Now let’s look at the right side of the Accounting Equation. In the most basic sense, it measures who supplied the funds to buy all those assets on the left side of the equation. There are two players in this effort … insiders and outsiders. The insiders are the business owners, and the outsiders are anyone else.
The funds placed into the business by the owners are normally considered a long-term committment if not semi-permanent. It therefore serves as the financial “foundation” of the business, and is called Capital. When outsiders provide funds or other resources (values) to the business, they have the full intention of having those values returned (repaid) either soon (short-term) or in the medium future (long-term). Thus these fund sources earn the name “liabilities”. Remember, both enable the company to acquire assets, and that’s why they reside on the same side of the equation.
The accounting equation also is the basis for what is called “dual-entry” accounting. This concept was created by a Venetian mathematician in the 15th century to help Italian merchants keep their books straight. I think his name was Carl.
The simple rules are (1) every business transaction (good or bad) is recorded twice … and (2) the equation must continuously be in balance, especially at the end of each accounting period … end of day, month, quarter, etc. Next, we will look at the balance sheet in a little more detail. By the way, there are some who are not interested in accounting, don’t like accounting, don’t get accounting. We call them “Venetian Blinds”.
Take a look at the individual items in the simplified balance sheet at the left. We will give it some personality and behavior in next post.
Douglas K. Steele