This is the amount invested by the owners in the business. It is also called as owner's equity. Owner’s equity is the owner’s stake in the business. It shows how much is his investment in the assets of the business.
It is the amount of cash or goods drawn by the proprietor from the business for his personal or domestic use.
Any thing that is owned by an individual or business and which can be valued in terms of money is called an asset. In other words, any thing which will enable the firm to get cash or a benefit in future is an asset. For example land, building, machinery, furniture, stock, debtors, bank balance and cash.
Classification of Assets
1. Fixed Assets: The assets which are acquired not for resale but with the purpose to increase the earning capacity of the business by employing them. For example - land, building, machinery, computer, furniture, vehicles, live stock.
2. Current Assets: Current Assets are those assets which are retained in the business with the purpose to convert them into cash within a short period of time (one year). For example - cash in hand, bills receivables, debtors, stock (goods).
3. Tangible Assets: The assets which can be seen and touched or have physical existence. For example - building, machinery, furniture, computer.
4. Intangible Assets: The assets which cannot be seen and touched or which do not have physical existence. For example - goodwill, trade mark, patents.
5. Wasting Assets: Wasting assets are those assets which are natural resources extracted and consumed as a raw material or otherwise. For example - mines, quarries, oil wells.
The assets of a business concern are financed by the funds supplied by the proprietors and outsiders. Money is invested by the proprietor to start his business. Money is also borrowed from others and invested in business. With this money, assets are purchased.
So the proprietor and outsiders have a claim against the assets of the business. This claim of the proprietor and outsiders is termed as ‘Liabilities’. Any amount which the firm owes to the proprietors and outsiders is liability for the business unit. Hence, liabilities are the obligations or debts payable by the business unit in future.
Liabilities have been classified as: External Liabilities and Internal Liabilities.
External liabilities are those liabilities which the business owes to the outsiders for goods purchased on credit, for expenses or for loans taken. For example:
- Creditors for goods: Sundry creditors, bills payable
- Creditors for expenses: Expenses yet to be paid like outstanding salaries, wages outstanding, rent due but not yet paid
- Creditors for loans: Bank loan, Bank overdraft, partners loan, loans taken from other outsiders
Internal liabilities are those liabilities which the business owe to the owners or proprietors. It is the proprietor’s claim against the assets of the business. The Business Entity Assumption states that business is separate from its owners. Any amount contributed by the owner towards the business concern is a liability for the business concern. This liability is also termed as Capital.
Hence, the owner’s claim against the assets of the business unit is called as capital. In case of one man business or sole proprietorship the capital is contributed by the proprietor himself. In case of partnership business firm, capital is contributed by the partners, and in case of companies, capital is contributed by the shareholders.
Owners of the business are those who contribute capital. They get profit of thebusiness, for the risk taken by them. So, the owners have a claim against the firm which is a liability for the firm. Owner’s claim can be expressed as:
- Interest on Capital (unpaid)
- Profits of the business (undistributed)
Revenue refers to the inflow of money or other assets that results from the sale of goods or services or from the use of money. It is the amount realized or receivable from the sale of goods. Amount received from sale of assets or borrowing loan is not revenue.
In broader sense, revenue is also used to mean receipt of rent, commission, discount, etc. Such inflows should be regular in nature and should be concerned with the day-to-day affairs of the business. It should be calculated in the period in which it is earned or realized. For example, sale of goods, rent received, interest on investment received, etc.
Consider an example before you understand meaning of expense. A businessman has a textile mill. He purchases raw cotton and converts it into cloth. For this purpose, he has engaged employees to whom he pays daily wages. He also has a showroom where he sells the cloth that he produces. He has three salesman to whom he pays salaries. In order to sell his product he has given advertisements in the newspapers and television. He has done all this to earn profits. Cost of raw cotton, wages, salaries and advertisement cost are all expenses which he has incurred in order to earn revenue.
All costs incurred in earning revenue is called as expense. It refers to the cost which is incurred in acquiring an asset or service like transportation cost incurred in transferring the raw cotton from the village to the factory. It is the amount spent in order to produce and sell the goods and services to earn the revenue. For example, cost of raw material, carriage, wages, insurance premium, rent paid for office, etc.
Expense may be different from expenditure. Expenditure is generally the amount spent for the purchase of assets. It increases the profit earning capacity of the business, for example, furniture purchased, machines purchased, etc. Expense, on the other hand, is an amount to earn revenue. Some examples of expenses are the payments made for rent, wages, salaries, etc.
Expenditure is considered as capital expenditure unless it is qualified with words like revenue expenditure on rent, salaries, etc. while expense is always considered as a ‘revenue expense’ because it is always incurred to earn revenue.
It is the excess of business revenue over the business expenses for a period. It is an addition to the owner’s equity.
It is the decrease in the value of net assets. It is the excess of business expenses incurred over the business revenue earned during the year. It decreases the owners equity.
Purchases always refer to purchases of merchandise. Purchases means the purchases of such goods and services in which a firm deals. Purchases of cars for an automobile dealer are purchases. For any other firm it is not a purchase.
It means exchange of such goods and services for money in which the firm deals in. One of the most important objective of a business is to make profit. This objective is achieved by selling goods and services at a price higher than their cost.
It means, in case of a trader, all the goods or merchandise that he has for sale in the ordinary course of business. In case of a manufacturer, stock may consist of:
- (a) Raw-material to be used for manufacturing goods
- (b) Semi-finished products or goods - raw-material in the process of manufacturing and which has not yet been finished and which is not yet fit for sale or subsequent use
- (c) Finished products or goods
The goods meant for sale in case of a trader and raw material, semi-finished goods or finished products for sale in case of a manufacturer are stock-in-trade or inventory.
In addition to debtors there may be some other persons also who owe money to the business. They are called receivables. This includes Bills Receivables also.
In addition to creditors there may be some other persons to whom the business owes money. This includes Bills Payables also. These are called payables.
Debtor and Creditor
A debtor is a person who owes money. A creditor is a person to whom money is owing. A person becomes a debtor when he receives some benefit. It may be in the form of money, goods, or services. A person becomes a creditor when he yields (gives) some benefit.
Debit and Credit
Every business transaction involves a debit and a credit. The debit amounts are equal to credit amounts. This practice of having equal debits and credits is called Double Entry Book-keeping. Under this system every transaction has two aspects - as debit aspect and credit aspect and at the time of recording a transaction, both these aspects are recorded.