Assets, liabilities and owner's equity

Three questions about any business

Before any journal, ledger or financial statement, accounting asks three plain questions about a business on a given day:

1. What does the business control that will bring it benefit later?
2. What does the business owe to outsiders?
3. What is left over for the owner?

The answers are called assets, liabilities and owner's equity. Everything else you learn this year is built on these three words, so it is worth getting them exactly right before any recording starts.

Assets

An asset is a resource the business controls and expects to benefit from in future. Money in the business bank account, cash in the till, equipment, vehicles, trading stock, and amounts customers still owe the business (debtors) are all assets.

Two tests help:

• Does the business control it, rather than the owner in a private capacity?
• Will it bring the business money or usable value later?

Liabilities

A liability is an amount the business owes to someone outside the business. A loan from a finance house, an amount owed to a supplier for stock bought on credit (creditors), and an unpaid electricity account are all liabilities. The outsider has a claim on the business's resources until the debt is settled.

Owner's equity

Owner's equity is the owner's claim on the business. It grows when the owner puts money in (capital) and when the business earns profit. It shrinks when the owner takes money or goods out for private use (drawings) and when the business makes a loss.

Notice that the business is treated as separate from its owner. That is why money the owner hands over to the business is recorded as a claim against the business rather than as a gift to it.

Putting it together

Worked example. Thandi Nkosi opens a barber shop, Kasi Kuts, in Tembisa on 1 March.

After those three events:

• Assets: Bank R48 500 plus Equipment R6 500 = R55 000
• Liabilities: Loan = R15 000
• Owner's equity: Capital = R40 000

The business controls R55 000 of resources. Outsiders have a claim of R15 000 on those resources and Thandi has a claim of R40 000. Nothing the business controls is left unclaimed, and that is not a coincidence.

Core checkpoint: for any item, decide whether the business controls it (asset), owes it to an outsider (liability), or whether it is what remains for the owner (owner's equity). If you cannot say whose claim it is, you have not classified it yet.