Adhering to the Accounting Equation

by Greg DePersio

1 min read

Small business owners should know the accounting equation, which is total assets equals liabilities plus owners’ equity. In a double-entry accounting system, for each entry in the general ledger, there is a debit and a credit, ensuring the two are equal. A debit means the amount is placed on the left side of the account, while a credit is on the right side. When an asset account is increased (decreased), there is a debit (credit) entry. Conversely, for liabilities and owners’ equity, it is the opposite. For instance, if your business takes out a $500 loan, cash is debited while debt is credited. A trial balance checks to see that debits equals credits. This can be done monthly or whenever you prepare your financial statements, such as the income statement and balance sheet. If the two are not in balance, there is an error. It can be a simple mistake someone made when posting a journal entry to the general ledger, or it can reflect larger accounting issues, such as improper controls. An improper entry should be easily detected by going over the transactions. More drastic action may be required, such as retraining or hiring supervisory personnel. Accounting software can minimize certain errors, such as simple mathematical mistakes or entering different debit and credit amounts for an entry. Ensuring the accounting equation is in balance is necessary to prepare proper financial statements, which are needed for an accurate assessment of your business’s performance and financial condition.

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