LESSON #2

ACCOUNTING EQUATION

 The accounting equation lies at the heart of accounting and is the foundation of the
double-entry accounting system.
 The key principle behind the accounting equation is that the stuff the business
owns is equal to the stuff that the business owes.
 The equation should always balance.
 The stuff that the business owns is called assets it is located on the left side of the
accounting equation.
 On the other side, we have two different words to describe what the business owes
and that depends on who the lender is.
 We use liabilities to describe what the business owes to third parties and we use
equity to describe what the business owes to its owner.
ASSETS= LIABIITIES + EQUITY

TABLE I. ACCOUNTING EQUATION

ASSETS = LIABILITIES + EQUITY

Cash Account Payable Stockholder’s or owner’s
equity
Account Receivable Loans Payable Retained earnings (profits
for future use)
Inventory Wages Payable
Plant Property & Taxes Payable
Equipment (PPE)
Land & Building
Investment
Goodwill
 LESSON #3
MISCONCEPTIONS OF DEBITS & CREDITS

 Debits and credits are neither good nor bad.

 Debits and credits are not the same as addition or subtraction.
 Debits and credits are words used to reflect the duality or double-sided nature of all
financial transactions.
 Debits and credits as heads and tails on a coin, since there are equal and opposite sides
to every transaction. In the world of finance, money doesn't magically appear or disappear.
For money to go to one account, it has to come out from another.
 Accountants consider every transaction to involve a flow of economic benefit from a source
to a destination.
 Economic benefit is the potential for an asset to contribute either directly or indirectly to
the flow of an entity's cash.
 Since accountants consider every transaction to involve a flow of economic benefit from a
source to a destination.
 Credits represent the source and debits represent the destination.
Destination that economic benefit can flow to include the following:
1. assets e.g., cash, buildings, and amounts owed to you by others.
2. expenses- where the business pays a third party for a good or service they have provided.
3. dividends- where a business distributes some of its cash to its owners.
 On the other hand, sources that economic benefit can flow from include the following:
1. owner’s equity- where business owners give their cash to the business.
2. liabilities such as amounts owned to a bank in exchange for a loan or to suppliers for
providing a good or service.
3. revenue
 Assets are on the debit side.
 Liabilities are on the credit side.

EQUITY

EQUITY = Owner’s equity – dividends + Retained earnings

Retained earnings = Revenue – Expenses

 DEBIT
Assets + Dividends + expenses
 Credit
Liabilities + Owner’s equity
Revenue
 DEBIT CREDIT
DEA LER

 The left side represents the debits they increase when debited and decrease when
credited.
 The right-hand side is the opposite. These are credits. These increase when credited
and decrease when debited.