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Balance Sheet Basics and the Accounting Equation

Service Revenues include work completed whether or not it was billed. Service Revenues is an operating revenue account and will appear at the beginning of the company’s income statement. Although accountants generally do not increase the value of an asset, they might decrease its value as a result of a concept known as conservatism. For example, after a few months in business, Joe may decide that he can help out some customers—as well as earn additional revenues—by carrying an inventory of packing boxes to sell. Let’s say that Direct Delivery purchased 100 boxes wholesale for $1.00 each. Since the time when Joe bought them, however, the wholesale price of boxes has been cut by 40% and at today’s price he could purchase them for $0.60 each.

• The third sample transaction also occurs on December 2 when Joe contacts an insurance agent regarding insurance coverage for the vehicle Direct Delivery just purchased.
• A current asset that reports the amount paid for advertising that has not yet taken place.
• From the accounting equation, we see that the amount of assets must equal the combined amount of liabilities plus owner’s (or stockholders’) equity.
• The reason Service Revenues is credited is because Direct Delivery must report that it earned $10 (not because it received $10).
• Joe looks at the total of $20,000 on the asset side, and looks at the $20,000 on the right side, and says yes, of course, he can see that it is indeed in balance.
• Service Revenues is an operating revenue account and will appear at the beginning of the company’s income statement.
• A long-term asset account that reports a company’s cost of automobiles, trucks, etc.

Other expenses, such as selling, general, and administrative (SG and A) expenses, are subtracted to arrive at net income. Often this is interest and dividends earned on a company’s investment in stocks accounting equation for dummies and bonds of other companies. A class of corporation stock that provides for preferential treatment over the holders of common stock in the case of liquidation and dividends.

Corporation Transaction C6.

A company’s net income from the start of the current accounting year until a specified date. For example, the year-to-date net income at May 31, 2025 for a calendar year company is the net income from January 1, 2025 until May 31, 2025. For a company with a fiscal year beginning on July 1, 2024 the year-to-date net income at May 31, 2025 is the net income for the 11-month period from July 1, 2024 through May 31, 2025. A current asset whose ending balance should report the cost of a merchandiser’s products awaiting to be sold.

Assets in Accounting: A Beginners’ Guide

The amount of goodwill is the cost to purchase the business minus the fair market value of the tangible assets, the intangible assets that can be identified, and the liabilities obtained in the purchase. Shareholders’ equity is the total value of the company expressed in dollars. Put another way, it is the amount that would remain if the company liquidated all of its assets and paid off all of its debts. The remainder is the shareholders’ equity, which would be returned to them. In other words, the total amount of all assets will always equal the sum of liabilities and shareholders’ equity. The double-entry practice ensures that the accounting equation always remains balanced, meaning that the left-side value of the equation will always match the right-side value.

• If assets increase, either liabilities or owner’s equity must increase to balance out the equation.
• This explanation of accounting basics will introduce you to some basic accounting principles, accounting concepts, and accounting terminology.
• If you need more practice on this and other topics from your accounting course, visit Dummies.com to purchase Accounting For Dummies!
• Speakers, Inc. purchases a $500,000 building by paying $100,000 in cash and taking out a $400,000 mortgage.
• Accounts receivable list the amounts of money owed to the company by its customers for the sale of its products.

Joe immediately writes a check for $1,200 and mails it to the insurance company. Below is a break down of subject weightings in the FMVA® financial analyst program. As you can see there is a heavy focus on financial modeling, finance, Excel, business valuation, budgeting/forecasting, PowerPoint presentations, accounting and business strategy. Practically everyone has trouble with the rules of debits and credits. The rules aren’t very intuitive, but learning them is a rite of passage for bookkeepers and accountants.

Accounting Equation for a Sole Proprietorship: Transactions 1-2

Before explaining what this means and why the accounting equation should always balance, let’s review the meaning of the terms assets, liabilities, and owners’ equity. In general terms, conservative accounting methods are pessimistic, and liberal methods are optimistic. The choice of accounting method also affects the values reported for assets, liabilities, and owners’ equities in the balance sheet. Continuing with this example, suppose that the total amount of the liabilities of the business is $1.0 million. This means that the total amount of owners’ equity in the business is $1.5 million, which equals total assets less total liabilities.

Corporation Transaction C2.

A current asset that reports the amount paid for advertising that has not yet taken place. When the advertising occurs the prepaid advertising is reduced and advertising expense is recorded. A sole proprietorship is a simple form of business where there is one owner. However, for accounting purposes the economic entity assumption results in the sole proprietorship’s business transactions being accounted for separately from the owner’s personal transactions. (Some corporations have preferred stock in addition to their common stock.) Shares of common stock provide evidence of ownership in a corporation.

Insurance Expense, Wages Expense, Advertising Expense, Interest Expense are expenses matched with the period of time in the heading of the income statement. Under the accrual basis of accounting, the matching is NOT based on the date that the expenses are paid. Fees earned from providing services and the amounts of merchandise sold. Under the accrual basis of accounting, revenues are recorded at the time of delivering the service or the merchandise, even if cash is not received at the time of delivery. Other examples of things that might be paid for before they are used include supplies and annual dues to a trade association. The portion that expires in the current accounting period is listed as an expense on the income statement; the part that has not yet expired is listed as an asset on the balance sheet.

Intangible Assets

The amounts in the general ledger accounts are then used to prepare the balance sheets and income statements. Notice that the year-to-date net income (bottom line of the income statement) increased stockholders’ equity by the same amount, $180. This connection between the income statement and balance sheet is important. For one, it keeps the balance sheet and the accounting equation in balance. Secondly, it demonstrates that revenues will cause the stockholders’ equity to increase and expenses will cause stockholders’ equity to decrease.

Accounting software will permit Joe to generate the financial statements and other reports that he will need for running his business. Investing and financing activities of a particular period are reported in that period’s statement of cash flows. In contrast, set-up and follow-up transactions for sales and expenses stay in the background, meaning that they are not reported in a financial statement. Nevertheless, these transactions are essential to the profit-making process. Accountants and bookkeepers record transactions as debits and credits, while keeping the accounting equation constantly in balance.

Other names used for this equation are balance sheet equation and fundamental or basic accounting equation. Marilyn moves on to explain the balance sheet, a financial statement that reports the amount of a company’s (A) assets, (B) liabilities, and (C) stockholders’ (or owner’s) equity at a specific point in time. Because the balance sheet reflects a specific point in time rather than a period of time, Marilyn likes to refer to the balance sheet as a “snapshot” of a company’s financial position at a given moment. For example, if a balance sheet is dated December 31, the amounts shown on the balance sheet are the balances in the accounts after all transactions pertaining to December 31 have been recorded. The balance sheet is also known as the statement of financial position and it reflects the accounting equation. The balance sheet reports a company’s assets, liabilities, and owner’s (or stockholders’) equity at a specific point in time.