5. POINT OUT THE CORRECT
ACCOUNTING EQUATION
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O ASSETS=LIABILITIES - CAPITAL
O LIABILITIES = CAPITAL + ASSETS
O CAPITAL = ASSETS + LIBILITIES
O LIBILITIES = ASSETS - CAPITAL
Answers
Explanation:
Liabilities
Liabilities are economic obligations or payables of the business.
Company assets come from 2 major sources – borrowings from lenders or creditors, and contributions by the owners. The first refers to liabilities; the second to capital.
Liabilities represent claims by other parties aside from the owners against the assets of a company.
Like assets, liabilities may be classified as either current or non-current.
A. Current liabilities – A liability is considered current if it is due within 12 months after the end of the balance sheet date. In other words, they are expected to be paid in the next year.
If the company's normal operating cycle is longer than 12 months, a liability is considered current if it is due within the operating cycle.
Current liabilities include:
Trade and other payables – such as Accounts Payable, Notes Payable, Interest Payable, Rent Payable, Accrued Expenses, etc.
Current provisions – estimated short-term liabilities that are probable and can be measured reliably
Short-term borrowings – financing arrangements, credit arrangements or loans that are short-term in nature
Current-portion of a long-term liability – the portion of a long-term borrowing that is currently due.
Example: For long-term loans that are to be paid in annual installments, the portion to be paid next year is considered current liability; the rest, non-current.
Current tax liabilities – taxes for the period and are currently payable
B. Non-current liabilities – Liabilities are considered non-current if they are not currently payable, i.e. they are not due within the next 12 months after the end of the accounting period or the company's normal operating cycle, whichever is shorter.
In other words, non-current liabilities are those that do not meet the criteria to be considered current. Hah! Make sense? Non-current liabilities include:
Long-term notes, bonds, and mortgage payables;
Deferred tax liabilities; and
Other long-term obligations
Capital
Also known as net assets or equity, capital refers to what is left to the owners after all liabilities are settled. Simply stated, capital is equal to total assets minus total liabilities. Capital is affected by the following:
Initial and additional contributions of owner/s (investments),
Withdrawals made by owner/s (dividends for corporations),
Income, and
Expenses.
Owner contributions and income increase capital. Withdrawals and expenses decrease it.
The terms used to refer to a company's capital portion varies according to the form of ownership. In a sole proprietorship business, the capital is called Owner's Equity or Owner's Capital; in partnerships, it is called Partners' Equity or Partners' Capital; and in corporations, Stockholders' Equity.
In addition to the three elements mentioned above, there are two items that are also considered as key elements in accounting. They are income and expense. Nonetheless, these items are ultimately included as part of capital.
Income
Income refers to an increase in economic benefit during the accounting period in the form of an increase in asset or a decrease in liability that results in increase in equity, other than contribution from owners.
Income encompasses revenues and gains.
Revenues refer to the amounts earned from the company’s ordinary course of business such as professional fees or service revenue for service companies and sales for merchandising and manufacturing concerns.
Gains come from other activities, such as gain on sale of equipment, gain on sale of short-term investments, and other gains.
Income is measured every period and is ultimately included in the capital account. Examples of income accounts are: Service Revenue, Professional Fees, Rent Income, Commission Income, Interest Income, Royalty Income, and Sales.
Expense
Expenses are decreases in economic benefit during the accounting period in the form of a decrease in asset or an increase in liability that result in decrease in equity, other than distribution to owners.
Expenses include ordinary expenses such as Cost of Sales, Advertising Expense, Rent Expense, Salaries Expense, Income Tax, Repairs Expense, etc.; and losses such as Loss from Fire, Typhoon Loss, and Loss from Theft. Like income, expenses are also measured every period and then closed as part of capital.
Net income refers to all income minus all expenses.
Conclusion
And we've come to the end of this lesson. We have covered all the elements of accounting. For a recap: assets are properties owned by a business; liabilities are obligations to other parties; and, capital refers to the portion of the assets available to the owners of the business after all liabilities are settled.
On the next page, you will find some exercises to test and solidify your knowledge of the accounting elements. Be sure to check it out