Compound School

Equity can grow through two paths: owners contribute capital, or the business earns profits and retains them.

Follow the arrows in the diagram and you can see how each path reaches equity.

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Paying for an asset and expensing its cost don’t always happen at the same time.

When a company buys a $500,000 machine, it records the qualifying cost as an asset. As the machine is used, that cost is recognized as expense through depreciation.

Capitalization doesn’t make the cost disappear. It changes when the cost becomes expense.

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Depreciation and impairment both reduce an asset’s carrying value—but they are not the same thing.

Depreciation is systematic allocation. Impairment is loss recognition.

Understanding that distinction makes the accounting much easier to reason through.

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Profit doesn’t disappear when the income statement ends—it flows into retained earnings.

Net income increases retained earnings. Dividends decrease it. Understanding this connection helps you see how the financial statements actually fit together.

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Book value and fair value can tell two different stories about the same asset.

One reflects an accounting measurement based on historical cost and depreciation. The other reflects the price that would be received in an orderly sale between market participants.

The difference isn’t necessarily an error—it’s a difference in measurement basis.

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Profit ≠ cash flow.

A business can report strong profits while generating significantly less cash. Accrual accounting explains why: revenue and expenses are recognized based on economic activity, not simply when cash moves.

Understanding the bridge between profit and cash flow is fundamental to understanding how a business actually performs.

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The accounting equation is more than a formula—it reveals the structure of the entire accounting system.

Assets are resources. Liabilities and equity are claims on those resources. Revenue, expenses, and dividends explain how the owners’ residual claim changes over time.

Everything traces back to one relationship: resources must equal claims on resources.

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Bonds issued at a premium or discount don’t stay there forever.

As the bond approaches maturity, its carrying value converges toward face value—the amount the issuer ultimately has to repay.

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Depreciation is not valuation.

A machine’s book value can decrease while its market value is higher—or move in an entirely different direction.

Why? Because they answer different questions.

Depreciation allocates cost. It doesn’t determine value.

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A single lease can create both an asset and a liability.

The lessee receives a contractual right to use an underlying asset, creating a right-of-use asset. At the same time, it assumes an obligation to make future lease payments, creating a lease liability.

One contract. Two accounting elements.

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