Accounting Equation

1 . Introduction : Formulation of the Accounting Equation

Financial reporting adopts a systematic approach in to ensure that the ultimate objective of financial accounting is achieved . In this respect , an accounting equation has been formulated on which the financial reports of an organization are based . There are a number of ways how to express such equation , in which one of the three elements is highlighted . For instance it could be portrayed as follows Under this equation , which is normally considered in United Kingdom and Continental European Countries the assets of the company are

br highlighted . However , in other countries the accounting equation is expressed as follows The important point that is of main relevance to this assignment is that the three variables of the accounting equation are always the same These encompass assets , liabilities and ownership interest . In the proceeding sections we will further explain and illustrate these three main variables

Assets of the Company

The assets of the company are normally regarded as the resources of the organization , necessary to perform the day-to-day operations the firm is committed to . An official definition provided by the American Standards Board entails rights or other access to future economic benefits controlled by an organization as a result of past transactions or events . The most prominent right to access encompasses the right of ownership . However , sometimes an entity does not have the right of ownership but does have the right to use an item for its estimated useful life . In such a stance the substance over form principle states that such item will be considered as an asset of the organization . A typical example that comes to mind on such facet is a finance lease

The principle of future economic benefits is also important for the recognition of an asset . If this is not present , like assets that can no longer be used due to obsolescence or inappropriateness , such elements should not be accounted for as assets of the company . For example , if a warehouse is used by the firm to store stock , this asset is leading to future economic benefits by aiding the company to create the cash flow from the sale of the goods stored and should thus be recognized . However , if the firm holds a motor vehicle that is no longer appropriate due to a broken engine , such item should not be accounted for as a fixed asset . This stems from the fact that it will not generate any future economic benefits since it cannot be used for delivery purposes . Indeed the concept of future economic benefits is one of the key drivers that lead to the depreciation of fixed assets

Assets are normally classified between fixed assets and current assets Fixed assets are resources used by the enterprise for a long-term period of time . Current assets comprise an asset that is envisaged to be converted into cash and cash equivalents within the trading cycle of the company . Fixed assets are further divided into tangible fixed assets like land and buildings...