If you are just starting to learn accounting, or as a business owner you want to understand financial statements better, it helps to start with five basic concepts: assets, liabilities, equity, income and expenses. This article is for beginner accountants, students and entrepreneurs. The definitions are based on the Conceptual Framework of the International Financial Reporting Standards (IFRS; MHBS in Azerbaijani).
What is the Conceptual Framework?
According to the IFRS Foundation, the IFRS Conceptual Framework defines the fundamental concepts of financial reporting. It helps keep the standards consistent and helps companies develop accounting policies when no standard applies. The definitions of assets, liabilities, equity, income and expenses are also given in this framework.
What is an asset?
According to the Conceptual Framework, an asset is a present economic resource controlled by the entity as a result of past events. An economic resource is a right that has the potential to produce economic benefits.
The definition can be checked with three questions:
- Is it a right that has the potential to produce economic benefits?
- Does the entity control it?
- Did it arise as a result of past events, and does it exist now?
For example, the cash in a company's bank account answers "yes" to these questions. The definition contains three key words: "control", "past events" and "present". That is why a resource you only plan to obtain in the future is not yet an asset.
What are liabilities and equity?
A liability is a present obligation of the entity to transfer an economic resource as a result of past events. For example, if a company has taken a loan from a bank, it has already received the money (a past event) and now has an obligation to repay it. By the same logic, a purchase that is only planned does not create a liability, because there is no past event.
Equity is the residual interest in the assets of the entity after deducting all its liabilities. That is why, to understand equity, you first need to know assets and liabilities.
Income and expenses: what changes equity?
Income is increases in assets, or decreases in liabilities, that result in increases in equity; contributions from equity holders are not included.
Expenses are decreases in assets, or increases in liabilities, that result in decreases in equity; distributions to equity holders are not included.
The definitions can be understood with simple examples:
- You provided a service to a client and the fee went straight into your bank account: assets increased, liabilities did not change, equity increased — this is income.
- The founder put additional money into the company as a capital contribution: assets and equity increased, but this is not income, because the definition excludes contributions from equity holders.
- Employees' salaries for this month have been accrued but not yet paid: liabilities increased, equity decreased — this is an expense.
The second example shows an important point: money coming into a company does not always mean income.
| Concept | Short definition (per the Conceptual Framework) |
|---|---|
| Asset | A present economic resource controlled by the entity as a result of past events |
| Liability | A present obligation to transfer an economic resource as a result of past events |
| Equity | The residual interest in the assets after deducting all liabilities |
| Income | Increases in assets or decreases in liabilities that increase equity (excluding contributions from equity holders) |
| Expenses | Decreases in assets or increases in liabilities that decrease equity (excluding distributions to equity holders) |
A short note for those who work with 1C
These concepts also come up when working in accounting software. According to the 1C company, the 1C:Enterprise 8 software system consists of a technology platform (core) and applied solutions built on it — "configurations". The system is used to automate the work of manufacturing and trading companies and of budget-funded and financial organizations, including keeping accounting records under several charts of accounts.
Consolidating these five concepts before you start learning the software makes it easier to understand the meaning of the transactions in it.
Summary
- An asset is a present economic resource controlled by the entity as a result of past events.
- A liability is a present obligation to transfer an economic resource as a result of past events.
- Equity is the residual interest in the assets after deducting all liabilities.
- Income increases equity, while expenses decrease it; contributions from owners and distributions to them are not included in these definitions.
- 1C:Enterprise 8 consists of a technology platform and configurations built on it.
At Estavor Academy, accounting and 1C courses are held online only — in individual or group format. If you have a question, message us on WhatsApp: +994 77 754 10 12.
📚 Sources
🌐 The original article is in Azerbaijani; the official sources are available in Azerbaijani.
More articles
Language levels A1 to C2: what do they mean? (English and Russian)
What do A1, B2 and C1 mean? CEFR language levels and how the Russian TORFL (TRKI) levels correspond to them, for learners of English and Russian.
6 Excel tools everyone should know
How does XLOOKUP work, and what is the key rule of VLOOKUP? SUMIF, IF, PivotTable and Flash Fill: 6 Excel tools that make everyday work easier.