1.5 Accounting Elements and Accounting Equation

1. Accounting Elements

(1) Assets refer to resources owned and controlled by the entity as a result of past transactions and events, from which future economic benefits are expected to flow to the entity.          

Current assets are assets which are expected to be converted to cash within the next 12 months or within normal operating cycle of a business.

Examples are cash and cash equivalents, receivables, inventories.

Non-current assets are assets which are not easily convertible to cash or not expected to become cash within the next year. 

Examples include long-term investments, land, building.

(2) A liability is a present obligation of the entity arising from past events, the settlement of which is expected to result in an outflow from the entity of resources embodying economic benefits.   

Current liability is considered current if it is due within 12 months after the end of the financial position date. In other words, they are expected to be paid in the next year.

Non-current liability – are considered non-current if they are not currently payable, i.e. they are not due within the next 12 months after the end of the accounting period or the company's normal operating cycle, whichever is shorter.

 (3) Equity is the residual interest in the assets of the entity after deducting all its liabilities. Equity is equal to total assets minus total liabilities.

(4) Revenue is the gross inflow of economic benefits (cash, receivables, other assets) arising from the ordinary operating activities of an enterprise (such as sales of goods, sales of services, interest, royalties and dividends).  

(5) Expenses are decreases in economic benefits during the accounting period in the form of outflows or depletions of assets or incurrences of liabilities that result in decreases in equity, other than those relating to distributions to equity participants. Expenses include ordinary expenses such as cost of sales, advertising expense, rent expense, salaries expense, etc.

2 Accounting Equation

 The fundamental accounting equation is the foundation for the double-entry bookkeeping system. For each transaction, the total debits equal the total credits.

The relationship between assets and the claims against the assets can be summarized in the following equation:

Asset = Liabilities + Owner’s equity

According to income statement, the relationship between revenue and expense is showed following:

Net income=revenue-expense

 The accounting equation applies to all economic and legal entities.