Accounting can be termed as a means for measuring and recording the financial value of the assets and liabilities of a business. It also allows monitoring of these values as they change with the passage of time. (Ahmed Raihi-Belkaoui, 2004 p.10)
Business assets are those things that belong to the business that have a positive financial value and are used by the business for carrying out its normal activities. Examples of assets include land, buildings, machinery, vehicles, equipment, stocks,
Business liabilities are those things that belong to the business but contrasting to assets, have a negative financial value i.e. they require the payment of money by the business at some point in the future. Examples of liabilities include unpaid taxes, bills, wages, overdrawn bank accounts and creditor’s money e.t.c.
The equity of a business is the value of the assets less the value of the liabilities. So basically equity is the differential (usually monetary) value that would be left if all the assets were sold and used to pay off all the liabilities. (Ahmed Raihi-Belkaoui, 2004 p.11)
The equity along with assets and liabilities are financial dimensions that are time specific. The financial statement that presents this information is known as the balance sheet. Therefore the balance sheet is a statement of the assets, liabilities and equity of a business at a particular point of time. (Donald E. Kieso. 2006 p.38)
Now let us move to the relation between the three entities that is represented by what is called the "accounting equation". (Donald E. Kieso. 2006 p.38)
OE = A - L
OE - Owner's Equity
A - Assets
L - Liabilites
So we can say that equity is the value of assets minus the value of liabilities. Rewriting the same equation we have:
A = L + OE
Meaning that the value of the assets is equal to the value of the liabilities plus the equity.
So by definition the accounting equation holds true for all cases. Now a balance sheet is usually divided into two sections, one section for assets and the other section for the liabilities and the equity (according to the second equation).
Since the balance sheet is time specific it is also known as the statement of financial position. Two other major financial dimensions that cover a period of time against a particular point of time are income and expenses. (Donald E. Kieso. 2006 p.50)
The income or revenue of a business is the total of those items that increase the value of the assets without corresponding increase in liabilities or equity such as revenue from the sale of goods, services, equipment, interest received, rent and capital gains.
The expenses of a business are those things that reduce the value of the assets without corresponding reduction in the liabilities or equity such as the cost of raw materials, wages, stock, rent, electricity bills, telephone, taxes, and depreciation.
The income and expenses of a business are dimensions that relate to a specific period of time and the financial statement that is used for presenting this information is the "income statement" which is the statement of income and expenses of a business during a specific period.
Now if we want to represent the relationship between the assets, the liabilities, the equity, the income and the expenses we can look at the equation given below:
A = L + OE + (I - E)
According to this equation the value of the assets is equal to the value of liabilities plus equity plus the excess of income over expenses.Rewriting this equation we have:
A + E = L + OE + I
This equation shows that assets plus expenses equals the value of the liabilities along with equity plus the income. The second equation is