Accounting 101

The basis for accounting is the fundamental accounting equation which states that assets must equal liabilities plus owners' equity. Assets are the resources of the business, such as cash, inventory, accounts receivable, buildings, land, and equipment. Liabilities represent obligations the business owes to others, such as loans, notes payable, and accounts payable. Owners' equity is the interest the owner's have in the business.

Financial accounting is primarily concerned with providing financial information to external users, such as investors, government agencies, creditors, customers, suppliers, and financial intermediaries. The financial information is reported to these users via financial statements. The four core financial statements are the income statement, balance sheet, statement of retained earnings, and statement of cash flows (Spiceland et al.).

Financial Statements

The income statement is a summary of operating results indicating revenues and expenses for a specific period of time. When the difference between revenues and expenses is positive the result is net income, and when the difference between revenues and expenses is negative the result is a net loss.

The balance sheet reports the assets, liabilities, and owners' equity as of a specific date, instead of over a period of time. On the balance sheet the assets must equal the sum of the liabilities and owners' equity.

The statement of retained earnings reports the changes in retained earnings over a period of time. It shows the retained earnings at the beginning of the period plus net income earned during the period minus dividends paid to shareholders during the period.

The statement of cash flows reports the cash inflows and cash outflows over a period of time. The changes in cash flows are broken down into three separate sections based on type of activity: operating activities, investing activities, and financing activities.