Fundamentals of Financial Statements

Fundamentals of Financial Statements

The accounting equation:

The accounting equation defines the relationship between the five account types. The

basic equation is assets equal liabilities plus equity. This is the format seen on a balance

sheet. The profit and loss accounts—revenues and expenses—also affects equity. Revenues

from the sale of goods and services increase equity, while expenses incurred in the course of

business decrease equity. Therefore, the accounting equation can be expanded to assets equal

liabilities plus equity plus revenues minus expenses. Small Business Accounting will record

the appropriate debits and credits, and track the changes to assets, liabilities, equity, revenue,

and expense accounts. Connie Rocha started a small new business ‘Aunt Connie's Cookies',

and she would take care of the marketing activities. She wants to extend her business, and

Connie's only concern was that she needed some one to maintain the accounts in her new

firm. Here I am analyzing the transactions using Horizontal model. The model arranges the

balance sheet, income statement and statement of cash flows horizontally across a single line

of text as shown below.

Assets = Liabilities + Owner's Equity == Net Income = Revenue - Expenses

Balance Sheet Income Statement

Assets, Liabilities, Equity, Revenue and Expenses:

These are all the different types of accounting transactions the Aunt Connie's

accounting system utilizes. Assets are accounts that add value to Connie's individual or

business worth. Liabilities are accounts that remove value from Connie's individual or

business worth. Equity is used to identify the individual contribution of money, or other

financial equivalent, invested in individual or business worth. The revenue account is simply

the account that tracks all income generated. Expense accounts are the individual accounts

setup to record the financial transactions that occur, as expenditure, in generating that

income.

Even after the information has been recorded, further steps must be taken in order to

complete the accounting cycle. These include the adjusted the income statement, the

statement of changes in owner's equity, and the balance sheet (all of which are explained in

the Financial Statements section). Probably the best way to illustrate the idea of recording