Corporatefinanceinstitute com 1 The Corporate Finance Institute Accounting For more eBooks please visit

Accounts

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corporatefinanceinstitute.com
8
The Corporate Finance Institute
Accounting
Whenever a company records a transaction, three key financial 
components must always be kept in balance: assets, liabilities, and 
equity. This is referred to as the accounting equation:
Assets = Liabilities + Equity 
For example, if a company purchased a vehicle for $50,000 in cash, 
assets would both go up and down by $50,000. The company has gained 
an asset (i.e. the vehicle) while losing as asset (i.e. cash) by purchasing 
the car. Hence, the accounting equation remains intact. In another 
example, if a company borrows $100,000 from a bank, the company’s 
cash asset account goes up as well as the company’s liability account. 
Because both assets and liabilities go up by $100,000, the accounting 
equation remains intact. All transactions must follow this general rule to 
implement proper financial reporting. If the accounting equation is not 
balanced, you know that something has gone wrong and need to make 
the necessary changes.
The Accounting Equation
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corporatefinanceinstitute.com
9
The Corporate Finance Institute
Accounting
When most people hear the term debits and credits, they think of debit 
cards and credit cards. Debit cards refer to straight up cash payments 
while credit cards are a form of borrowing. In addition, most non-
accountants think of debits as subtractions from their bank accounts 
and credits as additions to their accounts. In accounting, however, 
debits and credits refer to completely different things.
Debits and Credits are simply accounting jargons that trace their 
roots to hundreds years ago and are still used in today’s double-entry 
accounting system. A double-entry accounting system means that every 
transaction that a company makes is recorded in at least two accounts, 
where one account will get a “debit” entry while another account will get 
a “credit” entry.
These entries are recorded as journal entries in the company’s books. 
Debits and credits can mean either increasing or decreasing for 
different accounts, but their T-Account representations look the same in 
terms of left and right positioning.