For the equation, and thus the
accounting system to function properly, it is assumed
that a business owes someone for everything it has.
Profit or Loss is a calculation of: Revenues - Expenses.
If Revenues are more than Expenses, there is Profit.
If Expenses are more than Revenues, there is Loss. Revenues
are what the business earns for doing what it is in
business to do. Expenses are the cost of assets the
business uses to generate Revenues.
The purpose of the accounting system is to keep a record
of the changes in Assets, Liabilities and Owner's Equity
(including Revenues and Expenses) and to report the
effects of those changes. The reports are called financial
statements and there are different financial statements
to report different things.
The Balance Sheet reports what Assets, Liabilities and
Owner's Equity the business has as of a certain date.
The Income Statement reports the total Revenues and
Expenses and the difference (Profit of Loss) for a specific
period of time (month, quarter, year, etc.). The Statement
of Owner's Equity (sometimes called Statement of Changes
in Owner's Equity or Capital Statement) reports why
and how Owner's Equity changed for a specific period
of time (month, quarter, year, etc.). The Statement
of Cash Flows reports the sources and uses of Cash for
a specific period of time (month, quarter, year, etc.).
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