The Fundamental Accounting Equation

As a rule of thumb, work in the field of accounting ranging from the knowledge base called “the fundamental accounting equation”. The fundamental accounting equation is as follows:

Assets = Liabilities + Owner’s Equities

If Owner’s Equities       =     Preferred Stocks + Common Stocks + Additions Paid in Capital + Translation FX currency + Retained Earnings
and
Equities                        =     Preferred stocks + Common Stocks + Additions Paid in Capital + Translation FX Currency
then
    Asset                        =     Liabilities + Equities + Retained Earnings
    Assets                       =    Liabilities + Equities + Revenues – Expenses
    Assets + Expenses     =     Liabilities + Equities + Revenues

Assets, liabilities, equities, expense, and revenues are called the elements of financial statement. The first three are the elements of balance sheet and the last two are the elements of income statement.

Double entry bookkeeping

In the terms of accounting, double entry bookkeeping means that for every financial transaction that occurs, accountant must record it in a journal with two different sides, namely the debit side and credit side. Total debits must equal total credits. Consider like action and reaction of Newton's third law: “For every action, there is an equal and opposite reaction”. If debit is action then credit is reaction. Mathematically, double entry bookkeeping is as follows:

Debit = Credit

So for example, a company that buys merchandise for cash will not deduct cash using negative sign, but it will make journal merchandise purchase such as the following:

Merchandise or inventory (dr)         xxx
    Cash (cr)                                             xxx

Or if the purchase is done by debt, then the journal is as follows:

Merchandise or inventory (dr)         xxx
    Account payable (cr)                           xxx

Under the double entry, account payable balance is increasing. At the time of repayment, accounts payable will be reduced by crediting an equal amount of cash.

Account payable (dr)                      xxx
    Cash (cr)                                             xxx

Accounting does not recognize a negative sign as in mathematics. Back to the fundamental accounting equation above:

Assets + Expenses = Liabilities + Equities + Revenues

With the concept of double entry bookkeeping, then the debit side are the assets and expenses, while the credit side are the liabilities, equities, and revenues. This statement embodies the concept of double entry bookkeeping, which is in normal condition, assets and expenses are always on the debit side, while the liabilities, equities, and the revenues are always on the credit side.

Once again, it is emphasized here that the accounting does not recognize a negative sign. Therefore, if the asset is reduced then the asset will be credited. Or if the liability is reduced, then the liability will be debited.

All the normal condition for assets, expense, liabilities, equities, and revenue can be depicted using the table below:

Assets
If debit then increase	If credit then decrease
Normal balance:  Debits

+

Expenses
If debit then increase	If credit then decrease
Normal balance:  Debits

=

Liabilities
If debit then decrease	If credit then increase
Normal balance:  Credits

+

Equities
If debit then decrease	If credit then increase
Normal balance:  Credits

+

Revenues
If debit then decrease	If credit then increase
Normal balance:  Credits

Simply defined, assets are the company’s wealth, while liabilities and equities are the source from which its wealth originated. Revenues describes how the company get benefits from using its assets and expenses describe the company sacrifice it assets. If benefits are greater then its sacrifice, the company will get profit (net income), and if sacrifice are greater then its benefits, the company will get loss (net loss).