The basic accounting rules

The basic accounting rules group all finance related activities under five categories or (accounts). They are:

• Assets (everything you own such as your car, house, cash in the bank)
• Liabilities (Things you owe to others such as your mortgage)
• Equity (Your overall worth)
• Income (increase in equity such as salary)
• Expenses (decrease in equity such as dinner expenses)

These five accounts relate to each other with the god of all accounting equations

Assets = Liabilities + Equity

Equity increase through income and decrease through expenses. Equity Change = Income - Expenses.

Assets = Liabilities + Equity + (Equity Change)

Assets = Liabilities + Equity + Income - Expenses

Assets - Expenses = Liabilities + Equity + Income

This equation has to be balanced. And that means if any of those 5 accounts change another account has to change too.

For example, if you buy a new car worth 10,000 with a loan then the Assets account will increase by 10,000 (the worth of your new car) and so does the Liabilities account (you will have to pay for it after all even if not today) keeping the equation balanced. If you decide to pay in cash then the assets account will increase by 10,000 (with the car being an asset) and will decrease again by 10,000 with the decrease in cash and again the equation stays balance.

Follow up with the next article Double Entry Accounting