Understanding Assets, Liabilities, and 

Equity

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Before you set up your bookkeeping system, you have to understand the firm's basic accounts - assets, liabilities and equity. Assets are those things the company owns such as its inventory and accounts receivables. Liabilities are those things the company owes such as what they owe to their suppliers (accounts payable), bank and business loans, mortgages, and any other debt on the books. Equity is the ownership the business owner and any investors have in the firm.

Balancing the Books

In order to balance your books, you have to keep careful track of these items and be sure the transactions that deal with assets, liabilities, and equity are recorded correctly and in the right place. There is a key formula you can use to make sure your books always balance. That formula is called the accounting equation:

Assets = Liabilities + Equity

The accounting equation means that everything the business owns (assets) is balanced against claims against the business (liabilities and equity). Liabilities are claims based on what you owe vendors and lenders. Owners of the business have claims against the remaining assets (equity)

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Initial Bookkeeping Terms Related to the Accounting Equation

Let's take a closer look at assets, liabilities, and equity so you will have a complete understanding of what comprises each one.

Assets:

If you look you look at the format of a balance sheet, you will see the asset, liability, and equity accounts. Asset accounts usually start with the cash account and the marketable securities account. Then, inventory, accounts receivable, and fixed assets such as land, buildings, and plant and equipment are listed. Those are tangible assets. You can actually touch them. Firms also have intangible assets such as customer goodwill.

Liabilities: 

The liability accounts on a balance sheet include both current and long-term liabilities. Current liabilities are usually accounts payable and accruals. Accounts payable are usually what the business owes to its suppliers, credit cards, and bank loans. Accruals will consist of taxes owed including sales tax owed and federal, state, social security, and Medicare tax on the employees which are generally paid quarterly.

Equity: 

The equity accounts include all the claims the owners have against the company. Clearly, the business owner has an investment and it may be the only investment in the firm. If the firm has taken on other investment, that is considered here as well.

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