The preceding sections of this chapter have shown you the gears and wires behind the scenes that make everything work. Now, we are ready for the show: this is how accounting answers the three big questions we introduced at the beginning of the book:
• How much money came in?—revenue or gross income
• Where did the money go?—expenses
• How much money is left?—net income
The Income Equation

We find the direct answer to these three questions on the income and expense statement. The income statement equation— revenue – expenses = net income—is the key to the income statement. The result here is simple arithmetic: revenue (the gozinta) minus expenses (the gozouta) yields net income.
The Balance Sheet Equation

The balance sheet answers another set of crucial questions for a company. Today, what is my company worth? What’s in my bank account? How much money do other companies or people owe me? How much money do I owe other people or companies?

The fundamental equation of accounting underlies the balance sheet. It looks like this:
assets = liabilities + equity
assets – liabilities = equity
assets – equity = liabilities

The physical layout of the balance sheet matches the first equation:
assets = liabilities + equity

This makes logical sense: the value of what the company owns (assets) minus the value of what the company owes (liabilities) leaves you with what the company is worth (equity).

The Equations and the Normal Accounts

This table illustrates how the income equation balances if we enter our transactions properly on the normal side of each account

This table illustrates how the balance sheet equation—that is, the fundamental equation of accounting—balances properly if we enter our transactions on the normal side of each account.

Every transaction we enter follows the basic accounting equations. In fact, the T accounts are designed to make sure that we follow the equations. That is why some accounts are
credit accounts and others are debit accounts.

If each entry is balanced, then all of the entries are balanced and our balance sheet and income statement will come out right. If there is an error in one transaction, it will show up because our financial statements will be out of balance.

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