The asset accounts have net left-side balances, as previously explained. Hence, if all the detailed accounts which record assets are brought together, the sum total of the left-side balances of these accounts will represent the total assets of the business. Liability accounts have right-side balances, as also explained. Therefore, if all the accounts that record the liabilities of the business are brought together, the sum total of their right-side balances will represent the total liabilities of the business. The proprietorship accounts have right-side and left-side balances. The net total of all the proprietorship accounts will be a right-side balance, however, and will show the present net worth of the business.
Form 2. Chart of Accounts
Accordingly, when one views the accounts in the ledger in their fundamental groupings—namely, assets, liabilities, and proprietorship—it is seen that the equation of the balance sheet is also the equation of the ledger. The account is thus seen to be an integral part of the balance sheet. It is so arranged, however, as to sort and handle additions and subtractions and to furnish a net result for use in the balance sheet.
The asset portion of the proprietorship equation is in the ledger broken up into the various kinds of assets, record of which is desirable and necessary for purposes of adequate control of the business. In keeping the record, all the transactions affecting—that is, either adding to or subtracting from—a given asset are recorded in the account kept with that asset. In this way each account brings about a sorting of the transactions affecting it. It separates these transactions into two kinds, those which add to and those which subtract from its value, and by means of its net balance at any given time it summarizes the numberless transactions which have affected it during a period and gives a net result showing its present status.
In much the same way the liability item of the proprietorship equation is broken up in the ledger for purposes of detailed information, into a large number of individual liability accounts. The sum total of the balance of these accounts is the liability item of the proprietorship equation.
The proprietorship section of the equation is a little more complex when split up, as it is in the ledger. In accordance with the chart given in [Form 2], it will be seen that proprietorship is classified in the two main groups: (1) capital at the beginning of the period, and (2) changes of capital during the period. It is this latter group of accounts which, as they are carried in the ledger, have both right-side and left-side balances. The income accounts, which tend to increase capital and which, when merged with the capital accounts at the beginning of the period, add to that capital, have right-side balances. The accounts which tend to decrease capital, that is, the expense accounts, because they are subtraction items, have left-side balances. The net increase (or decrease) in capital for the period is the excess (or deficit) of the total income accounts over the total expense accounts. The summarized result therefore of current changes in capital added to the capital at the beginning of the period, gives the proprietorship of the business at any given time.
At the beginning of a business enterprise the accounts in the ledger will be an opening balance sheet of the business. Day by day by day as transactions take place, there will be a constant change in the values of the assets, liabilities, and the proprietorship account which will thus express the changing financial condition of the business. Some assets will be increased while others will be decreased; liabilities will also change; and with these changes there will be brought about a change in proprietorship—an increase or a decrease. The ledger must record these changing values as they take place, so that the condition of the business can be determined practically at any time.
The ledger is thus seen to contain and comprise the balance sheet of the business at all times. Certain groupings, summarizations, and adjustments may be necessary before a balance sheet technically correct as to form and content can be taken from the ledger, but the fundamental balance sheet equation is always contained in the ledger. This is pictured graphically in the chart shown in [Form 2]. A further consideration of the relationships between assets, liabilities, and proprietorship leads us to an explanation of the principles or philosophy of debit and credit, a matter which will be taken up in the next chapter.