The basics of accounting involve three fundamental elements; assets, liabilities and equity. These elements make up the basis for financial reports such as balance sheets, ledgers, and other means accountants use to maintain financial records for businesses, corporations and individuals. In accounting, it is vital that the equity that makes up the assets and the liabilities all balance mathematically.
Current and Long-Term Assets
An asset is a resource that a corporation, organization, or person owns and utilizes to maintain the functionality and operation of a business or lifestyle. Some assets such as your company's cash, office supplies and inventory are considered current assets since they are converted to cash or used up within a year. Long-term assets include your company's long-term investments, property and equipment, since you either use or hold these assets for a longer period than a year.
Assets, for businesses, can also be classified into several categories. Necessities are assets that a business could not function without. On a large scale, examples could be factories or heavy equipment, and, on a smaller scale, assets could be paper to run your business's cash register or shelving to display your merchandise.
Assets can also be convenience items, such as a water cooler in the break room, or useful items, such as your company cars, office furniture, or lighting. Individuals also possess assets, from real estate to vehicles to high-definition televisions. Another way to think of assets is something a business or person owns that can be used as collateral against a loan, such as a house or property.
Current and Long-Term Liabilities
In accounting terms, liabilities refer to debts or obligations that a business or an individual owes. A liability is not necessarily considered a negative function, in these terms, since obligations to creditors are a necessary function of business and personal life. Businesses need to pay for inventory, equipment, and real estate, and credit is the life blood for such activities.
Like assets, you categorize liabilities as current or long term. If your company takes out an account with a supplier to buy on credit and pay it back within a year, then that debt is current. A mortgage you take out to pay for your office building, however, would be a long-term liability since it will take several years to repay that obligation.
The same principle can be applied to individuals, who must make auto and home mortgage payments, credit card payments, and payments for medical or school bills. In a healthy business or household ledger, assets will outweigh liabilities, while problems occur when liabilities become too large and owners have difficulty keeping up with payments to creditors.
The Owner's Equity
Owner’s equity refers to the difference between what a person or a business owns and what is owed. Totaling the owner’s assets and liabilities is another way to measure the total assets. Equity in business increases when your company either generates revenue or investors add cash as an investment in business growth. Taking on additional debts and expenses will lower your owner's equity.
Individuals can gain equity through adding money through personal savings, gifts, or investment growth. A decrease in equity occurs when a businesses or individual withdraws funds from accounts or makes regular or large purchases. The measure of an owner’s equity is constantly changing as assets and/or liabilities rise and fall and, in accounting, it is vital to make sure all balance out properly.
- Jupiterimages/Comstock/Getty Images