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Assets

Assets refer to resources owned and controlled by the entity as a result of past transactions and events,
from which future economic benefits are expected to flow to the entity. In simple terms, assets
are properties or rights owned by the business. They may be classified as current or non-current.
A. Current assets Assets are considered current if they are held for the purpose of being traded,
expected to be realized or consumed within twelve months after the end of the period or its normal
operating cycle (whichever is longer), or if it is cash. Examples of current asset accounts are:
1.

Cash and Cash Equivalents bills, coins, funds for current purposes, checks, cash in bank, etc.

2. Receivables Accounts Receivable (receivable from customers), Notes Receivable (receivables


supported by promissory notes), Rent Receivable, Interest Receivable, Due from Employees (or
Advances to Employees), and other claims
Allowance for Doubtful Accounts This is a valuation account which represents the estimated
uncollectible amount of accounts receivable. It is considered a contra-asset account and is presented as a
deduction to the related asset, accounts receivable. Doubtful accounts are discussed in detail in another
lesson.
3. Inventories assets held for sale in the ordinary course of business
4. Prepaid expenses expenses paid in advance, such as, Prepaid Rent, Prepaid Insurance, Prepaid
Advertising, and Office Supplies
B. Non-current assets Assets that do not meet the criteria to be classified as current. Hence, they are
long-term in nature useful for a period longer that 12 months or the company's normal operating cycle.
Examples of non-current asset accounts include:
1.

Long-term investments investments for long-term purposes such as investment in stocks,


bonds, and properties; and funds set up for long-term purposes

2. Land land area owned for business operations (not for sale)
3. Building such as office building, factory, warehouse, or store
4. Equipment Machinery, Furniture and Fixtures (shelves, tables, chairs, etc.), Office Equipment,
Computer Equipment, Delivery Equipment, and others
Accumulated Depreciation This is a valuation account which represents the cumulative depreciation
expense. It is considered a contra-asset account and is presented as a deduction to the related asset.
Depreciation is discussed in detail in another lesson.
5.

Intangibles long-term assets with no physical substance, such as goodwill, trademark,


copyright, etc.

6. Other long-term assets

Liabilities
Liabilities are economic obligations or payables of the business.
Company assets come from 2 major sources borrowings from lenders or creditors, and contributions by
the owners. The first refers to liabilities, the second to capital.
Liabilities represent claims by other parties, aside from the owners, against the assets of a company.
Like assets, liabilities may be classified as either current or non-current.
A. Current liabilities A liability is considered current if it is due within 12 months after the end of the
balance sheet date. In other words, they are expected to be paid in the next year.
If the company's normal operating cycle is longer than 12 months, a liability is considered current if it is
due within the operating cycle.
Current liabilities include:
1.

Trade and other payables such as Accounts Payable, Notes Payable, Interest Payable, Rent
Payable, Accrued Expenses, etc.

2. Current provisions estimated short-term liabilities that are probable and can be measured
reliably
3. Short-term borrowings financing arrangements, credit arrangements or loans that are shortterm in nature
4. Current-portion of a long-term liability the portion of a long-term borrowing that is currently
due.
Example: For long-term loans that are to be paid in annual installments, the portion to be paid next year
is considered current liability. The rest, non-current.
5.

Current tax liabilities taxes for the period and are currently payable

B. Non-current liabilities Liabilities are considered non-current if they are not currently payable,
i.e. they are not due within the next 12 months after the end of the accounting period or the company's
normal operating cycle, whichever is shorter.
In other words, non-current liabilities are those that do not meet the criteria to be considered
current.Hah! Make sense? Non-current liabilities include:
1.

Long-term notes, bonds, and mortgage payables;

2. Deferred tax liabilities; and


3. Other long-term obligations

Capital
Also known as net assets or equity, capital refers to what is left to the owners after all liabilities are
settled. Simply stated, capital is equal to total assets minus total liabilities. Capital is affected by the
following:
1.

Initial and additional contributions of owner/s (investments),

2. Withdrawals made by owner/s (dividends for corporations),


3. Income, and
4. Expenses.
Owner contributions and income increase capital. Withdrawals and expenses decrease it.
The terms used to refer to a company's capital portion varies according to the form of ownership. In a sole
proprietorship business, the capital is called Owner's Equity or Owner's Capital; in partnerships, it is
called Partners' Equity or Partners' Capital; and in corporations, Stockholders' Equity.
In addition to the three elements mentioned above, there are two items that are also considered as key
elements in accounting. They are income and expense. Nonetheless, these items are ultimately included as
part of capital.
Income
Income refers to an increase in economic benefit during the accounting period in the form of an increase
in asset or a decrease in liability that results in increase in equity, other than contribution from owners.
Income encompasses revenues and gains.
Revenues refer to the amounts earned from the companys ordinary course of business such
asprofessional fees or service revenue for service companies and sales for merchandising and
manufacturing concerns.
Gains come from other activities, such as gain in selling old equipment, gain on sale of short-term
investments, and other gains.
Income is measured every period and is ultimately included in the capital account. Examples of income
accounts are: Service Revenue, Professional Fees, Rent Income, Commission Income, Interest Income,
Royalty Income, and Sales.

Expense
Expenses are decreases in economic benefit during the accounting period in the form of a decrease in
asset or an increase in liability that result in decrease in equity, other than distribution to owners.
Expenses include ordinary expenses such as Cost of Sales, Advertising Expense, Rent Expense, Salaries
Expense, Income Tax, Repairs Expense, etc.; and losses such as Loss from Fire, Typhoon Loss, and Loss
from Theft. Like income, expenses are also measured every period and then closed as part of capital.
Net income refers to all income minus all expenses.

Transactions include sales, purchases, receipts, and payments made by an individual or organizations.
Overview of Sales
A sale is a transfer of property for money or credit. Revenue is earned when goods are delivered or
services are rendered. In double-entry bookkeeping, a sale of merchandise is recorded in the general
journal as a debit to cash or accounts receivable and a credit to the sales account. The amount recorded is
the actual monetary value of the transaction, not the list price of the merchandise. A discount from list
price might be noted if it applies to the sale. Fees for services are recorded separately from sales of
merchandise, but the bookkeeping transactions for recording sales of services are similar to those for
recording sales of tangible goods (Figure 1).
Overview of Purchases
Purchasing refers to a business or organization acquiring goods or services to accomplish the goals of its
enterprise. This transaction results in a decrease in the finances of the purchaser and an increase in the
benefits of the sellers. Purchases can be made by cash or credit. As credit purchases are made, accounts
payable will increase.
Overview of Receipts
Receipts refer to a business getting paid by another business for delivering goods or services. This
transaction results in a decrease in accounts receivable and an increase in cash or equivalents.
Overview of Payments
Payments refer to a business paying another business for receiving goods or services. The business that
makes the payment will decrease its accounts payable as well as its cash or equivalents. On the other
hand, the business that receives the payment will see a decrease in accounts receivable but an increase in
cash or equivalent

Debits and Credits

Debit and Credit Definitions

In accounting transactions, we record numbers in two accounts, where the debit column is on the left and
the credit column is on the right.

A debit is an accounting entry that either increases an asset or expense account, or decreases
a liability or equity account. It is positioned to the left in an accounting entry.

A credit is an accounting entry that either increases a liability or equity account, or decreases
an asset or expense account. It is positioned to the right in an accounting entry.

Debit and Credit Usage

Whenever you create an accounting transaction, at least two accounts are always impacted, with a debit
entry being recorded against one account and a credit entry being recorded against the other account.
There is no upper limit to the number of accounts involved in a transaction - but the minimum is no less
than two accounts. The totals of the debits and credits for any transaction must always equal each other,
so that an accounting transaction is always said to be "in balance." If a transaction were not in balance,
then it would not be possible to create financial statements. Thus, the use of debits and credits in a twocolumn transaction recording format is the most essential of all controls over accounting accuracy.

There can be considerable confusion about the inherent meaning of a debit or a credit. For example, if you
debit a cash account, then this means that the amount of cash on hand increases. However, if you debit an
accounts payable account, this means that the amount of accounts payable liability decreases. These
differences arise because debits and credits have different impacts across several broad types of accounts,
which are:

Asset accounts. A debit increases the balance and a credit decreases the balance.

Liability accounts. A debit decreases the balance and a credit increases the balance.

Equity accounts. A debit decreases the balance and a credit increases the balance.
The reason for this seeming reversal of the use of debits and credits is caused by the underlying
accounting formula upon which the entire structure of accounting transactions are built, which is:

Assets = Liabilities + Equity

Thus, in a sense, you can only have assets if you have paid for them with liabilities or equity, so you must
have one in order to have the other. Consequently, if you create a transaction with a debit and a credit,
you are usually increasing an asset while also increasing a liability or equity account (or vice versa). There
are some exceptions, such as increasing one asset account while decreasing another asset account.

If you are more concerned with accounts that appear on the income statement, then these additional rules
apply:

Revenue accounts. A debit decreases the balance and a credit increases the balance.

Expense accounts. A debit increases the balance and a credit decreases the balance.

Gain accounts. A debit decreases the balance and a credit increases the balance.

Loss accounts. A debit increases the balance and a credit decreases the balance.
If you are really confused by these issues, then just remember that debits always go in the left column, and
credits always go in the right column. There are no exceptions.

Debit and Credit Rules

The rules governing the use of debits and credits are as follows:

All accounts that normally contain a debit balance will increase in amount when a debit (left
column) is added to them, and reduced when a credit (right column) is added to them. The types of
accounts to which this rule applies are expenses, assets, and dividends.

All accounts that normally contain a credit balance will increase in amount when a credit (right
column) is added to them, and reduced when a debit (left column) is added to them. The types of accounts
to which this rule applies are liabilities, revenues, and equity.

The total amount of debits must equal the total amount of credits in a transaction. Otherwise, an
accounting transaction is said to be unbalanced, and will not be accepted by the accounting software.
Debits and Credits in Common Accounting Transactions

The following bullet points note the use of debits and credits in the more common business transactions:

Sale for cash: Debit the cash account | Credit the revenue account

Sale on credit: Debit the accounts receivable account | Credit the revenue account

Receive cash in payment of an account receivable: Debit the cash account | Credit the accounts
receivable account
Purchase supplies from supplier for cash: Debit the supplies expense account | Credit the cash

account

Purchase supplies from supplier on credit: Debit the supplies expense account | Credit the
accounts payable account
Purchase inventory from supplier for cash: Debit the inventory account | Credit the cash account

Purchase inventory from supplier on credit: Debit the inventory account | Credit the accounts
payable account

Pay employees: Debit the wages expense and payroll tax accounts | Credit the cash account

Take out a loan: Debit cash account | Credit loans payable account

Repay a loan: Debit loans payable account | Credit cash account


Debit and Credit Examples

Arnold Corporation sells a product to a customer for $1,000 in cash. This results in revenue of $1,000 and
cash of $1,000. Arnold must record an increase of the cash (asset) account with a debit, and an increase of
the revenue account with a credit. The entry is:

Debit
Cash

Credit

1,000

Revenue

1,000

Arnold Corporation also buys a machine for $15,000 on credit. This results in an addition to the
Machinery fixed assets account with a debit, and an increase in the accounts payable (liability) account
with a credit. The entry is:

Debit
Machinery - Fixed Assets
Accounts Payable

Credit

15,000
15,000

Other Debit and Credit Issues

A debit is commonly abbreviated as dr. in an accounting transaction, while a credit is abbreviated as cr. in
an accounting transaction.

Debits and credits are not used in a single entry system. In this system, only a single notation is made of a
transaction; it is usually an entry in a check book or cash journal, indicating the receipt or expenditure of
cash. A single entry system is only designed to produce an income statement.

Assets

An asset is something that is either owned, is owed to you, or may provide a future benefit. Both
assets and liabilities can be either current (the benefit is received in less then 12 months) or non current
(more then 12 months).

Cash and its equivalents: the most common asset, cash may be held by the bank, but is available to
you at call. Term deposits are another vehicle in which cash can be invested but may not be available to
withdrawal until a certain period has passed.

Receivables/debtors: although not cash, debtors and receivables are still money owed to you or
the business. It may include short term loans provided to others, or trade debtors such as outstanding
invoices that customer are yet to pay.

Prepayments: in many circumstances it may be necessary or more beneficial to purchase


something in advance, before the benefit may be received. An example would be car insurance paid
annually. Although purchased at the beginning of the year, the full benefit is not received until the policy
has expired.

Property, plant & equipment: unlike the previous three examples, property, plant and equipment
is an asset because the item provides a benefit as its being used. Such assets range from office equipment
such as a computer or fax machine, to trucks, and production machinery.

* Liabilities

A liability on the other hand, is something that is owed to someone else, and therefore at one stage or
another an asset will have to decrease or equity increase to enable payment.

Overdrafts and credit cards: short term cash advances in the form of overdrafts and credit cards
are funds that have been used, but will, at one stage or another require repayment. In addition to payment
of the actual amount borrowed, called the principle, interest will also be incurred.

Payables/creditors: this is where payment is required for an outgoing, a benefit has been received
but not paid for. Similar to an overdraft or credit card, but payment is made directly with the supplier.

Unearned income: alternatively called income in advance, this is essentially a prepayment of


income, but the work has not been started or completed and therefore is essentially not earned. Putting it
simply, cash received is not income until it has actually been earned.

Long term borrowings: there is a wide range of long term financing, including bank loans, hire
purchases and finance leases. Borrowings are funds loaned from, in most cases a financial institution to
pre purchase cash, products or equipment in advance of repayment. As with overdrafts and credit cards, it
will be necessary to pay back interest as well as the principle initially borrowed.

* Capital

Unlike liabilities, capital is a cash injection or reserve that doesnt generally require repayment by the
business.

Shares: generally only available in companies, private or public, the issuing of shares is actually
selling a proportion of the company for a cash injection. Purchasing shares will usually result in rights as
an owner, including a share of the profit, or votes at shareholders meetings.

Retained earnings: when profit is not shared among the owners of the business, it is retained.
Retained earnings are either reinvested into the business, or used as a safety net in case there is a decline
in future profits.

Reserves: unlike other capital, reserves are not an injection of cash or profit already earned. Rather
reserves are a means of revaluing assets to market value, providing a more accurate view of the assets
worth if sold at a specific time.

Assets, liabilities and capital, are one of the fundamental terms used in accounting. Without an
understanding of these terms it is not possible to accurately analysis or read financial statements. The
accounting equation Assets Liabilities = Capital is also a fundamental rule that without it, would not
result in the double entry accounting method used so commonly in todays economic world.

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