Financial accounting

Financial accounting

it provides economic and financial information for investors, creditors, and other external users. The information needs of external users vary considerably. Taxing authorities, such as the Internal Revenue Service, want to know whether the company complies with tax laws. Regulatory agencies, such as the Securities and Exchange Commission or the Federal Trade Commission, want to know whether the company is operating within prescribed rules. Customers are interested in whether a company like Telsa will continue to honor product warranties and support its product lines. Labor unions such as the Major League Baseball Players Association want to know whether the owners have the ability to pay increased wages and benefits.

accounting equation

The two basic elements of a business are what it owns and what it owes. Assets are the resources a business owns. For example, Google has total assets of approximately $93.8 billion. Liabilities and owner’s equity are the rights or claims against these resources. Thus, Google has $93.8 billion of claims against its $93.8 billion of assets. Claims of those to whom the company owes money (creditors) are called liabilities. Claims of owners are called owner’s equity. Google has liabilities of $22.1 billion and owners’ equity of $71.7 billion. We can express the relationship of assets, liabilities, and owner’s equity as an equation.

Assets = Liabilities + Owners equity

 

Assets :

As noted above, assets are resources a business owns. The business uses its assets in carrying out such activities as production and sales. The common characteristic possessed by all assets is the capacity to provide future services or benefi ts. In a business, that service potential or future economic benefi t eventually results in cash infl ows (receipts). For example, consider Campus Pizza, a local restaurant. It owns a delivery truck that provides economic benefi ts from delivering pizzas. Other assets of Campus Pizza are tables, chairs, jukebox, cash register, oven, tableware, and, of course, cash.

 

Liabilities :

Liabilities are claims against assets—that is, existing debts and obligations. Businesses of all sizes usually borrow money and purchase merchandise on credit. These economic activities result in payables of various sorts:

• Campus Pizza, for instance, purchases cheese, sausage, fl our, and beverages on credit from suppliers. These obligations are called accounts payable.

• Campus Pizza also has a note payable to First National Bank for the money borrowed to purchase the delivery truck.

• Campus Pizza may also have salaries and wages payable to employees and sales and real estate taxes payable to the local government. All of these persons or entities to whom Campus Pizza owes money are its creditors. Creditors may legally force the liquidation of a business that does not pay its debts. In that case, the law requires that creditor claims be paid before ownership claims.

 

Owner’s Equity :

The ownership claim on total assets is owner’s equity. It is equal to total assets minus total liabilities. Here is why: The assets of a business are claimed by either creditors or owners. To fi nd out what belongs to owners, we subtract the creditors’ claims (the liabilities) from assets. The remainder is the owner’s claim on the assets—the owner’s equity. Since the claims of creditors must be paid before ownership claims, owner’s equity is often referred to as residual equity.