We may recall certain statements made so far : Accounting is the language of business. It conveys information about the business to insiders as well as to outsiders. It stems from, and is based on, recording of transactions and events over the course of business.
Over the years, certain basic concepts have developed according to which accounting records are made (developed and interpreted) of the transactions and events. These are generally referred to, true to the context, as GENERALLY ACCEPTED ACCOUNTING PRINCIPLES - abbreviated as GAAP.
To realise a full appreciation of these principles, it would be helpful to be familiar with oft-used terminology basically used in accounting and in the presentations based on it.
Assets
The entire property, or valuable resources, of all kinds, possessed or owned by, or owing to, a person, a business, or an organisation is collectively called its assets; they must have been acquired at a measurable money cost. As an economic resource, assets are qualified by following three requirements :
- The resource must be valuable; and it will be so if it is cash or convertible into cash; or it must be capable of providing future, or potential benefits to the operations of the owner.
- The resource must be owned - not by mere possession or custody or control over it; but to be owned in the legal sense.
- It must have been acquired at a measurable money cost; even if bequeathed, it must stand as measured monetarily - or, what the asset would have cost, had cash been paid for it.
We may briefly mention now that there are classifications of assets - as fixed, current, fictitious, intangible, liquid, wasting, etc.
Liabilities
Claims of outsiders on the individual or the firm are defined as his/its liabilities. That is, they represent what the firm owes to outsiders, i.e. other than owners. The amount shown against a liability is on the basis of the amount owned, not the amount payable.
Another way of conveying the same intent is : Liabilities are the debts or other obligations for which the individual, or the firm, or the business, is responsible. They are the claims of creditors against the enterprise, arising out of past activities and are to be satisfied by the disbursement or utilisation of corporate resources.
Depending on the periodicity of the funds needed to be disbursed, these are classifed as current, long-term, or fixed, liabilities.
Capital or Owners' Equity
Simply, it means the money invested. It refers to the claims of the owners of the business against the assets of the firm. In respect of the owners, it is the excess of assets over liabilities, and thus, represents the available resources for carrying on with the business unhindered.
One classification is as : fixed, circulating, working, etc. Again, it may be classified as : paid-up capital, i.e. the initial amount contributed; and retained earnings, by reserves and surpluses, i.e. part of the profit belonging to owners but which is not paid, out to them and, rather otherwise retained, or sloughed back, in the business.
The owners of the business are called shareholders - they may be either ordinary, or preference, shareholders. Preference shareholders are much like creditors, i.e. liabilities, of the firm. Ordinary shareholders, also called equity holders, are the real owners of the firm; their financial hold, or claim, on the firm is called the equity of the owners. These claims can be settled only when all other liabilities are cleared, and are therefore called "residual".
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