Key Accounting Principles Volume 1, 4th Edition - Textbook - page 14

Chapter 1 Financial Statements: Personal Accounting
14
We can also illustrate these transactions with the accounting equation to ensure that assets equal
liabilities plus net worth.This is shown in Figure 1.24.
Assets = Liabilities + Net Worth
+ 5,000
- 1,000
+ 500
+ 1,500
+ 5,000
4,000
4,000 = 4,000
2,000 2,000
- 1,000
- 500
- 1,500
Received salary
Paid food expense with cash
Billed for gas expense
Billed for entertainment expense
Explanation
______________
FIGURE 1.24
The accounting equation is balanced
Assets = Liabilities + Net Worth
$4,000 = $2,000 + $2,000
As the examples in Figure 1.23 and 1.24 illustrate, you need to match your expenses for the month
with what you earn for the month. According to the concept of accruals, the credit card expenses
would be recognized in January when they were incurred, not in February when they are paid.
It is easy to mistakenly think that since cash increased by $4,000 that net worth also increased by
the same amount. This is not the case. It is important to understand that net worth is affected by
revenue and expenses, regardless of when cash changes hands.
Borrowing Money and Repaying Debt
Other than cash in your bank account, every other financial aspect
of your life relates to values—not to cash. Your assets have value,
but will only become cash if you sell them. Your liabilities represent
an obligation you have, but they do not affect your cash until you
actually pay them.
When you borrow money, you increase your assets and your debts.
Net worth is not affected. When you pay your debts (principal),
you decrease your assets and your debts. Again, net worth is not
affected. Since net worth is not affected, there is nothing to record
on the income statement. Remember, the income statement is used
to track the reasons for a change to net worth.
For example, assume you borrow money from a friend and then
repay the money.
1. Borrow $100 from a friend: you have more cash, but your net
worth does not change.
No change in net worth
ASSETS
PERSONAL BALANCE SHEET
LIABILITIES
CASH
PREPAID
EXPENSES
CONTENTS
OF HOME
AUTOMOBILE
HOUSE
UNPAID
ACCOUNTS
MORTGAGE
LOANS
NETWORTH
1. + $100
2. - $100
1. + $100
2. - $100
______________
FIGURE 1.25