Understanding Accounting Basics (ALOE and Balance Sheets)

In accounting, the math usually isn't worse than multiplication. But accounting isn't about math -- it's about concepts, and some had me confused. Accounting has simple and surprisingly elegant ways to track a business.

This is a companion discussion topic for the original entry at http://betterexplained.com/articles/understand-accounting-basics-aloe-and-balance-sheets/

That was a nice quick summary.

You might add that if assets and liabilities are stuff you either own or owe, then income and expense track the movement of stuff in or out of the company. Cash from a sale increases assets and the off-setting double entry is to income. But the sale might also reduce inventory which shrinks assets and that adjustment would be recorded as an expense. The difference in the two adjustments is your gross profit on the sale.

Looking at a balance sheet shows you where a company stands financially at any given moment, the stuff they own and owe. Income and expense reports show movement and trends over time and break out the asset/liability changes into a variety of categories and types.

I might also add that debits and credits are not pluses or minuses. They are simply two different categories that are associated with account types. Assets and expenses carry a debit balance. That means to increase them you make an entry in the debit column and to decrease them, a credit column entry. Liabilities, equity and income carry a credit balance. Credit column entries increase them and debit column entries decrease their value.

No matter how long or convoluted an entry might be the only governing rule is that the debit column total and the credit column total must be the same. That is why assets=liabilities+equity is true. Quite literally, the only math in accounting is addition.

Hi Jim, thanks for the great comments! Yes, it took a while to realize that debits weren’t always “bad” and credits weren’t always “good”. One confusion is the common terms (credit or debit balance) get confused with the more specific accounting ones. Appreciate the thoughts!

Why doesn’t the balance balance? 15B$ Liabilities is less than 18B$ Assets… Where do the 3B$ benefits fit in?

Banks and other financial institutions have sort of a reverse or at least non-intuitive usage of the terms debit and credit since they carry your deposit on their books as a liability, not an asset. The money does belong to you after all. That is why a deposit is “credited” to your account and why a debit card transaction reduces your balance. In your own books a deposit is a debit to a cash asset and a withdrawal a credit.

GUI Junkie:

18,473,351 - total assets
1,433,511 - total liabilities
17,039,840 - total stockholder equity

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@Jim: Thanks for the clarifications!

@GUI Junkie: This example is a bit more complicated because Google reported “intangible assets” like Goodwill (things like brand recognition, etc.). As Jim said, their total reported assets, liabilities and equity add up.

The 15B number is reported after intangible items have been removed.

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A “hypothetical” question: my wife has trouble keeping track of her spending. I’ve considered buying an accountant’s notebook and tracking spending (with her) there, but I don’t know how to do the double-entry bookkeeping. I know it’s not strictly necessary - basic add/subtract is easy enough to get right - but it seems that doing it more thoroughly might help her understand things better.

How do I do that? I guess that’s basically asking how double-entry bookkeeping would work in a checkbook, eh?

Hi Dan, good question. These double-entry accounting systems are more for financial reports than personal finance – when keeping track of your own expenses, a simple add/subtract will probably do the trick.

One method is to keep all the receipts for a week (and write down any cash transactions) to see where the money is going. You can then check your credit card / debit card statements to make sure the amounts match. The simple dollar is a great finance blog and has more on this topic:

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it still amuses me from reading other posts here that one could claim to have 1B in the first year in OE and 3B in the fifth year yet the fifth year would be worth less due to inflation and competition.

I happily await zero inflation - the physicists tunnelling.

These explanations are very clear and easy. Helped out a lot.


Thanks Nigel, glad they were helpful.

i’m in school to become an accountant i found this information to be helpful for my test in payroll and fundementals of accounting…

@stewart: Glad you found it helpful.

Great explanation. I’d be interested in income statements and cash flow too!

@Matt: Thanks, those would be nice follow-ups.