CHAPTER 2 Flashcards
Equities
What liabilities and owner’s equity have in common is that they are both equities or claims on the assets of the business. That is, liabilities are what the business owes to external parties, while owner’s equity is what the business owes to the owner. Both types of claim must be funded from the business’s assets.
The accounting equation
Assets must always equal liabilities plus owner’s equity. It is not possible for the equation to be out of balance. It is not possible for owner’s equity to equal an amount greater then assets, because there would be insufficient assets to fund the claim.
On the other hand, it is not possible for owner’s equity to equal an amount less than assets - liabilities. It is not possible for an amount to remain unclaimed, proving that the accounting equation must always balance.
Balance sheet
The relationship between assets, liabilities and owner’s equity - as described by the accounting equation - is at the heart of the Balance Sheet. The Balance Sheet is an accounting report that details the firm’s assets, liabilities and owner’s equity at a particular point in time, and is a reflection of the firm’s accounting equation.
Current Asset
A resource controlled by the entity (as a result of a past event), from which a future economic benefit is expected for in 12 months or less
Non current asset
A resource controlled by the entity (as a result of a past event), from which a future economic benefit is expected for in more than 12 months.
Current liability
A present obligation of the business as a result of past events, the settlement of which is expected to result in an outflow of economic benefits in more than 12 months.
Current liability
A present obligation of the business as a result of past events, the settlement of which is expected to result in an outflow of economic benefits in more than 12 months.
Uses of the balance sheet
With current and non-current items identified, the Balance Sheet now has more Relevance for decision-making. For example, it can be used to identify the amount of debts that must be met in the forthcoming year; that is, current liabilities. If the owner wants to go further, the current liabilities can be compared against the current assets to assess the firm’s ability to meet those short-term debts. This is, in effect, an assessment of the firm’s liquidity by calculating its Working Capital Ratio.
Double entry accounting
A system of accounting where every transaction will affect at least two items in the accounting equation which is known as a double entry. After recording these changes, the accounting equation must and will still balance.
