In order for us to get to this point, we will back up a bit to take us to the beginning of a business. The main thing that we will be discussing will be a sole proprietorship, basically like a family farm/ranch operation. (A mom and pop operation, as the world views it) and the discussion will be given to make illustrations to where a corporation, a partnerships, etc, would have differences, but not a lot of time will be given to those two entities. At any time during this on line class, should you have questions please feel free to call and visit with me. If you have a question, please don't hesitate to let me know, so that I can clear up the area.
The basis for all of our following discussion goes into accounting. Accounting is defined as the process of identifying measuring and communicating economic information to permit judgments and decisions by qualified uses of this information. In other words, those who are in the lending of the funds to support our operations are judging what we have done by the way our information is given back to them.
The foundation for all of this work is based upon business transactions. A business transaction is the occurrence of an event or of a condition that must be recorded. For example, a purchase of fuel oil or gas or perhaps the sale of one of our products, ie, bales of cotton, heads of cows, etc. The properties owned by a business or operation are referred to as assets and the rights or claims to these properties are referred to as equities, so we can say that our assets = our equities. Equities may be subdivided into two principle types: 1) the rights of creditors and 2) the rights of owners. The rights of creditors represent debts of the business and are called liabilities. The rights of the owners are called owner’s equity. Expansion of the equation to give recognition to the two basic types of equities yields the following, which is known as the accounting equation:
ASSETS = LIABILITIES + OWNER’S EQUITY
It is customary to place liabilities before owner’s equity in the accounting equation because creditors have preferential rights to the assets. The residual claim of the owner or owners is sometimes given greater emphasis by transposing liabilities to the other side of the equation thus it would read:
ASSETS - LIABILITIES = OWNER’S EQUITY
All business transactions, from the simplest to the most complex, can be stated in terms of the resulting change in the three basic elements of the accounting equation. The effects of these changes on the accounting equation can be obviously seen in the outcome of the numerous different transactions. A particular business transaction may lead to an event or a condition that results in another transaction. Each of these events must be recorded so that they overall picture can be complete. One such transaction is called an internal transaction. All business transactions from the simplest to the most complex can be stated in terms of the resulting change in the three basic elements of the accounting equation. One type of account is called accounts payable. This one would be used whenever a purchase is made but it is not paid for at the time the service or items is acquired into your possession. Consumable goods purchased, such as supplies, are considered to be prepaid expenses, but these are actually assets. Another type of transaction would reflect the amount charged to customers for goods or services sold to them and is called revenue. Other terms may be used for certain kinds of revenue, such as sales for the sale of merchandise or business services, fees earned for charges by a physician to patients, and rent earned for the use of real estate or other property. Instead of requiring the payment of cash at the time goods or services be sold a business may make sales on account allowing the customer to pay later. In such case the firm acquires an accounts receivable, which is a claim against the customer.
After the effects of the individual transactions have been determined, the essential information is communicated to the users of the financial information network. The accounting statements that communicate this information are called financial statements. Those principal financial statements as we already stated, are the income statement, the statement of owner’s equity, the balance sheet and the statement of cash flow.