Week 2 Financial Statements

Financial Statements

The U.S. accounting system is based on the concept that everything a business has is owned, or “claimed” by someone. This concept is illustrated in the following equation:

Possessions = Claims

Possessions, i.e., Assets	Claims
Things that a business "possesses" are called assets (cash plus the cost--usually--of other things like buildings and equipment)	The people who bought, or otherwise contributed, the assets for the business are said to have claims on the business.

It is important to note that claims are divided into two categories:

Liabilities	Equity
The amounts of money that people have lent to the business	Represents the value of the contributions by the owners of the business

Fundamental Accounting Equation
With these terms in mind, the conceptual equation above, can be rewritten as below.

Assets = Liabilities + Equity

The ancient system of “double-entry bookkeeping” serves to keep the fundamental accounting equation in balance. According to the double-entry bookkeeping system, any changes to the assets, liabilities, or equity categories in the equation must be recorded twice in order to keep the equation in balance.