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Hi, and welcome to part two,
"Recording Accounting Entries"
in this HSTalks series
on Analysing Financial Statements.
My name is Dr. David Bond.
In this part,
I'll introduce the accounting cycle,
specifically how entities record
accounting entries,
and then how they ultimately create
financial statements
from these entries.
This all happens within an entity's
accounting information system,
but it is useful
to understand the process
so we will set through it.
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But before we dive in,
we need to make the accounting equation.
The basic accounting equation
is as follows,
Assets = Liabilities + Equity.
The three accounting elements
in the equation are:
assets, these are resources
controlled by the entity.
For example, cash, inventory, machinery.
Note that it is controlled, not owned.
Accounting takes an economic
not legal perspective.
Liabilities,
these are what the entity owes.
And equity, this is the owners' stake,
and is what is left over after
liabilities are deducted from assets.
If you own property
this is familiar to you.
The equity in your property
is the value of the property,
the asset, less the amount
you owe the bank, the liability.
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Let's now expand this out
in building revenue and expenses.
Revenues are what an entity owns
from selling goods or services.
Whilst expenses are the costs incurred
to earn those revenues,
i.e., cost of goods sold,
wages, and so on.
Revenues increase equity,
while expenses decrease it.
So now what we have
is an expanded accounting equation:
Assets = Liabilities + Equity + Revenues
- Expenses.
This equation and its five elements
must stay in balance
after every transaction.
This means that
whenever a transaction takes place,
at least two accounts will be affected,
otherwise the equation will end up
out of balance.
