Accounting in ordinary man's language- part 1

Accounting is really very simple if we dissect its basic principle and explain it plainly. First you should understand the equation that is the foundation of everything about accounting. Look at the accounting equation below.

The Accounting Equation

Assets (Pag-aari o Ari-arian) = Liabilities (Pagkakautang) + Equity or Capital (Kapital o Puhunan)

Everything that is studied about Accounting revolves around this simple equation.

What are Assets?

Assets provide future benefits. Examples are cash or money (you can use cash to buy office furniture or stocks which are also assets in themselves, cash may also be used to pay liabilities), receivables (since it can be converted to money) and inventories.

In the accounting equation, assets are on the left side. For you to be able to better understand this, think of the left side of the accounting equation as the Debit side. I will explain this concept in more detail later. For now, just remember that the left side is the debit.

What are Liabilities?

Liabilities are obligations to pay other entities or individuals with your assets. Example is when your business owes a bank a sum of money. That is a liability and it will result to future decline in some of your assets that will be used to pay that liability.

What are Equity or Capital?

Equity or Capital is nothing but the investment or funds that you put into the business be it in the form of cash or in-kind. This means that investing something like equipment in a business is a form of equity or capital which is valued accordingly. You can also invest cash into a business, this would result into a person who did the investing having an equity or capital in the business.

Both Liabilities and Equity or Capital is on the right side of the accounting equation which you should remember as the Credit side.

In addition to the account types in the Accounting equation which are assets, liabilities and equity accounts which are called real accounts (because their balances are forwarded to the next accounting period), there are still two types of accounts, which are called nominal accounts (their balances are not forwarded to the next accounting period because they are closed every end of the period) namely:

1. Expense accounts - records your various expenses.
2. Revenue accounts - records your income or revenue.

In my next post we will discuss this accounting equation further by using a few examples for you to understand it better.