The Accounting Equation and Financial Statements

For many people accounting can be a very difficult class to do well in

. During my first level accounting class in college I found myself looking to resources outside our text book to help understand what was going on. I clearly remember my professor stressing that you need to understand the basic concepts so when you start to learn more difficult concepts, you can build a strong foundation and succeed.

One of the first and most basic I learned in my first accounting class was the accounting equation. The accounting equation is liabilities plus equity equals assets. I'd suggest memorizing this. An example of companies assets are cash, supplies, and equipment. A companies liabilities are anything they owe someone else, also known as accounts payable. Some examples of equity are common stock and retained earnings. Liabilities and equity must always equal assets. If you add up all the liabilities and equity and it doesn't equal the total assets, something is wrong. This is a very basic concept and you'll use it for the rest of your career in accounting.

Some other things you'll probably learn in the first chapter are four financial statements. They are the income statement, the statement of retained earnings, the balance sheet, and the statement of cash flows. Just like the accounting equation, these statements are basic in accounting but in my opinion are not as easy. They are also very easy to mess up. Each of the four statements has a heading at the top. On all of them the company name is first. The second line down is the title of the statement. For the third line, the income statement, statement of retained earnings, and statement of cash flow all have for month ended, then the date. For the balance sheet just the month, day, and year is written down. The reason for this is because a balance sheet is created as a point in time. So, for example at the end of the month you can fill out the balance sheet to make sure the assets equal liabilities and equity. All of the statements tie together. This is where the difficult part kicks in. A specific value from each of the statements is used in the following statement. You have to make sure you transfer the correct number from sheet to sheet. You also must make sure you are putting right values on the correct sheet because each one does something different.

If you think about it, the income statement is pretty self explanatory. It should display the company's income. First, list all the revenues then total them up. Next, list all the expenses and total them up. The last thing you need to do is subtract the expenses from the revenues and you get the net income.

The next financial statement you'll want to complete is the statement of retained earnings. You take the retained earnings from the beginning of the month add the net income and subtract the dividends. That'll give you the retained earnings for the end of that particular month. Use the net income you calculated on the income statement.

The next statement you'll want to fill out is the balance sheet. In my opinion, this is the easiest one to do. The balance sheet refers directly to the accounting equation I mentioned earlier. It includes the assets, liabilities, and equity, and makes sure they equal just like the equation says it should. List all of the assets on the left hand side of the statement and total them at the bottom. The first thing you'll want to list under the assets is cash. On the left, list all of the liabilities then total them. Directly under the liabilities, list all the equity then total liabilities and equity. Under equity you must list the retained earnings. You can find that value from the statement of retained earnings you just completed. The total assets must equal the total liabilities and equity. If they do not, something is incorrect.

The statement of cash flows is a little more detailed than the other three financial statements. This statement makes list of where the cash has gone through the company. The main three sections you are listing are operating activities, investing operating activities, and financing activities. At the bottom of the statement of cash flows you list the cash balance at the beginning of the month and under that you list the cash balance at the end of the month. To get the cash balance for the end of the month look back at the balance sheet. Record the cash value that is under assets.

Hopefully this helps you understand the basic fundamentals of accounting and you can now build on your knowledge.

The Accounting Equation and Financial Statements

By: Koryn Barry

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