The Accounting Equation Demystified Lesson II

By Michael Onuorah | 4 min read
11th June 2017
The Accounting Equation Demystified Lesson II

Welcome back class chanted Professor Matthew.

I hope that you had time to review the Asset equation and have gotten some clarity on how the equation works. Professor Matthew asks the class.

Yes Professor Matthew, chanted Thomas. Although I have been thinking what constitutes an Asset.

 Is it only Profit, Owners Equity and Liabilities?

Also I want to ask Professor, Can liabilities be regarded as Assets?

These are all good questions, but I would like to start by clarifying the various types of Assets, after which we can review the various types of Liabilities and clarify some accounting terminologies. I hope that's ok chanted Professor Matthew.

I think that's Ok says Semiu who has been quietly listening and soaking in the accounting equation class since it started.

Ok, says Professor Matthew and thank you for your response Semiu.

Let me start by saying that there are primarily two main classifications of assets which are:

  • Current Assets
  • Non-Current Assets (Also known as Fixed Assets)

So let's list the various Asset types on a table and then we will fill the right entries:

S/No.

Asset Name

Classification and Benefit

1.

Computer

Non-Current Asset (Used for producing goods or services sold to customer says Abdul)

2.

Building/Office Space

Non-Current Assets (Used for providing work area for employees who work day to day to grow the business says Peter)

3.

Vehicle

Non-Current Assets (Used in the transportation of company staff or goods says Chiwendu

4.

Inventory

Current Assets (Generated from the sale of inventory says Kenneth)

5.

Cash

Current Assets (Cash is King or as a friend of mine Bayo will say: Cash is more important than your mother says Semiu)

6.

Receivables

Current Assets (Receivables will eventually result in inflow of cash says Chimezie)

 

Well done class, says Professor Matthew! However, I want to add one column to clearly show you the difference between current and non-current assets. I will draw another line called Depreciation as shown below.

S/No.

Asset Name

Classification and Benefit

Depreciation

1.

Computer

Non-Current Asset (Used for producing goods or services sold to customer says Abdul)

Yes

2.

Building/Office Space

Non-Current Assets (Used for providing work area for employees who work day to day to grow the business says Peter)

Yes

3.

Vehicle

Non-Current Assets (Used in the transportation of company staff or goods says Chiwendu

Yes

4.

Inventory

Current Assets (Generated from the sale of inventory says Kenneth)

No

5.

Cash

Current Assets (Cash is King or as a friend of mine Bayo will say: Cash is more important than your mother says Semiu)

No

6.

Receivables

Current Assets (Receivables will eventually result in inflow of cash says Chimezie)

No

 

Waow!! This clarifies that Non-Current assets depreciate because their cycle of usage is more than one year, while current assets do not depreciate because they are only valid for one year.

In a nutshell Professor Matthew, Assets are resources which a business owns or controls to benefit from its use bellows Abdul.

Yes Abdul, Professor Matthew responds. In fact, your definition is very similar to the IASB framework which defines "Assets as a resource controlled by the entity as a result of past events and from which future economic benefits are expected to flow to the entity."

Now that you are clear on Assets, let's talk liabilities said Professor Matthew.

According to the IASB Framework chants professor Matthew, Liabilities are present obligations of the enterprise arising from past events, the settlement of which is expected to result in an outflow from the enterprise of resources embodying economic benefits.

In simple terms, a liability is an obligation of the entity to transfer cash or other resources to another party. For example a bank loan constitutes a liability. Purchase of goods from a supplier constitutes a liability.

Liabilities may be classified into Current and Non-Current.

The difference is made on the basis of time period within which the liability is expected to be settled by the entity.

Current Liability is one which the entity expects to pay off within one year from the reporting date.

Non-Current Liability is one which the entity expects to settle after one year from the reporting date.

S/No.

Asset Name

Classification and Benefit

Are Debts Repayment Period Annual

1.

Long Term Bank Loan

Non-Current Asset (A form of debt that is paid off over an extended time frame that exceeds one year in duration.

Obtaining a long term loan provides a business with working capital that it can use to purchase assets, inventory or equipment which can then be used to create additional income for the business)

No

2.

Debenture

Non-Current Assets (Long term security yielding a fixed rate of interest issued by a company and secured against assets)

No

3.

Bank Overdraft

Current Assets (overdraft occurs when money is withdrawn from a bank account and the available balance goes below zero. In this situation the account is said to be "overdrawn")

Yes

4.

Short Term Bank Loan

Current Assets (loan scheduled to be repaid in less than a year to finance your temporary working capital needs.)

Yes

5.

Trade Payables

Current Assets (suppliers for goods delivered to or services consumed by the company in the ordinary course of business.)

Yes

6.

Tax Payable

Current Assets (ax payable is a type of account in the current liabilities section of a company's balance sheet comprised of taxes that must be paid to the government within one year)

Yes

 

This is really very straight forward says Jennifer.

Finally, we shall look at some accounting terminologies that are used interchangbly by finance professionals says Professor Matthew.

They include the following:

 

UK Accounting Naming Convention

US/IASB Accounting Naming Convention

1.

Profit and Loss Statement

Income Statement

2

Turnover

Sales or Revenue

3

Fixed Assets

Non-Current Assets

4

Stock

Inventory

5

Debtors

Accounts Receivable

6

Creditors

Accounts Payable

7

Shares

Stock

8

Acquisition

Purchase

9

Finance Lease

Capital Lease

 

So anytime, you hear these words or interchange them, they mean the same thing Abdel asked?

Yes replied Professor Matthew. And I hope that with these few points of mine, we have come to an agreement and conclusion on how to understand and analyze the accounting equation.

Yes sir chanted the class.

 

 

Michael Onuorah
My name is Michael Onuorah. I am first and foremost a teacher, problem solver and a servant leader. I want to honestly state that what drives me in life is helping people to start their journey to self-discovery. I believe that is my primary purpose. My secondary purpose is to be a teacher that demystifies various areas of learning ranging from Database Administration, Entrepreneurship, Information Technology, Business Administration, Marketing, Logic and Problem Solving. And My tertiary purpose is to be a problem solver. I want to teach people how to solve problems relating to what we encounter every day.
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