The accounting equation is the basis for all transactions in accounting. It provides the foundation for the rules of debit and credit in the journalizing process, where for each transaction total debits must equal total credits. As a result, theaccounting equation must be in balance at all times for a business’ financial records to be correct.

In our examples below, we show how a given transaction affects the accounting equation for a corporation. We also show how the same transaction will be recorded in the company’s general ledger accounts. Revenue and expense accounts were used temporarily and were ultimately closed to Retained Earnings.

Sole Proprietorship Transaction #3.

Since the accounting equation equation depicts a mathematical equality, it also goes that all debits must always equal all credits. In other words, a journal entry should have a minimum of at least one debit entry and one credit entry, and the total of those entries must be equal. The accounting equation is the fundamental formula in accounting—it shows that assets are equal to liabilities plus owner’s equity. It’s the reason why modern-day accounting uses double-entry bookkeeping as transactions usually affect both sides of the equation. The accounting equation is an accounting fundamental that bookkeepers need to master to be proficient. As you can see, there is one ledger account for Cash and another for Common Stock.

Net investment equals the sum of all investment in the business by the owner or owners minus withdrawals made by the owner or owners. The owner’s investment is recorded in the owner’s capital account, and any withdrawals are recorded in a separate owner’s drawing account. For example, if a business owner contributes $10,000 to start a company but later withdraws $1,000 for personal expenses, the owner’s net investment equals $9,000. Net income or net loss equals the company’s revenues less its expenses. Revenues are inflows of money or other assets received from customers in exchange for goods or services. Expenses are the costs incurred to generate those revenues.

Financial statement

Add the total equity to the $2,000 liabilities from example two. In real life, accountants record transactions in journal entries to various accounts using a recording system that involves Debits and Credits. The transactions in the accounts are then summarised to create summary values for each account. This data will then be used to construct the financial statements. An accounting transaction is a business activity or event that causes a measurable change in the accounting equation. An exchange of cash for merchandise is a transaction.

Harold Averkamp has worked as a university accounting instructor, accountant, and consultant for more than 25 years. He is the sole author of all the materials on AccountingCoach.com. Metro Corporation paid a total of $1,200 for utility bill. Metro Corporation paid a total of $900 for office salaries. Metro issued a check to Rent Commerce, Inc. for $1,800 to pay for office rent in advance for the months of February and March. The net assets part of this equation is comprised of unrestricted and restricted net assets.