Obviously, that’s not a great financial position to be in! You have no equity in the house, the bank essentially owns all of it until you start to make payments.Īsset (house) = Liability (mortgage) + Equity (zero) It’s the same as the bank giving you a 100% mortgage (liability) for a house purchase. Liabilities = $15,000 Ĭoming back to the Accounting Equation, now we have:Įquity is zero because for every dollar of assets we have, we have a dollar of liability. A liability is an obligation to pay based on whatever terms were decided between the company and the lender. The company also took out a $15,000 loan to pay for the delivery van. Because the company paid out the cash, the asset value has decreased. It’s something the company owns that has value and will be used to make revenue for the business. The company made a downpayment of $5,000 cash. The company has an Asset that cost $20,000.Īssets = $20,000 It purchased the van for a cash down payment of $5,000 and took out a loan for $15,000. The florist shop paid $20,000 for the van. The florist shop purchases a delivery van for use in delivering flowers to customers. Let’s use a delivery van for a florist shop as an example to explain. The difference between the two is called equity. The Accounting Equation looks at what a company owns and compares it to what a company owes. Let’s dig into the Accounting Equation so you have the start of a solid foundation! Basic Accounting Equation:Īssets = Liabilities + Equity (also known as Capital) Those account types determine how debits and credits will be used to increase and decrease accounts. It categorizes accounts into different account types. The Accounting Equation is the foundation of double entry accounting. It all starts with the Accounting Equation. What is the Accounting Equation?īefore you can understand debits and credits, you’ll need a little background on the structure of accounting.

To increase an Equity (Capital), Revenue, or Liability account, we credit. To increase an Asset, Dividend, or Expense account, we debit. The account types are Asset, Liability, Equity, Dividends, Revenue, Expense.

An account’s Normal Balance is based on the Accounting Equation and where that account is in the equation. Knowing whether to debit or credit an account depends on the Type of Account and that account’s Normal Balance. We increase and decrease accounts by debiting them or crediting them. In accounting, Debit means the left side of an account and Credit means the right side of an account. In this article, we will walk through step-by-step all the building blocks you need to debit and credit like a pro. If you’re not used to speaking the language of accounting, understanding debits and credits can seem confusing at first.

Debit credit assets liabilities equity