Over the last year, I have become aware of the severe gaps in accounting knowledge in this community. We are a leading voice of progressives, and frankly, we have to be better when talking about corporations and their accounting. Unfortunately, I'm not the best person to teach you accounting. Also unfortunately, I haven't seen anyone else step up to the task, so I'm going to try. Why should you listen to me? Well, you're who I was a year ago. Since then, I've had a year's worth of MBA classes. They certainly haven't taught me everything, but I am a Dean's Scholar, so hopefully I've learned enough to teach you some basics. And hopefully, your questions will let me learn some things, too. Hooray for the cycle of learning.
In the land before time, corporate accounting was easy. Assume Company A is a widget making company. During a particular timeframe, they make some widgets and they sell some widgets. If Company A needed to know if they were making money (for instance to pay income taxes), they just looked at their bank account. There was some money that went out for things like widget components, labor, utilities, etc, and there was some money that came in from selling finished widgets. The amount by which the money coming in exceeded the money going out was considered profit. This is accounting on a cash basis. And this isn't what accountants do anymore.
Some time in the 13th century, some Italians came up with a better system that used double-entry bookkeeping. This was the ancestor to our modern accrual based accounting system. I'd explain why this system is so much better, but you really just have to see it in action through the course of these diaries.
Modern accounting tracks three categories of a company's finances: assets (A), liabilities (L), and owner's equity (E) in a balance sheet.
Assets are things of measurable financial value to the company. These are things like cash, inventory, property, equipment, money owed to you, etc. So you know, workers are not an asset of a company. Since the mid 1800s in this country, companies haven't been able to own labor. Because labor isn't owned, it doesn't go on the balance sheet as an asset.
Liabilities are financial obligations of the company that stem from past agreements or transactions. These are things like money owed from taking out a loan, taxes you owe on previous profits, etc.
Equity is the residual value of the company once liabilities are deducted from assets. These are things like stock and preferred stock.
So, the fundamental formula for accounting is A = L + E. Assets must always equal liabilities + equity. Let's go through some basic examples. Some guy named Markos wants to start some computer blog company thing. That's great. Poof, company created, let's call it DailyKos. At inception, a company's balance sheet looks like this:
Balance Sheet for DailyKos |
Assets |
Liabilities |
0 |
0 |
Owner's Equity |
0 |
0 |
0 |
Of course, the company will need some startup cash. So, let's say Markos will lend DailyKos $10,000. DailyKos' balance sheet will now look like this:
Balance Sheet for DailyKos |
Assets |
Liabilities |
$10,000 cash |
$10,000 Markos loan |
Owner's Equity |
0 |
$10,000 |
$10,000 |
You can see the $10,000 now as an asset of the company, but you can also see the company's obligation to repay the $10,000 as a liability. So our A = L + E formula holds true. The last line in the table is just the total, if you were wondering. The first thing DailyKos needs to do is buy a server, so let's buy a shiney new server for $2,000.
Balance Sheet for DailyKos |
Assets |
Liabilities |
$8,000 cash
$2,000 server |
$10,000 Markos loan |
Owner's Equity |
0 |
$10,000 |
$10,000 |
If you want to see the balance sheet of a public company, all you have to do is go to yahoo finance (
http://finance.yahoo.com), type in a company's name next to the "Get Quotes" button, press the button, then scroll down to the bottom of that left column and click where it says "Balance Sheet."
Here's Bank of America's balance sheet. You can see their assets, liabilities and equity. You'll notice that the A = L + E forumla holds true.
I think I'll stop here for today. Use the comments for questions and for any advice on how to teach this stuff.