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Friday, March 4, 2011

The Fundamental Equations of Accounting

The Income Equation- We find the direct answer to these three
questions on the income and expense statement. The income
statement equation— revenue – expenses = net income—is the
key to the income statement. The result here is simple arithmetic:
revenue (the gozinta) minus expenses (the gozouta) yields net income.

The Balance Sheet Equation- The balance sheet answers another set
of crucial questions for a company. Today, what is my company worth?
What’s in my bank account? How much money do other companies or people
owe me? How much money do I owe other people or companies?

The fundamental equation of accounting underlies the balance
sheet. It looks like this:

assets = liabilities + equity
assets – liabilities = equity
assets – equity = liabilities

The physical layout of the balance sheet matches the first

assets = liabilities + equity

This makes logical sense: the value of what the company
owns (assets) minus the value of what the company owes (liabilities)
leaves you with what the company is worth (equity).

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