Accounting equations

• Asset


  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
• Asset


  A present economic resource controlled by an entity that has the potential to produce future economic benefits
• Potential to produce future economic benefits


  To be considered as an asset, an item such as office equipment will usually be used for a number of years in the future, and in each year that it is used it will bring some form of economic benefits
• Liability


  A present obligation of the entity to transfer an economic resource
• Owner's equity


  The residual interest in the assets of the entity after the liabilities are deducted
• What liabilities and owner's equity have in common is that they are both equities
• The accounting equation is the foundation of the double-entry accounting systems
• Accounting equations


  • A = L + OE
  • L = A - OE
  • OE = A - L
• Current assets


  A present economic resource controlled by the entity that is expected to be sold, consumed or converted into cash within 12 months after the end of the reporting period
• Non-current assets


  A present economic resource controlled by the entity that is expected to be used by the business for a number of years and is not held for the purpose of resale
• Current liabilities


  Obligations of the entity that are reasonably expected to be settled in the next 12 months after the end of the reporting period
• Non-current liabilities


  Obligations of the entity that are not expected to be settled in the next 12 months after the end of the reporting period
• Liquidity


  The ability of a business to meet its short-term debt as they fall due
• Working capital ratio


  A liquidity indicator that measures the ratio of current assets to current liabilities to assess the firm's ability to meet its short-term debts
• As long as the working capital ratio is above the minimum of 1:1, this would indicate sufficient liquidity as there are enough current assets to cover the current liabilities of the business
• Stability


  The ability of the business to meet its debts and continue its operations in the long term
• Debt ratio


  Measures the proportion of the firm's assets that are funded by external sources
• A high debt ratio means that a high proportion of the firm's assets are funded by external sources
• Excessive drawing that decreases owner's equity will increase the debt ratio, risking the business as well as affecting the level of liquidity
• Capital contribution by the owner can reduce the debt ratio and the financial risk of the business as well as providing short-term relief to liquidity
• Every transaction will change at least two items in the accounting equation, and after those changes are recorded, the accounting equation must still balance
• The classification of items in the balance sheet as current or non-current enhances the usefulness of the report because it allows for the calculation of performance indicators
• Financial indicator


  A measure that expresses profitability, liquidity or stability in terms of the relationship between two different elements of performance
• working capital ratio

  current assets/ current liabilities
• debt ratio

  total liabilities/total assets