Elements of Accounting

Elements of Accounting

Accounting has four basic elements that form the foundation of all financial statements:

1. Assets

   Definition: Resources owned or controlled by a business that are expected to provide future economic benefits.

   • Things that a business owns or controls that have value.

   • Examples: Cash, inventory, buildings, machinery, prepaid expenses.

2. Liabilities

   Definition: Present obligations of a business, arising from past transactions, that will result in an outflow of resources (usually money).

   • Obligations or debts that a business owes to others.

   • Examples: Loans, accounts payable, Salaries Payable, taxes payable.

3. Equity / (Owner’s Equity / Capital)

   Definition: The residual interest in the assets of a business after deducting liabilities; in simple words, the owner’s claim on the business.

   • The owner’s claim on the assets after all liabilities are paid.

   • Formula: Equity = Assets − Liabilities

   • Examples: Capital invested, retained earnings.

4. Revenue and Expenses

   Revenue (Income)

   Definition: The inflow of economic benefits during a period from ordinary activities of the business, which increases equity (other than owner’s contribution).

   Expenses

   Definition: The outflow or consumption of resources in order to earn revenue; these decrease equity.

   • Revenue: Money earned by the business from operations.

     • Example: Sales, service income.

   • Expenses: Costs incurred to earn revenue.

     • Example: Salaries, rent, utilities.

🔹 Summary

• Assets = Liabilities + Equity

• Revenue − Expenses = Profit (or Loss)

These elements are the building blocks of accounting, used to prepare financial statements like the Balance Sheet and Profit & Loss Statement.

1. Balance Sheet Items

The modern name of Balance Sheet is:

👉 Statement of Financial Position

The Balance Sheet shows the financial position of a business at a specific date.
It has 3 main parts:

✅ Assets (What the company owns)

• Current Assets → Cash, Accounts Receivable, Inventory, Prepaid expenses

• Non-Current Assets → Property, Plant, Equipment, Investments, Intangible assets (patents, goodwill)

✅ Liabilities (What the company owes)

• Current Liabilities → Accounts Payable, Short-term Loans, Accrued Expenses, Taxes Payable

• Non-Current Liabilities → Long-term Loans, Lease Obligations, Bonds Payable

✅ Equity (Owner’s share after paying liabilities)

• Share Capital (Owner’s investment)

• Retained Earnings (Accumulated profits kept in business)

• Reserves

📌 Formula: Assets = Liabilities + Equity

🔹 2. Income Statement Items

The Income Statement (Profit & Loss Statement) shows the performance of a business over a period of time.

The modern name of Income Statement is:

👉 Statement of Profit and Loss (or simply Statement of Profit or Loss) / (or simply Statement of financial performance)

✅ Revenue (Income earned)

• Sales Revenue

• Service Revenue

• Other Income (interest, investment income)

✅ Expenses (Costs incurred)

• Cost of Goods Sold (COGS)

• Operating Expenses (Salaries, Rent, Utilities, Marketing)

• Depreciation & Amortization

• Interest Expense

• Taxes

Result

• Net Profit (if Revenue > Expenses)

• Net Loss (if Expenses > Revenue)

Formula: Net Income = Revenue − Expenses

Quick Example

Balance Sheet (at 31 Dec 2024):

• Assets = $100,000

• Liabilities = $40,000

• Equity = $60,000

Income Statement (for year 2024):

• Revenue = $150,000

• Expenses = $120,000

• Net Profit = $30,000

👉 Balance Sheet = What you have & owe (snapshot at a date)
👉 Income Statement = How much you earned & spent (over a period)