Different approaches in understanding accounting

There are different approaches to understand basic principles of accounting.

Balance sheet perspective of accounting starts with stating balance equation (Assets = Liabilities + Equities/”Net Assets”). This always does not means change in balance in one side (i.e. Assets) always affect other side (i.e. Liabilities or Equity). A very simple example to justify the statement is cash purchase of machine. Here, both elements of double entry transaction are covered under assets heading where, decrease in cash results in increase in value of machinery.

The long-term financing approach used in UK and elsewhere is fixed assets + current assets - short term payables = long-term debt plus equity.

Another simplified approach to practice accounting is to apply general rule (Debit for increase in Assets and Expenses and credit for increase in Liabilities, Equity and Revenue/Income).

For simplicity, better understanding and clean presentation I like to adopt breakeven equation approach, which combines (balance sheet) financial position and income statement. We know that (Expenses + Profit = Revenue) and (Assets = Liabilities + Equity). Combining both (given Profit is Zero) at breakeven we get Expenses + Assets = Liabilities + Equity + Revenue.  Understanding the concept simplifies problems encountered in accounting process.

Having discussed different approaches we now see how double entry accounting system affects two sides of the equation and how they simplifies the presentation in different books accounts and financial statements.

The Debit Side : The recording of transaction starts from journal. The debit side/left side of journal amount represents the increase in value of Assets and Expenses or decrease in value of Liabilities, Equity and Revenue. The same rule applies to individual nominal ledger account where normal opening (b/f or b/d) stands on left for assets or expenses. The rule again follows to trial balance. Income statement records expenses in debit side under same rule whereas balance sheet debit side records assets.

The Credit Side : The credit side/right side of journal amount represents the decrease in value of Assets and Expenses or increase in value of Liabilities, Equity and Revenue. The same rule applies to individual nominal ledger account where normal opening (b/f or b/d) stands on right for liabilities, equity, or revenue. The rule again follows to trial balance. Income statement records revenue in credit side under same rule whereas balance sheet credit side records liabilities and equity.