5. Assets

As a thought experiment, let’s imagine an extremely simplistic accounting system. The system uses the double-entry bookkeeping method, but uses only two accounts, referred to as “Inside” and “Outside.” The Inside account represents all financial resources, regardless of use or liquidity, that are available for the company to use. The Outside account, of course, needs to represent all of the rest of the financial resources that are of interest to the company. More specifically, the Outside account represents resources, including property rights and obligations, which do not belong to the business (typically, they belong to owners, creditors and expenses recipients).

The company begins business as a blank sheet, with both accounts being empty and therefore having a balance of zero. Because both balances are zero, we can safely say that the combined balance of both accounts is also zero.

Inside + Outside = 0

As the company begins doing business, the balance of the Inside account changes. Regardless of whether the first transaction represents a contribution from the owner, a sale, or monies borrowed from a bank, it must have the effect of increasing the Inside account. Since the company does not have any resources to control, the first transaction cannot be a withdrawal from that account – it must be a deposit.

After the first transaction, the Inside account should have a balance that reflects a net depositing of resources (a debit balance, shown here as a positive amount).

Inside > 0

According to the rules of double-entry bookkeeping, however, the deposit in the Inside account must be matched by a corresponding withdrawal from the source account. In this simplistic example that can only come from the Outside account. At the end of the first transaction, the Outside account must have a balance that reflects a net withdrawing of resourced (a credit balance, shown here as a negative amount).

Outside < 0

And, since the withdrawal from the Outside account must be equal to the deposit in the Inside account, the balance of the general ledger itself (the whole system) must remain at zero.

Inside + Outside + deposit entry + withdrawal entry = 0

Or, simply:

Inside + Outside = 0

Each transaction after this first one will also keep the balance of the general ledger at zero. Further sales, loans, and contributions cause deposits to be recorded to the Inside and withdrawals to be equally recorded to the Outside. Expenses, loan repayments, and dividends cause withdrawals to the Inside account matched by deposits to the Outside account. Since the deposits are always equal in size to the withdrawals, the balance of the general ledger remains zero.

Inside + Outside + total deposits + total withdrawals = 0

Or, simply:

Inside + Outside = 0

Now, to bring our thought experiment closer to modern practice, we rename the Inside account “Assets” and our Outside account “Non-Assets,” we have the following:

Assets + Non-Assets = 0

And this mathematical expression of true balance is something very different from the traditional expression of the Accounting Equation, which, in our simplistic example would be expressed as:

Assets = Non-Assets

This final expression must always be false except in the degenerate case of when the Assets balance itself is zero.