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information which allows others to make the best possible financial decisions.

OK let's take this a bit further. We can begin to see two separate elements of accounting being formed here. Accounting incorporates both;

(1) the information process that identifies, classifies and summarises the financial events that take place within an organisation (this is the part typically handled by bookkeepers)

and

(2) the reporting system that communicates relevant financial information to interested persons which allows them to assess performance, make decisions and/or control the economic resources in the organisation. (this part is usually handled by qualified accountants)

There, a start-point in the series accounting for dummies' with the definition of accounting. OK, let's try and tackle some other basic accounting concepts.

Now, accounting is not rocket science. Physics is rocket science and one of their key equations looks like this (E=mc2). The key accounting equation on the other hand looks like this (A = L + OE). So, for all its scary numbering system, accounting only uses adding, subtracting and every now and then a percentage. You don't need to be a mathematical genius to be an accountant, just remember your fifth grade lessons.

Let's try and understand the ACCOUNTING FORMULA a little better. What does it mean for business? Well, basically it means that everything of value in the business is owned by someone. I told you it was not rocket science! Breaking it down further, A = assets (valuable things a business owns) is legally claimed by either people that have lent the business money (L = liabilities) or is the OE = owner's equity (the money invested in the business by the owners of that business).

Summarising, ASSETS are things of monetary value that a business owns, benefits from, or has use of and which have the potential to earn future income for the business. They may be (1) physical like cash, equipment and property (2) a legal claim against others like monies owed to the business from customers (3) certain intellectual property rights like patents and trademark and (4) goodwill which usually materializes when a business is sold.

LIABILITIES are the legal obligations of a business and is the money it owes to others. For example, they include monies owed to suppliers, loan funders and insurance, tax, salary, utility bills that have not yet been paid.

OWNERS EQUITY is simply the owner's rights to the assets of the business. It is what would be left over if you sold all the assets of the business and paid off all the liabilities. That's why it is often referred to as 'net worth'. Owners Equity is made up of the investments made by the owners and is increased by profits from the business and decreased by owners withdrawing their equity via drawings (personal takings) or dividends (payments to shareholders)

So what have we covered;

1 - The definition of accounting

2 - The accounting equation

3 - The definitions of Assets, Liabilities and Owners Equity.

For stage 1, that's probably enough, but if you would like to know more about Basic Accounting Concepts see my more comprehensive article by the same name.

Learn more about this author, Peter Baskerville.
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