Notes on basic accounting identity

Assets = Liability

Assets = (outsiders') liability + owners' equity
(1) outsiders’ claims have to be settled first. Owner’s get the residual value
(2) If assets increase (owing to operations), owners’ equity increases. If assets fall in value, owners’ equity falls.

Assets = Short term liability + Long term liability + owners' equity

Current assets + Fixed assets = short term liability + long term liability + owners' equity\

The classification of asset shows which assets can be liquidated fairly fast (useful in order to pay off liabilities)

Current Assets are assets which will probably be used up within an operating cycle or within a year. (Cash, Marketable securities, Debtors, Inventories, Prepaid Expenses). Of course other such assets may replace them so that there is always some stock of these assets at the end of the year.

Investments: They are like Marketable Security, but we expect them to remain for a long time.

Equity Method Investments: This is when a company owns 20% to 50% of another company and have to account for these investments in a special proportional way.

Fixed Assets (Land, Buildings, Plant & Machinery, Furniture) are assets expected to last longer than one year.

Current Liabilities: (Suppliers, Notes or Bills payable). Will be liquidated on disposing off the current assets, usually within a year.  

Provisions: These are expenses which have not been incurred during the financial year but may occur with a high probability. These could be clubbed with current liabilities or with long term liabilities, or bifurcated between the two, depending on the nature and probability.

LT Liabilities (LT loans, bonds and all other liabilities owed to outsiders) : Liabilities to be paid after a year.

Owner’s equity: The residual balancing figure. It will not equal shareholder’s original equity except by sheer chance. Usually we bifurcate the original investment (called Equity Stock) and the Retained Earning or Reinvested Earnings, which is the true residual figure. This is cumulative over the years. For each year, the additional amount of residual figure is equal to net income – dividends paid to share holders.