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B. Read the text. The whole of financial accounting is based on the accounting equation
The whole of financial accounting is based on the accounting equation. The resources possessed by the firm are known as Assets, and obviously, some of these resources will have been supplied by the owner of the business. The total amount supplied by him is known as Capital (Owners’ equity), if in fact he was the only one who had supplied the assets then the following equation would hold true:
Assets = Capital (Owners’ equity)
On the other hand, some of the assets will normally have been provided by someone other than* the owner. The indebtedness of the firm for these resources is known as Liabilities. The equation can now be expressed as:
Assets = Capital (Owners’ equity) + Liabilities
Assets are economic resources owned by a business that are expected to benefit future operations. Assets consist of property of all kinds, such as inventories (goods held for sale), land, buildings, machinery and motor vehicles (nonmonetary physical things), also benefits such as debts owing by customers and the amount of money in the bank account (monetary items called also account receivable). Other assets – the rights granted by patent, trademark, or copyright – are nonphysical.
Liabilities consist of money owing for goods supplied to the firm, and for expenses, also for loans made to the firm. So we can say that liabilities are present obligations of a business to pay cash, transfer assets, or provide services. Among these obligations are debts of the business, amounts owed to suppliers as we said above and services bought on credit (called account payable), borrowed money, salaries and wages owed to employees, taxes owed to the government.
Capital is often called the owner's equity or net worth. Owners’ equity represents the claims of a business to the assets of the business. Theoretically, it is what would be left over if all the liabilities were paid and sometimes is said to equal net assets. By rearranging the accounting equation, we can define owners’ equity this way:
Owners’ equity = assets – liabilities
The owners’ equity of a corporation is called stockholders’ equity, so the accounting equation becomes:
Assets = liabilities + stockholders’ equity
Stockholders’ equity has two parts: contributed capital and retained earnings:
Stockholders’ equity = contributed capital + retained earnings.
Contributed capital is the amount invested in the business by the stockholders. Retained earnings represent the equity of stockholders generated from the income –producing activity of the business and kept for use in the business.
Simply stated, revenues and expenses are increases and decreases in stockholders equity that result from operating a business. Generally speaking, a company is successful if its revenues exceed its expenses. When revenues exceed expenses, the difference is called net income; when expenses exceed revenues, the difference is called net loss.Net income – or net loss – is of course, “the bottom line”, and discloses whether or not a company has been profitable for a given period. Dividends are distributions to stockholders of assets (usually cash) generated by past earning. It is important not to confuse expenses and dividends, both of which reduce retained earnings.
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