Let's imagine that you run a sick GBD merchandise business. For the holiday, you produce shirts, hoodies, hats, etc... and everyone on campus loves them.
Since your enterprise has started to grow over the years, it's time that you take your financials more seriously. You want to make sure that not a dollar goes unaccounted for, so that you can reap the benefits of owning the up-and-coming GBD merch business.
Throughout this series of concepts for Exam 1, we're going to relate everything back to your GBD merch business (we'll call it "GBD Fits").
The first order of business: make sure that the accounting equation is in-line for your business!
The accounting equation
Hold tight, here's the accounting equation! (It's a tough one! #sarcasm)
Assets = Liabilities + Equity
This equation serves as the basis of all accounting work that you'll do in this course.
In relation to GBD Fits, let's say that currently we've got $5,000 in assets. This includes our printing press, merch in storage, ink, etc.
$5,000 = Liabilities + Equity
This means that our liabilities and equity must equate to $5,000 as well. Let's say we currently have $1,000 of payment we made on credit that still needs to be paid off (which will be represented as a liability)...
$5,000 = $1,000 + Equity
...and the remaining $4,000 is ours as equity. If we sold the business, we'd receive $4,000.
$5,000 = $1,000 + $4,000
Based on these findings, we're in good shape. Our accounting equation matches up! Assets equal $5,000, and liabilities + equity equal $4,000 + $1,000 = $5,000 too!
Your assets must always equal your liabilities + equity! If they don't you've done something wrong!
Now... what goes into assets, liabilities, and equity? Let's find out below, starting with assets!
Assets explained
Assets, in essence, are...
Assets are anything that provide economic value to a firm.
Assets covers a lot of aspects of a business that provide economic value, so it's a little bit easier to segment them down into the following 3 categories:
- Current Assets
- Long Term Assets
- Contra Assets
Current assets
Simply put...
Current assets are assets in which they can easily be turned into cash or they expire within 1 year.
Lucky for us, there's only 4 current assets that you need to know of! I've listed them below, and given a quick description of what they might look like in relation to GBD Fits!
| Account | GBD Fits Description |
|---|---|
| Cash | Literally cash. Can be physical or in the bank. |
| Accounts Receivable | Johnny promises to pay you back $45 in a week for his sick, custom GBD hoodie you made him. |
| Inventory | Ink for the printing press machine. |
| Supplies | Notepad used to jot down orders. |
One crucial difference to note...
Supplies help run the daily operations of the business. Inventory is used to create the end-product that's eventually sold to customers.
Long term assets
Unlike current assets...
Long term assets are used in business operations longer than 1 year.
Here are some relevant examples to what you'll face on your exam:
| Account | GBD Fits Description |
|---|---|
| Property | The house that you run your GBD merch sales out of. |
| Plant | A massive warehouse that you use to mass-produce your merch. |
| Equipment | A printing press to place graphics on clothing. |
There is a subcategory of long term assets that's important to recognize...
Intangible assets
Intangible assets are assets that you cannot physically touch, however they still provide economic benefit to your company.
Here's some examples of these in relation to GBD Fits:
| Account | GBD Fits Description |
|---|---|
| Copyright | You create original design that has blown up; everyone on campus is wearing it. You file that design for copyright. |
| Trademark | You've filed for trademark on your company name and logo so no other companies can copy it. |
| Patent | You've patented your ink concoction that reduces wear-and-tear on graphics. |
Contra assets
This is the last type of asset account that we need to understand!
Contra assets are accounts that decrease your assets.
The only contra asset that you will need to know of is the account accumulated depreciation.
Accumulated depreciation decreases your asset account because over a period of time, assets tend to lose value. This loss in value reduces how much an asset is worth.
Here's an example applied to your GBD Fits business:
| Account | GBD Fits Description |
|---|---|
| Accumulated Depreciation | You've been using your printing press for 3 years now, and in-turn has some wear-and-tear. |
Liabilities explained
Similar to assets, there are short term and long term liabilities. Let’s first go over short term liabilities!
Short term liabilities
Short term liabilities are those debts that your company expects to pay off within 1 year.
Here's some examples of the relevant short term liabilities in relation to your GBD Fits business:
| Account | GBD Fits Description |
|---|---|
| Accounts Payable | You paid for some base-model clothing on credit, promising to pay back within a year. |
| Notes Payable (short term) | You took a loan out from the bank for a printing press, which will be paid back in 1 year. |
| Wages Payable | Marc is helping you out with production, and you promise to pay him back for work within a year. |
| Unearned Revenue | Sarah pays you $100 for her GBD merch package, which you have not printed & delivered to her yet. |
One thing to note: it's easy to mix up Accounts Payable and Notes Payable. The difference is...
Notes Payable deal with loans. Accounts Payable deal with purchases on credit.
Also: it's really easy to mistaken Unearned revenue
Long term liabilities
Long term liabilities are those debts that your company expects to be paid in 1+ years.
Here's some examples of the relevant long term liabilities in relation to your GBD Fits business:
| Account | GBD Fits Description |
|---|---|
| Notes Payable (long term) | You took a loan out from the bank for a printing press, which will be paid back in over 1 year. |
| Mortgage Payable | You bought a building to print merch out of and need to pay it off over the next 5 years. |
If you're ever in doubt if an account is a liability, use the following tip:
If an account has "Payable" at the end of it, it's probably a liability! (Don't forget about Unearned Revenue!)
Equity explained
Equity is a bit simpler than assets and liabilities. There's only two accounts that make it up!
Common stock
Common stock which is also known as “contributed capital”, is when owners make an investment through the company through the purchase of stock.
Applied to GBD Fits, this would look like so:
| Account | GBD Fits Description |
|---|---|
| Common Stock | Business has been boomin', so you issue 100 shares of stock to raise more capital for expansion. |
Retained earnings
Retained earnings is the net income earned by a company after they have paid their stockholders dividends.
Applied to GBD Fits, this would look like so:
| Account | GBD Fits Description |
|---|---|
| Retained Earnings | You've raised $10,000 in net income this semester on merch, and issued $1,000 in dividends out to shareholders. |
There are a couple inner-workings to net income that are important to understand before moving on...
Net income
Net income is in direct correlation to Retained Earnings, and is made up of revenue and expenses.
In relation to GBD Fits, here are some of the relevant revenue accounts you might see:
| Account | GBD Fits Description |
|---|---|
| Service Revenue | Susie pays you $50 to repair her GBD jacket. |
| Sales Revenue | You sell 10 hoodies, resulting in $500 of sales. |
Here are some relevant expense accounts you might see as well:
| Account | GBD Fits Description |
|---|---|
| Cost of Goods Sold | To sell those 10 hoodies, you had to buy 10 base-models for $10 each. |
| Rent Expense | The building you run merch sales out of costs $1,000 a month in rent. |
| Wages Expense | You pay Steve $200 per week to help out with merch production. |
Don't forget...
Cost of Goods Sold, despite not having "Expense" in the name, is still an expense!
I’m a Miami University (OH) 2021 alumni who majored in Information Systems. At Miami, I tutored students in Python, SQL, JavaScript, and HTML for 2+ years. I’m a huge fantasy football fan, Marvel nerd, and love hanging out with my friends here in Chicago where I currently reside.