South African School Accounting: Fundamental Definitions

These definitions are not usually required as such, but are of immense important for all grades.

Fundamental Definitions in Accounting

Note that these definitions are slightly relaxed for the school level.

The Five Elements of Accounting

Assets

Assets are resources that a business owns or controls (due to a past event) that will result in an inflow of future economic benefit.

Assets are normally broken into two types: current assets, which have a "life-span" of a year or less, and non-current assets, which have a life-span of more than a year.

Examples of current assets are cash, money in the bank, trading stock, and debtors.

Examples of non-current assets are long-term investments (like fixed deposits), land and buildings, equipment, and vehicles.

Equity

Equity is the value of the business, or alternatively the owner's/owners' share of the business. It is calculated as the value of all the business's assets less its liabilities. This ties in with the Accounting Equation, shown in the next section.

Liabilities

Basically, a liability is something that we owe. More formally, it is a present obligation due to a duty, responsibility, or legally binding contract that occurred due to a past event.

Liabilities are broken up into current liabilities, which are liabilities that have to be paid back in the short-term (less than one year) like the business's creditors, and non-current liabilities, which are ones that only have to be paid back after a year or more.

Income

An income is when equity increases due to either an increase in assets or a reduction in liabilities.

Note that income is not the same as just receiving money! Incomes are also called revenues, but at school they will only be referred to as incomes.

Expenses

An expense is when equity decreases due to either a decrease in assets or an increase in liabilities.

Note that expenses are not the same as spending money!

The Accounting Equation

The Accounting equation is given by:

Equity = Asset - Liabilities

or

Assets = Equity + Liabilities

This follows from the definition of equity... or perhaps the definition of equity follows from this! This does make sense intuitively though: assets represent the total value of the business. This value is split between the people who own the business, and the people to whom the business owes money.

A lot of people forget that the accounting equation is actually an equation. That means that if we make a change to one side, we must make the same change to the other side. The following are some valid examples:

• If Assets increase, then Assets can also decrease. For example, if we pay cash for equipment: cash decreases, and equipment increases.
• If Assets increase, then Equity can increase. For example, the business is paid cash for services rendered: cash increases, and equity increases (because we this is an income).
• If Assets increase, then Liabilities can increase. For example, if the business takes out a loan from the bank: assets will increase, because the business received cash, and liabilities will increase because the business owes money to the bank.
• If Owner's Equity decreases, then Liabilities can increase. For example, if the business uses the telephone but doesn't pay the bill on time: equity decreases, because the telephone account is an expense, and liabilities increase, because the business owes the telephone bill. (This ties is with the concept of <<<Accrual>>>.)

In the last case, note how nothing happens to assets... but nothing happens (in total) to the other side of the accounting equation either, because the "plus" and the "minus" cancel out.