The Fundamental Problem of Accountancy.—The aim of all private businesses being the increase of wealth, the first problem of accountancy is to determine how much wealth is invested in a given enterprise and what ownership or proprietorship exists at given periods, so that by comparison the increases and decreases in the proprietorship may be known. When accurate information is obtained, an intelligent plan of action can be adopted to remedy such ills of the business as are shown and to increase any profitable line of activity. Accordingly, proprietorship and its changing values are the basic problems of accountancy as well as of business.
Definition of Terms.—Before proceeding to a definition or determination of proprietorship, it is necessary to understand what is meant by the terms “assets” and “liabilities.” The root idea of the word “assets” is “sufficiency.” Specifically, assets are the “entire property of all sorts, of a person, association, or corporation applicable or subject to the payment of debts.” Similarly, the liabilities of a person, firm, or corporation are his or its pecuniary obligations or debts. Proprietorship is the difference between the value of the assets and the amount of the liabilities, and is defined and measured by the equation:
Assets - Liabilities = Proprietorship
This proprietorship equation is a basic formula. It is also written:
Assets = Liabilities + Proprietorship
It will thus be seen that proprietorship represents the equity of the owners of an enterprise in its assets. The assets are first applied in paying the claims of creditors of the business, and whatever of them remains belongs to the owners of the business.
Development of the Proprietorship Equation—The Balance Sheet.—To indicate the basis of the standard form of the proprietorship equation, several illustrations will be given. The equation is in its simplest form when it indicates proprietorship in a new business immediately after the owner has invested cash to provide the business with capital. For example, assume that on January 1, 19—, James T. Runyon starts business by investing $5,000 cash capital in the enterprise.
Here the proprietorship equation is:
Assets (cash $5,000) = Proprietorship ($5,000)
As yet there are no liabilities. However, in order to carry on his business, Runyon must purchase a stock of merchandise and equipment for his store. Accordingly, he purchases store furniture and fixtures from Lowell Brothers for $500, of which he pays $250 in cash, and owes the balance. He also buys a stock of groceries for $2,500 from Reid Murdock & Co. on 10 days’ time. He now has more assets than the original $5,000 cash, but he has become indebted for the additional amount, so that the amount of his proprietorship has not changed—as is shown by the following equation, somewhat more complex than the first: