Accounting: Examining Both Sides of Business Transactions
The accountant’s job is to capture all the transactions of the business, determine the financial effects of every transaction, record every transaction in the business’s accounts, and from the accounts prepare the financial statements.
To carry out their mission, accountants must understand how transactions (and certain other events) affect the financial condition of the business. To illustrate the impact of transactions, consider the case of a business that has been in operation for many years. Its condensed balance sheet at the start of the year appears below.
Most businesses report more than just the four kinds of assets shown in the example, but these four are the hard-core assets of a business that sells products. (PP&E stands for property, plant, and equipment, which is the generic name for the long-term operating assets of a business. The term net means that the amount of accumulated depreciation that has been recorded up to this time is deducted from the cost of the assets.)
Liabilities are divided into two types based on their sources:
Those that arise out of operating activities
Those that result from borrowing money on interest-bearing debt
Operating liabilities are short-term and do not bear interest. Owners’ equity is shown in two different accounts in the figure above. The first is for capital invested in the business by its owners. This source of owners’ equity is segregated from the other owners’ account, which expresses profit that has been earned and retained by the business.
In the example, you can see that the total assets and the total liabilities plus owners’ equity appear below the line. This information is the accounting equation of the business. The accounting equation is in balance, as it should be.