The basic model accounting system

ADS The Basic Model
The first objective of any accounting system is to identify the economic events that can be expressed in financial terms by the system. 1 An economic event for accounting purposes is any event that directly affects the financial position of the company. that financial position comprises assets, liabilities, and owners’ equity. Broad and specific accounting principles determine which events should be recorded, when the events should be recorded, and the dollar amount at which they should be measured. Economic events can be classified as either external events or internal events. External events involve an exchange between the company and a separate economic entity. Examples are purchasing merchandise inventory for cash, borrowing cash from a bank, and paying salaries to employees. In each instance, the company receives something (merchandise, cash, and services) in exchange for something else (cash, assumption of a liability, and cash).

On the other hand, internal events directly affect the financial position of the company but don’t involve an exchange transaction with another entity. Examples are the depreciation of machinery and the use of supplies. As we will see later in the chapter, these events must be recorded to properly reflect a company’s financial position and results of operations in accordance with the accrual accounting model.The Accounting Equation

The accounting equation underlies the process used to capture the effect of economic events.
Assets = Liabilities + Owners’ Equity

This general expression portrays the equality between the total economic resources of an entity (its assets)shown on the left side of the equation and the total claims against the entity (liabilities and equity) shown on the right side. In other words, the resources of an enterprise are provided by creditors and owners. The equation also implies that each economic event affecting this equation will have a dual effect because resources always must equal claims

Each transaction is analyzed to determine its effect on the equation and on the specific financial position elements. The accounting equation can be expanded to include a column for each type of asset and liability and for each type of change in owners’ equity. ADS