Wednesday, August 08, 2007

The Accounting Equation

This entry is highly filtered and is meant only for educational purpose.

To understand any subject or knowledge, one must understand the basic foundation of the knowledge. As for accounting, the foundation of this knowledge is the accounting equation itself:


This entry however is not about the detail depth of this knowledge - accounting, but is about how the equation can be applied usefully in daily life.

ASSETS is categorized as: Fixed Assets, Current Assets and Intangible Assets.
LIABILITIES is categorized as: Long-Term Liabilities and Short-Term Liabilities.


Fixed Assets + Current Assets + Intangible Assets = Long-Term Liabilities + Short-Term Liabilities + Capital + Retained Earnings - Withdrawals.

Balanced Sheet

Without detailing the subject, please take note that The Accounting Equation itself is The Balance Sheet which is an intelligent document showing details on WEALTH.

Profit/Loss Statement

Profit and Loss statement however is more on detailing the INCOME.

Earnings then is accumulated into the Retained Earnings in the Balance Sheet:

Retained Earnings = Previous Retained Earnings + Earnings + Return On Intangible Assets

Note To Ponder Number 1: Are we wealth or profit oriented?
At the end of this entry, one may decide to be either wealth or profit (or income) oriented. Hopefully, one may see which is a wiser choice to take.

Note To Ponder Number 2: The Government tax us on Income
Yes, the government basically tax us on income. The government basically do not tax us on increase of Retained Earnings unlike the Abrahamic way where zakat is an obligation to any inventories. Here lies the greatest loophole in the capitalist system supported by a secular government or Islamic (as claimed by some ... hehehehe).

Question: What do you mean by increase of Retained Earnings??? Is not increased of Retained Earnings is when we add income or profit into it??? Is not Income or Profit is taxable???
Answer: Good question! (Hehehehe, I love this question-answer thing as I do notice readers don't really ask so I might as well ask myself ... hehehehe ... me so smart ass one).

Never mind. Let's go back to The Accounting Equation:



RETAINED EARNINGS = Previous Retained Earnings + Earnings (From Profit/Loss Statement) + Return on Intangible Assets (From the right side of The Accounting Equation).

Therefore, Retained Earnings can be be increased by two ways: Either through Income or through Return On Intangible Assets.

Question: What is Intangible Assets? What is Return On Intangible Assets?
Answer: Intangible Assets is like when you have extra money and you invest that extra money in order to make more extra money. Examples are mutual trust, fixed income deposits, shares, futures trading etc. Caution: Investment on Intangible Assets can be risky and there is no guarantee on return of investment. Before one decide to invest, one must know about the investment especially the Risk/Reward thingy.


Last month, Azer bought some shares in the equity market with value worth RM 10,000.00. This month, his investment has increased to RM 11,000.00. Therefore his return on investment is RM 1,000.00. This return on investment is basically NOT TAXABLE :-)

Note To Ponder Number 3: The more expenses we make, the less tax we pay :-)

Question: Bullshit! The amount of taxes I pay does not changed though I have to spend for my daily consumption - toll, petrol, fair, bills etc.
Answer: True. This is true to those who earn their living by fixed basic salary but NOT TRUE to those who run a business. To those who run a business or more, more expenses mean less profits. Less profits mean less tax to pay.

Question: That does not solve any problem. The more you spend, the less profit you'll be making.
Answer: Do you know that you can incorporate your own name as an enterprise providing you do have a product to sell or a service to offer.


Azer is working with a company as a programmer. In order to earn more income, he sell various software. Azer incorporate a proprietor company for his selling activities. Through the company he incorporated, Azer debits some of his daily expenses (toll, petrol, food, mobile bills etc) into his company' accounts. This way, his taxes on software sales can be reduced by his daily expenditure documented.

Caution: To those in the public sector, please refer to more references as some government departments do not allow the public servants to run a business.

Note To Ponder Number 4: Create wealth via properties.

Fixed Assets can be categorized as Land and Buildings, Vehicles, Machineries, Office Equipments, and Furniture and Fittings.

All fixed assets depreciate but exceptional goes to Land and Buildings. Mostly, Land and Building appreciate in time. In accounting however, fixed assets are documented as depreciating including Land and Buildings. According to a simple linear method, a building depreciate 5% of its book value a year. By documenting the depreciation cost, not only buying properties like Land and Buildings helps creating wealth, it also helps reducing tax as depreciation is a cost which reduces profits.
Understanding The Equation In General

1. This entry is highly filtered as understanding The Accounting Equation can make anyone understand the loopholes created by Capitalism. There are so many other points to ponder but it stops here.

2. This blog believes every Individual should have at least a product to sell or a service to offer. Those who rely on salaries can't do much to adapt inflation and cost-of-living but those who are in business are more adaptable by increasing the sale prices and charges the expenditure into the expenses accounts.

3. Every individual should learn investing as return on investment is NOT taxable. Be very wise though on this.

Question To Ponder: Is It Possible To Have Losses In Profit/Loss Statement BUT Still Wealth Is Being Built?
The Answer is YES. It is there in THE ACCOUNTING EQUATION. Think! :-)

Extra Note To Ponder: Our Inner-Self Is The Most Valuable Intangible Assets Of All.

On Business Roll
Just bumped into a good blog: Tips On How To Manage Your Money by Emily - Emily Wee is a Chartered Accountant and Certified Financial Planner.
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