The Accounting Equation – Assets Equal Liabilities Plus Equity
This equation, which is at the very core of accounting, expresses one of the biggest accounting basics: everything must remain in balance. Changes in one side of the equation require changes in the other.
The form of this equation comes from the basic idea that assets are financed with a combination of liabilities and equity. You can pay for your assets by using existing capital, by raising additional capital, or by borrowing funds. The transactions will be different, but the accounting equation will remain in balance no matter which way you go. For example, when you use existing capital to finance an asset purchase, you are spending resources you already have. That transaction results in a debit to the new asset and a credit to whichever asset you used to buy it (such as cash or a traded-in vehicle). Although individual asset balances are affected, the total asset balance is not, and the equation remains in balance.
The same balance holds true when you raise new capital to purchase an asset. Your asset account and your equity account will increase by equal amounts, maintaining the balance. Financing your assets with debt acts exactly the same way: assets increase, but so do liabilities. As long as each individual transaction has equal debits and credits, your books will be in balance, and the accounting equation will be true.