The Basics of Balance Sheets, Financial Statements Article

Thus, the use of debits and credits in a two-column transaction recording format is the most essential of all controls over accounting accuracy. The accounting equation is used in double-entry accounting. It shows the relationship between your business’s assets, liabilities, and equity. By using the accounting equation, you can see if your assets are financed by debt or business funds.

The accounting equation is also called the balance sheet equation. The financial position of any business, large or small, is assessed based on two key components of the balance sheet, assets, and liabilities. Owners’ equity or shareholders’ equity, is the Double entry Book keeping explained in 10 minutes third section of the balance sheet. The accounting equation is a representation of how these three important components are associated with each other. The accounting equation is also called the basic accounting equation or the balance sheet equation.

What is a Transaction

Assets are listed on the left side of the balance sheet. Liabilities include accounts payable or any type of payment made on a long-term loan.

“Day Books” or journals are used to list every single transaction that took place during the day, and the list is totalled at the end of the day. These daybooks are not part of the double-entry bookkeeping system. The information recorded in these daybooks is then transferred to the general ledgers. Not every single transaction need be entered into a T-account. Usually only the sum of the book transactions (a batch total) for the day is entered in the general ledger.

Some balance sheet items have corresponding contra accounts, with negative balances, that offset them. Examples are accumulated depreciation against equipment, and allowance for bad debts (also known as allowance for doubtful accounts) against accounts receivable.

Is a car an asset?

Good assets– Income producing assets such as stocks, rental properties, real estate crowdfunding projects, bonds, and a business. Neutral assets – Appreciating assets such as your home, gold, artwork, antiques, and collectibles. Liabilities– Depreciating assets like your TV, furniture, and other personal properties.

Accounting Equation Formula

what is the accounting equation

The balance sheet contains assets, liabilities, and owners’ or shareholders’ equity. The assets include cash, property, inventory, and anything else owned by the company.

United States GAAP utilizes the term contra for specific accounts only and doesn’t recognize the second half of a transaction as a contra, thus the term is restricted to accounts that are related. For example, sales returns and allowance and sales discounts are contra what are retained earnings revenues with respect to sales, as the balance of each contra (a debit) is the opposite of sales (a credit). To understand the actual value of sales, one must net the contras against sales, which gives rise to the term net sales (meaning net of the contras).

Every transaction produces both debit entries and credit entries for each party involved, where each party’s total debits and total credits for the same transaction are equal. Continuing the example, the tenant will also credit the bank account from which they pay rent, and the landlord will debit the bank account where they deposit it. We now offer eight Certificates of Achievement for Introductory Accounting and Bookkeeping. The certificates include Debits and Credits, Adjusting Entries, Financial Statements, Balance Sheet, Income Statement, Cash Flow Statement, Working Capital and Liquidity, and Payroll Accounting. Contra entries are those entries in which same account can be debited and credited in contrary situation.For example we debit Bank account when depositing cash.At the same time we credit bank account when withdrawing money from bank.

Who is the father of accounting?

Su Lin CPA is the mother of Accounting.

  • This field involves the reconstruction of financial information when a complete set of financial records is not available.
  • If the actual value is lower, the acquirer will likely reduce the size of its bid.
  • If your small business uses the double entry accounting system, you may have heard the term “accounting equation.” What does this mean, and why does it matter to your business?

Contra account

AssetDebits (Dr)Credits (Cr)XThe “X” in the debit column denotes the increasing effect of a transaction on the asset account balance (total debits less total credits), because a debit to an asset account is an increase. The asset account above has been added to by a debit value X, i.e. the balance has increased by £X or $X. Likewise, in the liability account below, the X in the credit column denotes the increasing effect on the liability account balance (total credits less total debits), because a credit to a liability account is an increase.

what is the accounting equation

The accounting equation is considered to be the foundation of the double-entry accounting system. The accounting equation shows on a company’s balance sheet whereby the total of all the company’s assets equals the sum of the company’s liabilities and shareholders’ equity.

Comparison: current assets, liquid assets and absolute liquid assets

A debit to one account can be balanced by more than one credit to other accounts, and vice versa. For all transactions, the total debits must be equal to the total credits and therefore balance.


Credits actually decrease Assets (the utility is now owed less money). If the credit is due to a bill payment, then the utility will add the money to its own cash account, which is ledger account a debit because the account is another Asset. Again, the customer views the credit as an increase in the customer’s own money and does not see the other side of the transaction.

On the other hand, when a utility customer pays a bill or the utility corrects an overcharge, the customer’s account is credited. This is because the customer’s account is one of the utility’s accounts receivable, which are Assets to the utility because they represent money the utility can expect to receive from the customer in the future.

All accounts must first be classified as one of the five types of accounts (accounting elements) ( asset, liability, equity, income and expense). To determine how to classify an account into one of the five elements, the definitions of the five account types must be fully understood. The definition of an asset according to IFRS is as follows, “An asset is a resource controlled by the entity as a result of past events from which future economic benefits are expected to flow to the entity”. In simplistic terms, this means that Assets are accounts viewed as having a future value to the company (i.e. cash, accounts receivable, equipment, computers).

In manual accounting Contra entry is recorded in the journal by marking (C) in the Particulars column after ledger name. or in other words contra entry is Bookkeeping entry that is entered on the opposite side of an earlier entry to cancel its effect on the account balance. The accounting equation shows on a company’s balance sheet where the total of all the company’s assets equals the sum of the company’s liabilities and shareholders’ equity. Each transaction that takes place within the business will consist of at least one debit to a specific account and at least one credit to another specific account.

In double entry bookkeeping, debits and credits are entries made in account ledgers to record changes in value resulting from business transactions. A debit entry in an account represents a transfer of value to that account, and a credit entry represents retained earnings balance sheet a transfer from the account. For example, a tenant who pays rent to a landlord will make a debit entry in a rent expense account associated with the landlord, and the landlord will make a credit entry in a receivable account associated with the tenant.

what is the accounting equation