UNDERSTANDING ACCOUNTING TALK 1: Common Sense Accounting

Basically, Accounting is a common sense way of looking at and recording your wealth and how changes in your income and expenses affect it –whether you are a corporation, a small business which is a corporation or a small business which is a proprietorship, or whether you are looking at and recording your own personal wealth, income and expenses.

There are, of course, other activities or transactions which will affect wealth that is neither income nor expense (for example, the normal day-to-day wear-and-tear on your possessions, investing, etc). But, let us leave these for the moment to keep the discussion simple and to be able to see the common sense of accounting.

Being common sense, accounting should be commonly understood. However, over the years, accountants have developed a form of shorthand which makes their job easier, but which has also served to make accounting some kind of jargon or esoteric language. Curiously, the first mentions of accounting were in the 13^th or 14^th century as a section on bookkeeping in an algebra book. Since then the fundamental concepts have not changed, but the level of jargon has increased, seemingly pushing accounting beyond the bounds of common sense. It is the same case in ICT where the proliferation of acronyms (url, html, etc) can be intimidating or in law where legalese (the whereas and wherefore and res gestae, etc) confounds the common sense of common people.

“Assets” is the accounting name for wealth. If you look at what you have or possess (note: I am using the term “have” or “possess,” not “own”), you will find that, whatever you have or possess, you came by it, either by buying it with your own money or by borrowing money to buy it or by borrowing the asset.

You now have the basic accounting equation of:

Assets = Liabilities + Equity or Assets – Liabilities = Equity.

Equity is the accounting name for what you own. Liabilities is the accounting name for what you owe or for claims on what you have or possess. Thus, your assets / wealth –you have or possess because you bought these with your own money (your equity) or you borrowed it or borrowed money to buy it (i.e., somebody has a claim on your assets besides yourself). Therefore, if you deduct what you borrowed or the value of the claims on your assets / wealth (your liabilities), you will arrive at what you truly own.

This is true in the case of a corporation, a small business, or your own personal finance.