BUS103: Introduction to Financial Accounting

The balance sheet relationship is expressed as; Assets = Liabilities + Equity.

Learning Objective

• Differentiate between the three balance sheet accounts of asset, liability and shareholder's equity

Key Points

• Assets have value because a business can use or exchange them to produce the services or products of the business.
• Liabilities are the debts owed by a business, often incurred to fund its operation.
• A company's equity represents retained earnings and funds contributed by its shareholders.
  

Terms

• Assets
  A resource with economic value that an individual, corporation, or country owns or controls with the expectation that it will provide future benefit.
• liabilities
  Probable future sacrifices of economic benefits arising from present obligations to transfer assets or providing services as a result of past transactions or events.
• equity
  Ownership interest in a company, as determined by subtracting liabilities from assets.
  
  

Components of the Balance Sheet

The balance sheet contains statements of assets, liabilities, and shareholders' equity.

Assets represent things of value that a company owns and has in its possession, or something that will be received and can be measured objectively. They are also called the resources of the business, some examples of assets include receivables, equipment, property and inventory. Assets have value because a business can use or exchange them to produce the services or products of the business.

Liabilities are the debts owed by a business to others–creditors, suppliers, tax authorities, employees, etc. They are obligations that must be paid under certain conditions and time frames. A business incurs many of its liabilities by purchasing items on credit to fund the business operations.

A company's equity represents retained earnings and funds contributed by its owners or shareholders (capital), who accept the uncertainty that comes with ownership risk in exchange for what they hope will be a good return on their investment.

Fundamental Relationship

The relationship of these items is expressed in the fundamental balance sheet equation:

Assets = Liabilities + Equity

The meaning of this equation is important. Generally, sales growth, whether rapid or slow, dictates a larger asset base - higher levels of inventory, receivables, and fixed assets (plant, property, and equipment). As a company's assets grow, its liabilities and/or equity also tends to grow in order for its financial position to stay in balance. How assets are supported, or financed, by a corresponding growth in payables, debt liabilities, and equity reveals a lot about a company's financial health.