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Accounting Textbooks Boundless Accounting Accounting Information and the Accounting Cycle The Basics of Accounting
Accounting Textbooks Boundless Accounting Accounting Information and the Accounting Cycle
Accounting Textbooks Boundless Accounting
Accounting Textbooks
Accounting
Concept Version 11
Created by Boundless

Fundamental Accounting Equation

To ensure that a company is "in balance," its assets must always equal its liabilities plus its owners' equity.

Learning Objective

  • State the fundamental accounting equation


Key Points

    • The accounting equation displays that all assets are either financed by borrowing money or paying with the money of the company's shareholders.
    • The balance sheet is a complex display of this equation, showing that the total assets of a company are equal to the total of liabilities and shareholder equity. Any purchase or sale has an equal effect on both sides of the equation or offsetting effects on the same side of the equation.
    • A mark in the credit column will increase a company's liability, income, and capital accounts but decrease its asset and expense accounts. A mark in the debit column will increase a company's asset and expense accounts, but decrease its liability, income, and capital account.

Terms

  • debit

    an entry in the left hand column of an account to record a debt; debits increase asset and expense accounts and decrease liability, income, and equity accounts

  • credit

    an entry in the right hand column of an account; credits increase liability, income, and equity accounts and decrease asset and expense accounts

  • double-entry bookkeeping system

    A double-entry bookkeeping system is a set of rules for recording financial information in a financial accounting system in which every transaction or event changes at least two different nominal ledger accounts.


Full Text

The fundamental accounting equation can actually be expressed in two different ways. A double-entry bookkeeping system involves two different "columns;" debits on the left, credits on the right. Every transaction and all financial reports must have the total debits equal to the total credits. A mark in the credit column will increase a company's liability, income and capital accounts, but decrease its asset and expense accounts. A mark in the debit column will increase a company's asset and expense accounts, but decrease its liability, income and capital account.

For example, if a person buys a computer for $945. He borrows $500 from his best friend and pays for the rest using cash in his bank account. To record this transaction in his personal ledger, the person would make the following journal entry.

Computer (Increase in asset) $945

Cash (Decrease in an asset) $445

Loan from friend (Increase in debt) $500

As you can see, the total amount of the debits (the amount on the left) equal the credits (the total amount on the right). The transaction is in "balance. "

An extension of that basic rule involves the balance sheet. The total assets listed on a company's balance sheet must equal the company's total liabilities, plus its owners' equity in the company. This identity reflects the assumption that all of a company's assets are either financed through debt or through the contribution of funds by the company's owners.

A simple balance sheet example:

Assets

Cash $100,000

PP&E $200,000

Liabilities & Equity

Mortgage $150,000

Equity $150,000

As you can see, the business's total assets equal the company's total liabilities and equity. This company is "balanced. "

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