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Getting familiar with assets and liabilities

In this step from the University of Padova learn about the relationship between liabilities, assets and equity.
two post-it on a wood background with the worlds Assets and Liabilities

An asset is a resource available to the firm that is expected to generate future economic benefits (future cash inflows or reduce future cash outflows)

An asset is recognised upon acquisition from past transactions or exchanges.

The value of its future benefits should be measurable. The benefits of the asset accrue to the company. Assets are debited, if the value increases, or credited if the value decreases.

Liabilities

A liability is a claim on a company’s resources held by “creditors” (non-shareholders); a liability represents an obligation to make future payment of cash, goods, or services.

A liability is recognised when:

– The obligation is based on benefits or services received currently or in the past

– The amount and timing of payment can be ascertained with reasonable certainty. Liabilities are debited if the value decreases, or credited, if the value increases.

Equity

Stockholders’ equity is the residual claim of the owners of the company on assets after settling claims of creditors

Assets – Liabilities = “net worth” or “net assets” or “net book value”

Sources of Stockholders’ equity:

Paid-in capital arises from issuance of shares, namely: 1. Common stock 2. Additional paid-in-capital (excess over par value) 3. Treasury Stock (stock repurchased by company).

Retained earnings arise from operations: 1. Accumulation of net income (revenues minus expenses), less dividends, since start of business 2. Retained Earnings (T1) = Retained Earnings (T0) + Net Income (T1) – Dividends (T1)

Dividends represent a distribution of retained earnings to shareholders. Dividends are not recorded as an expense, instead as a reduction of retained earnings: in fact, shareholders are getting cash in exchange for a reduced value of their claims.

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Introduction to Financial Accounting

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