Top 5 most confusing things about accounting
At Accounting Cafe we’re discussing how we can clear up the confusing things about accounting.
Terms that we take for granted are confusing for students. Make their learning journey faster and easier using these simple tips.
Here are our top 5 most confusing things about accounting:
1. The most valuable assets are rarely on the balance sheet
Companies that generate their own assets do not show them on their balance sheets. Although if they buy the same kind of asset, they do. So the same class of asset might be shown or might not be shown, depending only on there being a specific transaction that gave rise to it.
The result is that the most valuable assets are often not recognised. For example, Apple Inc’s balance sheet does not include the Apple brand. And this is one of the most valuable corporate assets in the world. Bizarrely, Apple Inc. includes the Beats brand, because they bought that one.
2. Income (revenue) is not money received
Income (or revenue in the US) is not the same as cash received. Cash received is an asset, and income is not an asset.
Income is activity that generates value — it is not in itself valuable. This is a subtle but important point that a lot of students don’t fully understand.
It is somewhat related to the idea that there is no such thing in accounting as a cash sale. There is cash and there is a sale.
3. Prepayments are post-payment transactions
Why do we call prepayments pre-payments?
Transactions that give rise to pre-payments have usually already been paid. So actually they are post-payments. This is confusing to students if you don’t spend time spelling it out.
And this isn’t the only problem with prepayments. Sometimes they’re not paid at all — a company can be invoiced for expenses in advance and the invoice remains unpaid for a while. In this case pre-payments are actually no-payments.
We prefer the also imperfect but better term, deferred expenses.
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4. Accrued expenses are not expenses
We describe accrued expenses as a type of expense. This is misleading for students, because they’re an obligation — not an expense.
In a similar vein, accrued income is not income and deferred expenses are not expenses. And deferred revenue is not revenue.
5. Equity is not valuable
Equity is an obligation, so it can’t be valuable.
Admittedly, lots of accountants raise an eyebrow when you point out that equity is an obligation. They are so used to talking about equity from the point of view investors that they never stop to think about its nature from the point of view of the entity.
From the entity’s point of view, equity is better described as the residual obligation to investors.
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