Knowing accounting equation is very essential especially if we are in the early process of establishing a new company.
Accounting equation is the way to express the relationship between resources supplied by the owner and the resources in the business.

Resources supplied by the owner = Resources in the business

In accounting we have to know the 'jargon' language which means the special terms are used to describe something.
In this case, the amount of resources supplied by the owner is called capital. The actual resources that are then in the business are called assets. So, the accounting equation can be shown as:

Capital = Assets

In order to run the business, the owner might ask other people to supply some of the assets. Meaning that the business Liabilities is the name given to the amounts owing to these people for these assets. The accounting equation has now changed to:

Capital = Assets - Liabilities
Assets = Capital + Liabilities
Liabilities = Assets - Capital

However, the common way to express the equation is:

Assets = Capital + Liabilities
The above equation is known as the basic acounting equation or the balance sheet equation. it forms the basis of the whole double entry bookkeeping system. The equality of the accounting equation is always maintained regardless of the number of transactions recorded in the business. Any change in the amount of the total assets is always accompanied by an equal change in the amount of the total liabilities and owner's equity.
The accounting equation A = C + L is expressed in a financial statement known as the Balance Sheet. It is the detailed expression of the accounting equation.

Business transactions can be classified into five categories that are assets, owner's equity, liabilities, revenues, and expenses. All those categories also known as the elements of financial statements. Assets, liabilities and owner's equity are recorded in BALANCE SHEETS whereas revenues and expenses are recorded in INCOME STATEMENTS.



Financial statement is a written report which quantitatively describes the financial health of a company. This includes an income statement and a balance sheet, and often also includes a cash flow statement. Financial statements are usually compiled on a quarterly and annual basis. They are used for both internal and external purposes.

Why important?

• Financial statements describe the organization’s financial health and performance in a condensed and highly informative format.

• They give an overall view of the entire organization

• Managers use it to plan ahead and set goals for upcoming periods. When they use the financial statements that were published, the management can compare them with their internally used financial statements.

• Managers can also use their own and other enterprises’ financial statements for comparison with macro economical data and forecasts, as well as to the market and industry in which they operate in.

Types of Financial Statements

1) Balance sheets -Balance sheets provide the observant with a clear picture of the financial condition of the company as a whole. It lists in detail the tangible and the intangible goods that the company owns or owes. These good can be broken further down into three main categories; the assets, the liabilities and the shareholder’s equity.

a) Assets include anything that the company actually owns and has disposal over. Examples of the assets of a company are its cash, lands, buildings, and real estates, equipment, machinery, furniture, patents and trademarks, and money owed by certain individuals or/and other businesses to the particular company. Assets that are owed to the company are referred to as accounts-, or notes receivables.

Current Assets include anything that company can quickly monetise. Such current assets include cash, government securities, marketable securities, accounts receivable, notes receivable (other than from officers or employees), inventories, prepaid expenses, and any other item that could be converted into cash within one year in the normal course of business.

Fixed Assets are long-term investments of the company, such as land, plant, equipment, machinery, leasehold improvements, furniture, fixtures, and any other items with an expected useful business life usually measured in a number of years or decades (as opposed to assets that wear out or are used up in less than one year. Fixed assets are usually accounted as expensed upon their purchase. They are normally not for resale and are recorded in the Balance Sheet at their net cost less (less is accounting term for minus) accumulated depreciation.

Other Assets include any intangible assets, such as patents, copyrights, other intellectual property, royalties, exclusive contracts, and notes receivable from officers and employees.

b) Liabilities - Liabilities are money or goods acquired from individuals, and/or other corporate entities. Some examples of liabilities would be loans, sale of property, or services to the company on credit. Creditors (those that loan to the company) do not receive ownership in the business, only a (usually written) promise that their loans will be paid back according to the term agreed upon.

Current Liabilities are accounts-, and notes-, taxes payable to financial institutions, accrued expenses (eg.: wages, salaries), current payment (due within one year) of long-term debts, and other obligations to creditors due within one year.

Long-Term Liabilities are mortgages, intermediate and long-term loans, equipment loans, and other payment obligation due to a creditor of the company. Long-term liabilities are due to be paid in more than one year.

c) Shareholder’s equity (or net worth, or capital) The shareholder’s equity is money or other forms of assets invested into the business by the owner, or owners, to acquire assets and to start the business. Any net profits that are not paid out in form of dividends to the owner, or owners, are also added to the shareholder’s equity. Losses during the operation of the business are subtracted from the shareholder’s equity.

2) Cash flow statements - These statements show how money is predicted to move around (hence the phrase cash flow) at a given period of time. It is useful for planning future expenses. It shows whether or not there will be enough money to carry out the planned activities and whether or not the cash coming in are enough to cover the expenses. The cash flow statement is useful in the determination of the company’s liquidity in a given period of time.

3) Income statements - Income statements measure the company’s sales and expenses over a specific period of time. They are prepared each month and fiscal year end. Income statements show the results of operating during those accounting periods. They are also prepared using the Generally Accepted Accounting Principles (GAAP) and contain specific revenue and expense categories regardless of the nature of the company.


Financial statements are useful, because they show the financial condition of a company at a given period. There are many types of financial statements uses and purposes, measuring different financial aspects of the company. They can be used for both internal, and external uses.

Accounting information should be readily understandable and decision usefulness ( the ability to be useful in decision making) to the intended users of the information.  

Understandability means that users must understand the information within the context of the decision being made. This is a user-specific quality because users will differ in their ability to comprehend any set of information. To be useful, information must make a difference in decision process.

 Primary Qualitative Characteristics

The primary decision-specific qualities that make accounting information useful are relevance and reliability. Both are critical. No matter how reliable, if information is not relevant to the decision at hand, it is useless. Conversely, relevant information is of little value if it cannot be relied on. So, to be useful for decision making, accounting information should be relevant and reliable.

-To make a difference in the decision process, information must possess
  1. Predictive value
  2. Feedback value                                                                                                                     (Generally, useful information will possess both qualities. For example, if net income and its components confirm investor expectations about future cash-generating ability, then net income has feedback value for investors. This confirmation can also be useful in predicting future cash-generating ability as expectations are revised.)
  3. Timeliness also is an important component of relevance. Information is timely when it is available to users early enough to allow its use in the decision process. The need for timely information requires that companies provide information to external users on a periodic basis. Information is timely if it is available to users before a decision is made.

  1. Verifiability implies a consensus among different measurers. For example, the historical cost of a piece of land to be reported in the balance sheet of a company is usually highly verifiable. The cost can be traced to an exchange transaction, the purchase of the land. However, the market value of that land is much more difficult to verify. Appraisers could differ in their assessment of market value. The term objectivity often is linked to verifiability. The historical cost of the land is objective but the land’s market value is subjective, influenced by the measurer’s past experience and prejudices. A measurement that is subjective is difficult to verify, which makes it more difficult for users to rely on.
  2. Representational faithfulness means when there is agreement between a measure or description and the real-world phenomenon that the measure is supposed to represent. For example, assume that the term inventory in a balance sheet of a retail company is understood by external users to represent items that are intended for sale in the ordinary course of business. If inventory includes, say, machines used to produce inventory, then it lacks representational faithfulness.
  3. Reliability assumes the information being relied on is neutral with respect to parties potentially affected. In that regard, neutrality is highly related to the establishment of accounting standards. Changes in accounting standards can lead to adverse economic consequences to certain companies, their investors and creditors, and other interest groups. Accounting standards should be established with overall societal goals and specific objectives in mind and should try not to favor particular groups or companies.

Secondary Qualitative Characteristics

  1. Comparability is the ability to help users see similarities and differences between events and conditions. It is important to the investors and creditors to compare information across companies to make their resource allocation decisions.
  2. Closely related to comparability is the notion that consistency of accounting practices over time permits valid comparisons between different periods. The predictive and feedback value of information is enhanced if users can compare the performance of a company over time.

Cost effectiveness constraint 

 - the cost of producing such information should be reasonable in relation to the expected benefit.

Materiality constraint 

 - may not have to be fully followed for immaterial items if full compliance would result in unwarranted higher costs.


Generally Accepted Accounting Principles (GAAP) is the rules adopted by the accounting profession as guides for measuring and reporting the financial condition and activities of a business. To use and interpret financial statements effectively, we need to have a basic understanding of these principles. The primary purpose of GAAP is to make information in financial statements relevant, reliable and comparable.

To achieve basic objectives and implement fundamental qualities, GAAP has four basic assumptions, four basic principles, and four basic constraints.


Business Entity -assumes that the business is separate from its owners or other businesses. Revenue and expense should be kept separate from personal expenses.

Going Concern: assumes that the business will be in operation indefinitely. This validates the methods of asset capitalization, depreciation, and amortization. This assumption is not applicable when the liquidation is certain.

Monetary Unit principle: assumes a stable currency is going to be the unit of record.

Time-period principle implies that the economic activities of an enterprise can be divided into artificial time periods.


Cost principle requires companies to account and report based on acquisition costs rather than fair market value for most assets and liabilities. This principle provides information that is reliable (removing opportunity to provide subjective and potentially biased market values), but not very relevant. Thus there is a trend to use fair values. Most debts and securities are now reported at market values.

Revenue principle requires companies to record when revenue is (1) realized or realizable and (2) earned, not when cash is received. This way of accounting is called accrual basis accounting.

Matching principle - Expenses have to be matched with revenues as long as it is reasonable to do so. Expenses are recognized not when the work is performed, or when a product is produced, but when the work or the product actually makes its contribution to revenue. Only if no connection with revenue can be established, may cost be charged as expenses to the current period (e.g. office salaries and other administrative expenses). This principle allows greater evaluation of actual profitability and performance (shows how much was spent to earn revenue). Depreciation and Cost of Goods Sold are good examples of application of this principle.

Disclosure principle - Amount and kinds of information disclosed should be decided based on trade-off analysis as a larger amount of information costs more to prepare and use. Information disclosed should be enough to make a judgment while keeping costs reasonable. Information is presented in the main body of financial statements, in the notes or as supplementary information

Objectivity principle - the company financial statements provided by the accountants should be based on objective evidence.

Materiality principle - the significance of an item should be considered when it is reported. An item is considered significant when it would affect the decision of a reasonable individual.

Consistency principle- It means that the company uses the same accounting principles and methods from year to year.

Prudence principle - when choosing between two solutions, the one that will be least likely to overstate assets and income should be picked.


Accounting is the process of identifying, classifying, measuring, recording and communicating economic information and business events in monetary term to permit informed judgements and decisions by users of the information.

Bookkeeping – it is a part of the field of accounting, refers to the mechanical aspects of accounting, such as recording, classifying and summarizing transaction.

What accountants do?

1. Accountants CLASSIFY, SUMMARIZE, INTERPRET facts , TRANSLATE into useful information, and REPORT DATA to managers.

2. They suggest strategies for improving the financial condition of the company.

3. Accountants help entities be successful, ethical, responsible participants in society.

4. Accountant design and maintain accounting system.

5. Accountants also responsible for preparing several types of documents (e.g. employees’ salary and wage records)

What bookkeepers do?


2. Then they RECORD THE DATA from the original transaction documents (sales slips, etc.) into record books called JOURNALS.

3. A JOURNAL is the FIRST PLACE transactions are recorded.


1. To help managers evaluate the financial condition and the operating performance of the firm so they may make better decisions.

2. To report financial information to people outside the firm such as owners, suppliers, and the government.


1) Financial Accounting

- Financial accounting provides information to decision makers who are not involved in the day-to-day operations of an organization. The information is distributed primarily through general purpose financial statements. The focus of financial accounting is reporting on historical information. The information is reported periodically. It is often broken down into monthly, quarterly, and annual reporting periods. At a minimum, financial accounting information must be reported annually.
2) Management Accounting

- Involves providing information to an organization’s managers. Management accounting reports often include much of the same information used in financial accounting. However, management accounting reports also include a great deal of information that is not reported outside the company.

3) Cost Accounting

- To plan and control operations, managers need information about the nature of cost incurred. Cost accounting is a process of accumulating the information managers need about operating costs. It helps managers identify measure and control these costs. Cost accounting may involve accounting for the costs of products, services or specific activities. Cost accounting information is also useful for evaluating each manger’s performance.

4) Tax Accounting

- Many taxes raised by federal, state and city governments are based on the income earned by taxpayers. These taxpayers include both individuals and corporate businesses. The amount of taxes is based on what the laws define to be income. Tax accountants help taxpayers comply with these laws by preparing their tax returns. Another tax accounting activity involves planning future transactions to minimize the amount of tax to be paid.

5) Auditing

- Just as independent auditing adds credibility to financial statements, internal auditing adds credibility to report produced and used within an organization. Internal auditors not only examine record-keeping processes but also assess whether managers are following established operating procedures.


Accounting is very important for the purpose of decision making. It tells where, when, how and why money has been spent. It is helpful in the evaluation of performance and indicates the financing implications of choosing one plan/ investment or project versus another. Some form or other of accounting is needed to ensure the smooth-running of all organizations. It helped users by enable assessment of amount, timing and uncertainty of prospective net cash flow to the operating enterprise.


• Accountants help entities be successful, ethical, responsible participants in society.

• Accountants identify, analyze, record and accumulate facts, estimates. Forecasts and other about the unit’s activities, then translate into useful information.

• Accountant design and maintain accounting system.

• Accountants also responsible for preparing several types of documents (e.g. employees’ salary and wage records)

The job of accountants nowadays not restricted to the process of collecting, recording and summarizing the accounting data. There are various employment opportunities for a person who studied in the accounting field and the job is slightly differing from one another. The four broad areas are:
a) Public Accounting – Public accountants are those who are offer their professional services to the general public for a fee. Such services include auditing, tax services, accounting services and management consultancy. Public accounting services are offered only by those who have a license to practice.

b) Private Accounting – Private accountants are those individuals who are employed by organizations in various positions such as financial accountants, management accountants, cost accountants and internal auditors.

c) Governmental Accounting – Accountants who are working in government usually are employed by a federal agency, a state agency or a local authority.

d) Educations – Some accountants become educators that they teach accounting and related courses. Some of them also engage in research and publications as well as consultancy.


(a) Lenders. Lenders are interested in information that enables them to determine whether their loans, and the interest attaching to them, will be paid when due.

(b) Suppliers and other trade creditors. Suppliers and other creditors are interested in information that enables them to determine whether amounts owing to them will be paid when due. Trade creditors are likely to be interested in an enterprise over a shorter period than lenders unless they are dependent upon the continuation of the enterprise as a major customer.

(c) Customers. Customers have an interest in information about the continuance of an enterprise, especially when they have a long-term involvement with, or are dependent on, the enterprise.

(d) Potential investors. They need the information in order to make a decision whether want to invest or not. Normally, the potential investors or shareholders will contribute their capital in a company that show impressive record in financial position.

(e) Governments and their agencies. Governments and their agencies are interested in the allocation of resources and, therefore, the activities of enterprises. They also require information in order to regulate the activities of enterprises, determine taxation policies and as the basis for national income and similar statistics.

(f) Public. Enterprises affect members of the public in a variety of ways. For example, enterprises may make a substantial contribution to the local economy in many ways including the number of people they employ and their patronage of local suppliers. Financial statements may assist the public by providing information about the trends and recent developments in the prosperity of the enterprise and the range of its activities.

(g) Investors. The providers of risk capital and their advisers are concerned with the risk inherent in, and return provided by, their investments. They need information to help them determine whether they should buy, hold or sell. Shareholders are also interested in information which enables them to assess the ability of the enterprise to pay dividends.

(h) Managers. Managers need to make day-to-day decision making. They need to know how well things are progressing financially and about the current status of the business.

(i) Employees. Employees and their representative groups are interested in information about the stability and profitability of their employers. They are also interested in information which enables them to assess the ability of theenterprise to provide remuneration, retirement benefits and employment opportunities.