Assets, liability and equity

Most people have heard of assets, liabilities and equity. Especially when they had dealings with accounting at school or in a course or when doing practical bookkeeping. It’s important to really understand these concepts since they are at the foundation of much of what we do in accounting.

Assets

What are assets?

For accounting purposes here is a good working definition of what assets are:

  • assets belong to the business
  • assets have a re-sale value, or a cash value and
  • assets are usually used for the running of the business and generating income.

Some examples of assets include cars, equipment or machines, land and buildings, cash in the bank, money owed to the company (debtors), patents or trademarks, and stock.

Distinctions are also made between different kinds of assets. Financial statements will sometimes describe some assets as fixed, or as current assets.

Fixed assets are assets that a business is planning to hold on to for a long period of time. At least longer than 12 months. Of the examples listed above cars, equipment and machines, land and buildings fall into the fixed asset category.

Current assets are those assets that are much more short term in nature. Eg cash, debtors, stock, these are all examples of current assets. Current assets are either cash or assets that the company intends to convert into cash within a period of 12 months from the date it is reporting.

Liabilities

Think of liabilities as money that the business owes to someone. This someone can be the bank, a supplier, SARS, the landlord, etc. This specifically excludes money owed to the owner himself.

Examples of liabilities are loans, loans for machinery or cars (hire purchase agreements), mortgage bonds, trade creditors (people you buy things for business from eg. a shoe distributor), tax payable, and VAT.

Just as in the case of fixed assets, some financial statement will talk about long-term liabilities and current liabilities. Long term liabilities are those debts that need to be repaid more than 12 months from the period being reported.

Current liabilities are those debts that will be repaid within 12 months from the date being reported.

Equity or Owner’s Equity

Equity has quite a few definitions. Owners equity is those transactions that directly affect the owner.

This includes contributions made by owners, loans to and from owners and all income and expenses.

It is useful to think of all income and expenses as part of one big account called the trading account. And this trading account falls under the equities. More on this later when we deal with debits and credits.

Assets, Liabilities, Equity and the Chart of Accounts

Below is a standard set of accounts one would often find when using an accounting package. Go through them one by one and see if they seem familiar.

 

Sales
Cost of Sales
Accounting Fees
Bank Charges
Commissions
Depreciation
Interest Paid
Levies
Motor Expenses
Salaries and Wages
Retained Income
Members Loans
Bank Account
Motor Vehicle – at cost
Accounts Payable
Stock on Hand
Accounts Receivable

 

All of these accounts (any account that you will ever come across) can be classified as either an asset account, a liability account or an equity account.

In other words, accounts are really a more detailed view of what could really be shown as assets, liabilities and equity. For example, in a balance sheet statement you have an item called assets. Those assets are then split into more detail like bank, stock, account receivable.

Table of Commonly Used Accounts

Here is a table of commonly used accounts grouped by these three categories. Have a look at the table to see if it makes sense based on the definitions and examples given above.

assets liability equity

Examples of Accounting Statements

The reports that follow are what accounting is all about. After the hard work of capturing invoices, receipts, and payments etc is done, this is what we are looking for: all financial transactions recorded in a form that is easily understood. Here is a list of three popular ones.

Balance Sheet

A balance sheet statement is a snapshot of a business’s financial position on a specific day. In essence this report says here’s what we own (assets), here’s what we owe people (liabilities) and here’s what the difference is (equity).

Income Statement (or Profit and Loss Statement)

An income statement is a report on the trading activities of a business. These are commonly published for a year of trading. That means that this report tells us about the income the business made and the expenses that was incurred making that income.

Trial Balance

The trial balance is more of a standard report than financial statement. It is a report that shows a summary of all accounts and shows debit or credit balances for these accounts. That means everything. Not just trading accounts as in the case of the income statement and not just a summary of assets, equity and liabilities as in the case of the balance sheet.

Trial balances tend to be used by management and others like auditors. Published financial statements don’t include trial balances as one of the statements. Later on in this course we will thoroughly cover the trial balance.

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