Let’s start with the basics, just to make sure we are all on the same page. When we are talking about Rent to Own financial statements we are referring to a Balance Sheet and a Profit & Loss Statement. As you may already know, these two reports are made up of only five sections. The Balance Sheet has three sections: Assets, Liabilities, and Equity. The Profit & Loss Statement has two sections: Income and Expense. Each of these sections includes particular accounts, whereby all the transactions that occur within the business are accumulated. These accounts are called general ledger accounts.

A ledger is nothing more than a page with a line drawn down the middle. Therefore, the page is said to have a left side and a right side. Entries made to a particular ledger page are recorded on either side depending on their nature. The rule governing this process is called, “The Accounting Equation”, and it is stated as:

ASSETS = LIABILITIES + EQUITY

This is not mysterious at all if you have ever purchased a home. Let’s say you bought your home for $150,000. You took $50,000 out of your personal savings and made the down payment. You borrowed the remaining $100,000 from the bank. Sounds familiar doesn’t it? Apply this information to the “Accounting Equation”:

Asset ($150,000) = Liabilities ($100,000) + Equity ($50,000)

Now you could switch things around and say:

Assets ($150,000) - Liabilities ($100,000) = Equity ($50,000)

But, it is all the same. For instance, 2+2=4 or 4-2=2.

This is a key concept in accounting because this is why a Balance Sheet has to balance. This is known as “Double-Entry” accounting. Here is the reason:

Remember our ledger page? The rule is that the left side of the ledger page has to equal the right side in order to balance. Therefore, every entry made on one side of the ledger must have an equal entry on the opposite side when the transaction is complete. Here is a sample ledger page with our house transaction recorded on it:

You can see that they are equal. You can also see that there was nothing very complicated about that process, yet, you just learned the fundamental concept that forms the basis for double-entry accounting. Using this system, you can account for every single penny that comes into and goes out of your business.

Learning accounting is no different than learning a new card game. A card game has certain rules that make the game what it is. Without these rules, there is no game. Accounting rules make accounting work. Knowing the rules allows you to think in accounting logic. You get in trouble when you try to apply regular logic in place of accounting logic.

The next article will discuss, “The Accounting Model”. This model is the key that unlocks the mystery of accounting. It is like the Rosetta Stone of accounting. It is the cipher which, when memorized, enables you to think and speak the language of business, i.e., accounting.

John also writes a monthly newsletter called “The Journal Entry” which is filled with definitions of accounting terms, practical solutions, tips, and answers to accounting questions. He is the author of three e-Books:

Dream or Nightmare: Four Must Do’s Before Starting A Small Business. This is a short book about differentiating business quicksand from solid ground.

Volumes I & II - Accounting Issues for Small Business: A Compendium. These two volumes consist of over sixty articles, and twenty definitions, covering a broad spectrum of accounting issues, many of which you will never find in an accounting textbook

You can find these e-Books on his web site http://www.reallifeaccounting.com.