Okay, my friend, pull up a chair and make yourself comfortable. I'm about to take you on a brief journey into the mystical realm called "Geekdom". Now, "Geeks" are not a lost tribe that were alluded to in the "Illiad" nor a Grecian person with a speech impediment. Rather, they are fellow human beings who have been swept away through some bizarre dimensional shift portal into a space where relational balanced numbers define all meaningful aspects of life. Sad, but true!
Long ago, and far away, there lived in a nice Italian kingdom around the 14th century, a fine monk who everyone called Pacioli. It seems that this monk had much too much time on his hands, wanted to make a name for himself or possibly, had a miraculous vision of a "new world". I know not, …nor do I really care. This is the one, this monk called Pacioli, that vast legions of people throughout all the generations have sworn devotion and loyalty to as they unceasingly invade all aspects of our personal, public and business lives. For it was Pacioli that codified modern accounting concepts.
Forgive me my friend, I did not wish to frighten nor alarm you by making this unique world appear to be sinister nor malevolent. You'll understand and be more comfortable if you would but close your eyes momentarily and envision a place that dwells in a perfect balanced harmony. A place that may be static or dynamic- but always perfectly balanced. Contemplate this magical dimension which seems to have come from a Creator entity that gave to mankind the divine principle of balanced harmony and who permitted mankind to freely create this world as mankind chose- abiding by only one commandment- "Balance".
Okay, okay- so much for having a little fun. Actually, balance is the fundamental guidance for recording all accounting transactions, with numbers being the operative language and monetary value the purpose. A simple way to understand accounting is to visualize a large mobile with buckets suspended from two large horizontal poles. The large pole on top is suspended at it's center point. On the left side we suspend one bucket which is labeled "Assets". On the right side we suspend another bucket labeled "Liabilities". Directly beneath the "Liabilities" bucket, we suspend the third bucket called "Equity". The whole rigging so far; pole and three buckets represent what is called- ready for this- the Balance Sheet.
We use a Balance Sheet to report the aggregate effects of accounting transactions at a point in time [Dec 31, Sep 30, Jan 31, etc.]. The Balance Sheet is relatively static in nature, acting pretty much like storage containers. "Stuff" happens during a period of time [month of December, month of May, etc.]. The clock strikes "Point in Time", and the various weights in the Balance Sheet buckets are shifted to reflect what effect that period of time had on the whole system. Hang in there! We'll hang some dynamic period of time buckets [that's where the action is] and make the whole thing work.
The second rigging has a large pole suspended at its center from the Balance Sheet's "Equity" bucket.
This pole has two large buckets
suspended on either end. On the left side is the bucket labeled "Expenses"
and the bucket on the right side is called "Income". This rigging arrangement
is called the Profit & Loss Statement, commonly referred to as the
P&L.
But hold it! The whole basic idea of a business is to make
money- a profit. To do this, we have to have more weights going into the
"Income" bucket than the "Expense" bucket. There's no way this rig can
stay in balance! You're right! Now we'll add that last little piece- a
sliding weight on the second pole which is called "Retained Earnings".
It acts just the weights on the doctor's scales when you go in for a checkup.
Move the weights across so many monetary increments to make the pole balance.
Retained Earnings is really the mathematical difference [aggregate effect]
between income and expense over a period of time.
So that's what it looks like- now let's use it!
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