Free course · Lesson 2 of 12 · 12 min
The accounting equation and double entry
Assets equal liabilities plus equity. Every transaction keeps that true, and debits and credits are simply the way double-entry bookkeeping writes it down.
Bookkeeping Basics / Lesson 2
- State the accounting equation and explain each part.
- Explain what debits and credits are, and what they are not.
- Know the normal balance of each of the five account types.
- Record a transaction as a balanced journal entry and read a trial balance.
The accounting equation
Everything in bookkeeping rests on one line: Assets = Liabilities + Equity.
- Assets are what the business owns or is owed: cash, money customers owe you, inventory, equipment, vehicles.
- Liabilities are what the business owes others: supplier bills, loans, credit card balances, sales tax collected, payroll withholdings not yet sent in.
- Equity is the owner's claim: what would be left for the owner if the assets paid off every liability. It goes up when the owner puts money in and when the business earns a profit. It goes down when the owner takes money out and when the business makes a loss.
Because profit is income minus expenses, the equation can be written out in full: Assets = Liabilities + Owner contributions − Owner draws + Income − Expenses. That longer version is why income and expenses behave the way they do in the books.
Every transaction keeps the equation in balance
A new consulting business has five transactions in its first month. Watch each one change both sides by the same amount.
| Transaction | Assets | Liabilities | Equity |
|---|---|---|---|
| 1. The owner puts $10,000 into the business bank account | +$10,000 bank | +$10,000 contributions | |
| 2. Buys a $3,000 computer, paid from the bank | +$3,000 equipment, −$3,000 bank | ||
| 3. Receives a $500 bill for advertising, to pay next month | +$500 accounts payable | −$500 (expense) | |
| 4. Invoices a client $2,000 for work done | +$2,000 accounts receivable | +$2,000 (income) | |
| 5. The client pays the $2,000 invoice | +$2,000 bank, −$2,000 receivable | ||
| Balances at month end | $12,000 | $500 | $11,500 |
Assets of $12,000 ($9,000 in the bank plus the $3,000 computer) equal liabilities of $500 plus equity of $11,500. It will always come out even, because every transaction is recorded on both sides.
Debits and credits
Double-entry bookkeeping records each transaction with at least one debit and at least one credit, and the total debits always equal the total credits. Debit simply means the left side of an account and credit the right side. They are not good and bad, and a debit does not mean money leaving.
Whether a debit increases or decreases an account depends on the account's type. Each type has a normal balance, the side that increases it.
| Account type | Normal balance | A debit | A credit |
|---|---|---|---|
| Asset (bank, receivables, equipment) | Debit | increases it | decreases it |
| Expense (rent, wages, supplies) | Debit | increases it | decreases it |
| Owner draws | Debit | increases it | decreases it |
| Liability (payables, loans, tax owed) | Credit | decreases it | increases it |
| Equity (contributions, retained earnings) | Credit | decreases it | increases it |
| Income (sales, service revenue) | Credit | decreases it | increases it |
Why does your bank statement call a deposit a credit? Because it is the bank's books. To the bank, the money in your account is a liability it owes you, and liabilities increase with credits. In your own books the same deposit is a debit to your bank account, an asset.
Journal entries
A journal entry records one transaction: the date, the accounts, the debit and credit amounts, and a memo. Here are the five transactions above as journal entries.
| # | Account | Debit | Credit |
|---|---|---|---|
| 1 | Bank | $10,000.00 | |
| Owner contributions | $10,000.00 | ||
| 2 | Computer equipment | $3,000.00 | |
| Bank | $3,000.00 | ||
| 3 | Advertising expense | $500.00 | |
| Accounts payable | $500.00 | ||
| 4 | Accounts receivable | $2,000.00 | |
| Consulting income | $2,000.00 | ||
| 5 | Bank | $2,000.00 | |
| Accounts receivable | $2,000.00 | ||
| Totals | $17,500.00 | $17,500.00 |
By convention the debit lines are listed first and the credit lines indented or listed after. In accounting software you rarely type journal entries for everyday work: creating an invoice, entering a bill or writing a cheque makes the entry for you. You still need to understand them, because every report is built from them.
The general ledger and the trial balance
Each line of each journal entry is posted to its account in the general ledger, so every account shows its own running balance. A trial balance lists each account's balance in a debit or a credit column. The two columns must be equal.
| Account | Debit | Credit |
|---|---|---|
| Bank | $9,000.00 | |
| Computer equipment | $3,000.00 | |
| Accounts payable | $500.00 | |
| Owner contributions | $10,000.00 | |
| Consulting income | $2,000.00 | |
| Advertising expense | $500.00 | |
| Totals | $12,500.00 | $12,500.00 |
A balanced trial balance shows that every entry had equal debits and credits. It does not prove the books are right. An entry posted to the wrong account, entered twice or left out entirely still balances. That is why the monthly bank reconciliation in lesson 7 matters so much.
Key terms
- Debits and credits (Dr / Cr)
- Double-entry bookkeeping
- Journal entry (JE)
- General ledger (GL)
- Trial balance (TB)
- Owner's equity
Try it
- Chart of accounts template: See the five account types laid out with numbers.
- Balance sheet template: The accounting equation as a one-page report.
- Debits and credits in the glossary: A second explanation with another example.
Check your understanding
Pick an answer to see if it is right and why. Nothing is sent anywhere; your result is kept in this browser.
Part of Bookkeeping Basics, a free course from AcboBooks LLC. General information, not tax, legal or accounting advice. Last reviewed October 25, 2026.