1. It embodies a future benefit, either on its own or in combination with other assets. For instance, in the case of for-profit enterprises, assets contribute either directly or indirectly to future net cash flows. In not-for-profit organizations, assets contribute to provide services.
2. The business entity has controlled access to the asset's benefits.
3. The deal or occurrence that entitled the business to have control over the asset was something that happened in the past.

Liabilities

Generally speaking, a liability is viewed as anything a company owes, either to people or other businesses. This could entail money owed to a supplier; payroll due to employees; taxes that need to be paid to local, state, and federal tax agencies; and credit amounts carried with banks or other lending institutions.

On the balance sheet, increases in owners' equity are reported on the credit side of a journal entry, whereas decreases in owners' equity are reported on the debit side of a journal entry.

The Income Statement: Revenue, Expenses, Income, and Retained Earnings

When dealing with accounting, you need to understand income statements and balance sheets. These reports tell you where the company stands financially for any given period of time. Once you understand how to read a company's financial statements, you can make the right decisions to increase the company's revenue and profit.

The purpose of the income statement is to provide investors, owners, shareholders, and other interested people periodic reports about how the company is doing financially. The income statement should include revenue, expenses, and net income or profit, as well as the timeline the report represents, which is known as the accounting period. Almost all companies will produce an income statement annually and often run reports for more frequent accounting periods. For example, some organizations may choose to run the income statement biweekly, monthly, or quarterly. Needless to say, an astute owner or manager runs this report frequently.

There are many reasons why the income statement is so important to interested parties. It is almost impossible to succinctly list all its effective benefits. However, its most obvious and important purpose is to show whether the sum total of all assets of an organization have increased or decreased during the accounting period. In short, it answers, in numbers, the question: "How well did we do?"

The following is an example of an income statement for a small computer repair shop called Orion Computer Repair Company:

A few things to note about this example:

• The name of the company is at the top of the income statement.
• The second line is the accounting period for the report.
• As typical with income statements, this one shows revenue first, then expenses, as expenses are deducted from revenue. Last is the total income, or bottom line. 
• Negative numbers are represented in parentheses, although it is not necessary to use them because you should know that expenses are always negative.
• As with all financial statements, you are reading this from top to bottom.

Without revenue, there is no business, at least, not in the long run. Most newcomers to the accounting world understand that revenue means you are receiving income, or cash from sales. However, many newcomers will erroneously confuse revenue with profit. So let us be absolutely clear what revenue is.

Revenue for a company is the total amount of income received from sales, interest, dividends, etc. Revenue is divided  into separate categories that indicate where the revenue came from and then summed up for the income statement. Revenue usually is divided into broad categories, then totaled on the income statement so investors can see what parts of the company received how much revenue.

If our little enterprise, Orion Computer Repair Company, repaired 200 computers at the cost of $200 per computer, its revenue would be $40,000. But this does not cover the cost of repairs to the computers and the computer spare parts  used to fix the computers. While the company repaired each computer for $200, it cost $120 to fix each computer. The total expenses incurred for repairing those 200 computers added up $24,000. Therefore, the company's profit, the money made after paying off expenses, is only $16,000. As you can see, profit does not equal revenue. Revenue is the total amount of income received for a given period of time. Profit is how much money is retained after all the expenses have been deducted.

Expenses

Expenses are the cost of doing business, the cost of goods sold, and the use of any services. If the Orion Computer Repair Company pays $100 for spare parts for each computer fixed and $20 in labor to fix those computers, then its cost of goods sold (expense) would be $120 a computer. Expenses include payroll, utilities, rent, insurance, vehicles, etc.

Different people call net income many different things. Some people refer to it as profit; some people refer to it as just income or earnings. In financial statements, it is common practice to call it "net income." For example, when public corporations post their quarterly earnings, they will seldom use the word profit because, in general, profit has some negative associations. Profit is often seen as corporate greed and the reason why children in China work 18-hour days in American-owned factories. In the financial world, profit is usually referred to as net income. Net income is a good term because the interested party without question understands that it is a sum of calculations.

Net income is defined as the difference between an organization's total revenue and its total expenses for a specific period of time, known as the accounting period. So when you see or hear the term "net income," think "profit."

If you remember the fundamental accounting equation, Assets = Liabilities + Owners' Equity, also remember that retained earnings are part of owners' equity. It is a major component of the balance sheet. Retained earnings are the continued profit part of the owners' equity. There are two parts to owner's equity: contributed capital, or seed money, and retained earnings, which can be summarized as profit/net income = revenue - expenses.

As typical when learning the terminology of any subject, you will see several terms used to mean the same thing or similar things. So far, we have seen that income, profit, net income, earnings, and retained earnings all mean essentially revenue minus expenses. The only major difference is that when you use retained earnings, you are usually referring to the balance sheet or the accounting equation (owners' equity), and it is cumulative, meaning the overall retained earnings for a company will increase from year to year for profitable companies. Hence, the word "retained." Simply put, it is profit saved.

Income tax is exactly what it sounds like, and the same thing you calculate every year for yourself. It is the tax on a company's income. The important thing to note is that most accountants treat income tax as an expense, though accountants could alternatively look at it as a complete loss or that the government is an investor entitled to some portion of a company's profits. For our purposes, we will consider it an expense to be deducted from revenue. The problem is deceiving, and financial statements should show or otherwise itemize pre- and post-tax expenses.

All companies must choose how they are going to account for their revenue and expenses. They choose to use either cash accounting or accrual accounting. In cash accounting, a company does not claim revenue until it actually has received money for services or goods; for example, physically received a check. Additionally, expenses are not realized until the check has left the company to pay for the expense. This works well for small businesses, but the majority of larger companies will use the accrual method of accounting, also known as accrual basis.

In accrual accounting, revenue and expenses are claimed at the time they occur. For example, revenue is recorded when services of a business have been provided (service revenue), or the goods of a company have been shipped (sales revenue). This means that if the Orion Computer Repair Company sends out 20 fixed computers and invoices to the customers for each computer, the company would account for the money as revenue even though it has not yet received payment under the accrual method of accounting.

The idea behind accrual accounting is to maintain a current and accurate picture of what is going on financially in a company at a specific point in time. If the Orion Computer Repair Company has a fantastic summer of repairing computers but did not get paid for services until three months later, under the cash basis accounting system it would look as if summer is slow for repair sales and that fall and/or winter are extremely profitable. In accrual accounting, the company would see a more accurate representation of when computer repair sales are highest.