GAAP and the Accounting Equation

GAAP governs all accounting functions. But to understand accounting functions, including what is written above, you have to learn the basic accounting equation as it relates to the GAAP. The actual accounting formula is written like this: Assets = Liabilities + Owner’s Equity. Below we will look at each one in turn:

 

·        Assets: When dealing with GAAP, all assets have to be recorded properly. Assets are known as economic resources that may benefit the company later in the future. Examples of assets are cash, inventory, furniture, and land.

·        Liabilities: Liabilities have to be recorded properly as well. Liabilities are debts to outsiders or creditors. For example, a loan to buy equipment is a liability.

·        Owner’s Equity: This is what is left of the company’s assets after all liabilities are subtracted. As you know, the purpose of any business is to profit and make money. This means raising the equity in the business by means of revenue. Revenue is defined as money received from the sale of products or services. On the other hand, expenses are money paid out for assets that are used up, or for increasing liabilities in the process of doing business. Expenses decrease owner’s equity.

 

As you can see, GAAP has a major impact when dealing with accounting even to the little expense. All transactions, no matter what they are, are bound and recorded by GAAP rules and principles.