the use of this information, its analysis and interpretation. Accountants look for meaningful relationships between events and financial results; they study the effect of various alternatives; and they search for significant trends that might help determine what will happen in the future.

Bookkeeping means the recording of transactions, the record-making phase of accounting. The recording of transactions tends to be mechanical and repetitive; however it is only a small part of accounting and probably the simplest part. Whereas accounting includes the design of accounting systems, preparation of financial statements, audits, cost studies, development of forecasts, income tax work, computer applications to accounting processes, and the analysis and interpretation of accounting information as an aid to making business decisions.

All accounting procedures are developed for consistency, comparability and continuity. The procedures need to be consistent so they can be comparable between periods, such as a month, or between years. This would also apply to comparing different companies, even if in different industries. The continuity is referred to as the “going concern” concept. Will this business be around in one year, five years, ten years, etc.?

International Accounting Standards (IAS) is used, while frequently countries have some variations that are unique to their country but generally are in keeping with IAS. In the United States, these procedures are referred to as Generally Accepted Accounting Principles, (GAAP). If accounting principles are followed by all companies, anyone looking at the financial statements of one company can feel comfortable in comparing it to another company. GAAP requires four basic financial statements; Balance Sheet, Income Statement, Statement of Retained Earnings and Statement of Cash Flows. The statements may also be known by other names. e.g. Balance Sheet is also known as Statement of Financial Position; the Income Statement is also known as the Statement of Operations or a Profit and Loss Statement, or P & L for short.

Training Pros International
Balance Sheet
December 31, 20xx
Cash	$20,000	Liabilities:
Accounts Receivable	10,000	Accounts Payable	$11,000
Furniture and Fixtures	3,000	Notes Payable	18,000
Automobiles	15,000	Total Liabilities	29,000
Land	20,000	Owner's Equity:
Building	50,000	Stockholders' Equity	89,000

Total	$118,000	Total	$118,000

The heading of the balance sheet lists three items: (1) Who? – the name of the business, (2) What? – the name of the business form, (3) When? – the date of the balance sheet. The purpose of the balance sheet is to show the financial position of a business at a particular date or point in time. It consists of a listing of the assets, liabilities, and the owner’s equity.

In fact, the balance sheet can be expressed in a very simple equation:

Assets = Liabilities + Owner’s Equity
($118,000 = $29,000 + $89,000)

An alternate form of the equation:

Assets - Liabilities = Owner’s Equity

Assets are the economic resources owned by a business and are expected to benefit future operations. Simply stated, Assets are what a business owns. Liabilities are debts; what a business owes. Therefore, the formula is what a business owns, less what they owe, is what they are worth.

One of the most basic problems in accounting is the valuation of assets; that is, the assignment of dollar values to the assets of a business. Most assets are accounted for on the basis of the dollars that have been invested in these resources, that is, the historical cost incurred in acquiring such property or property rights. Therefore, the “value” or “valuation” of an asset means the cost of that asset to the entity owning it.

Liabilities are debts. The liability arising from the purchase of goods or services on credit is called an accounts payable, and the company to whom the account payable is owed, is called a creditor. When money is borrowed, a formal written agreement (note), or contract, stating the amount to be repaid, plus interest, at a definite time in the future, is a notes payable.

Owner’s Equity represents the resources invested by the owner. It is equal to the assets minus the liabilities. Borrowing money from creditors does not increase owner’s equity. The owner’s equity comes from two sources: (1) investment by the owner, (2) Earnings retained in the business from the profitable operation of the business. Owner’s equity decreases in one of two ways: (1) Withdrawals of cash or other assets by the owner, or (2) Losses from unprofitable operation of a business. (In the corporate environment the owners own shares of stock. Therefore, for a corporation, the equity is known as stockholders’ equity).

Per the equation above, every transaction can be expressed in terms of the effect on the accounting equation. An increase or decrease in assets will result in a corresponding increase or decrease in liabilities or owner’s equity.

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