Accounting and Finance Foundations

Unit 5

Accounting and Finance Foundations Unit 5: Accounting Terminology 317

Accounting Terminology

Chapter 13

Accounting EquationLesson 13.1

Accounts can be classified one of five ways: assets, liabilities, owner’s equity, revenue, and expenses. Any-

thing of value that is owned is called an asset (asset = own). Assets have value because they can be used

either to acquire other assets or to operate a business. Some examples of accounts that can be classified

as assets are: cash, petty cash, prepaid insurance, supplies, equipment, and accounts receivable.

An amount owed to a business is called a liability (liability = owe). Some examples of liabilities are

accounts payable and notes payable.

The amount remaining after the value of the liabilities is subtracted from the assets (amount owned -

amount owed) is called owner’s equity. Owner’s equity is the amount of the business actually owned by the

owner. An equation can be written in order to better understand the relationship between assets, liabilities,

and owner’s equity. The two accounts most commonly classified as owner’s equity are the capital and

drawing accounts. The capital account is used to summarize the owner’s equity in the business. The

drawing account is used when an owner withdraws either cash or merchandise for personal use.

Revenue is any income earned from the sale of a good or service and results in an increase in owner’s

equity. Examples of revenue are fees earned for services performed and cash received from the sale of

merchandise. An example of a revenue account is sales.

An expense is the price paid for goods or services used to operate a business, resulting in a decrease in

owner’s equity. In order for a business to generate any revenue, expenses must be incurred. Examples of

expenses are rent, advertising, and utilities.

The accounting equation is written as:

Assets = Liabilities + Owner’s Equity

The accounting equation must always be in balance, and for that reason our accounting system is called a

dual entry system or double entry system.

Student Guide