The
Accounting Equation
and its
Components
Business is run through transactions. Transactions are financial in nature and they affect the financial position of
any business. Every transaction increases or decreases Assets, Liabilities, or Capital.
BASIC ACCOUNTING
EQUATION EXPANDED ACCOUNTING EQUATION
LIABILITIES
OWNER’S
EQUITY
ASSETS
REVENUES
EXPENSES
LIABILITIES
OWNER’S
EQUITY
ASSETS
REVENUES
EXPENSES
EXPANDED ACCOUNTING
FURTHER EXPANDED ACCOUNTING EQUATION
EQUATION
LIABILITIES LIABILITIES
OWNER’S OWNER’S CAPITAL
EQUITY
ASSETS ASSETS DRAWINGS
REVENUES
REVENUES
EXPENSES EXPENSES
Assets
Assets are general resources that are owned by a
company. Assets help businesses generate revenue.
Assets can be broken down into Current & Non-
Current assets.
Current assets are short term assets. They are
generally liquid and can easily be converted to cash.
E xamples of s u ch as s et s in clu de cas h & cas h
eq u i valen t s , m ar ket ab le s ecu r i t i es , accou n t s
receivables, inventories.
Non-Current assets are those assets that have a
validity of more than a year. Land, buildings, fixtures &
fittings, equipment, machinery all are classified as non-
current assets. Furthermore, non-current assets also
include intangible assets such as goodwill, brand name,
patents & copyrights.
Liabilities
Liabilities include amounts which a company
owes to another party.
Like assets, liabilities can also be divided into
current & non-current.
Current liabilities are short term in nature and
are used to finance short term assets of the
company. Examples of current liabilities
i n clu de s h o rt t erm lo an s , o v erdraft s ,
accounts payable, etc.
Non-Current liabilities are mainly used to
finance non-current assets and include long
term debt, mortgage, bonds, etc.
Owner’s Equity
The owner’s equity represents the
amount that is invested by the owner
in the company plus the net profit
retained in the company.
For a sole trader, equity would be the
amount invested by the sole proprietor
plus net income less any withdrawals.
Revenues
Revenue is what comes when the company
sells their products or deliver their services.
Revenue is the income of the business, thus
res u lt i n g i n i n creas i n g o f as s et s an d
decreasing of liabilities.
Cash revenues lead to an increase in the
revenue and credit sales lead to a decrease
in the liabilities as your customer commits to
pay you after a specific period of time.
Expenses
An expense is a cost involved in running a
business so that one can earn revenue.
S o m e o f th e exam p les o f exp en s es a
business incurs include:
Building rent, Utility bills, including electricity,
water, telephone, and internet, Marketing and
advertising costs, Cost of transportation,
Salaries, Wages, Commissions, incentives,
and related costs, Shipping expenses.
ABDUL ENTERPRISE
CHART OF ACCOUNTS
ASSETS
CODE CURRENT ASSETS
101 Cash
102 Notes Receivable
103 Accounts Receivable
104 Store Supplies
105 Office Supplies
106 Prepaid Insurance
107 Prepaid Advertising
108 Prepaid Rent
NON-CURRENT ASSETS
109 Land
110 Service Vehicle
111 Accumulated Depreciation-Service vehicle
112 Building
113 Accumulated Depreciation-Building
114 Store Equipments
115 Accumulated Depreciation-Store equipments
116 Office Equipments
117 Accumulated Depreciation-Office Equipments
118 Furniture and Fixtures
119 Accumulated Depreciation-Furniture and Fixtures
120 Tools and Equipments
121 Accumulated Depreciation-Tools and equipment
ABDUL ENTERPRISE
CHART OF ACCOUNTS
LIABILITIES
CODE CURRENT LIABILITIES
201 Accounts Payable
202 Accrued Slaries and Wages Payable
203 Accrued Taxes Payable
204 Unearned Service Income
205 Accrued Utilities Payable
NON-CURRENT LIABILITIES
206 Notes Payable
207 Bank Loan Payable
208 Mortgage Payable
OWNER'S EQUITY
301 Abdul, Capital
302 Abdul, Drawings
303 Income and Expense Summary
ABDUL ENTERPRISE
CHART OF ACCOUNTS
CODE REVENUE
401 Service Income
402 Interest Income
EXPENSES
501 Salaries and Wages Expense
502 Utilities Expense
503 Depreciation Expense
504 Interest Expense
505 Rent Expense
506 Insurance Expense
507 Communication Expense
508 Store Supplies Expense
509 Advertising Expense
510 Office Supplies Expense
511 Miscellaneous Expense
Effects of Transactions on the Accounting
Equation
Business is run through transactions. Transactions are
financial in nature and they affect the financial position of
any business.
Every financial transaction increases or decreases
Assets, Liabilities, or Equity.
Effects of Transactions on the Accounting Equation
Assets = Liabilities + Equity
Sale of Service on Credit INC NE INC
Receipt of Deferred Revenue INC INC NE
Purchase of Assets Using Cash NE NE NE
Purchase of Assets on Credit INC INC NE
Payment of Operating Expenses DEC NE DEC
Recording of Accrued Expenses NE INC DEC
Payment of Accrued Expenses DEC DEC NE
Depreciation of Fixed Assets DEC NE DEC
Fund Transfer Between Bank Accounts NE NE NE
Invest Cash in the Business INC NE INC
Payment to Creditors DEC DEC NE
Owner’s Withdrawal DEC NE DEC
ILLUSTRATIVE EXAMPLE
SOLE PROPRIETORSHIP TRANSACTION #1.
Let's assume that J. Ott forms a sole proprietorship called Accounting Software Co. (ASC). On December 1, 2022, J.
Ott invests personal funds of $10,000 to start ASC. The effect of this transaction on ASC's accounting equation is:
Sole Proprietorship Transaction #2.
On December 2, 2022, J. Ott withdraws $100 of cash from the business for his personal use. The effect of this
transaction on ASC's accounting equation is:
Sole Proprietorship Transaction #3.
On December 3, 2022, Accounting Software Co. spends $5,000 of cash to purchase computer equipment for use in
the business. The effect of this transaction on the accounting equation is:
The combined effect of the first three transactions is shown here:
Sole Proprietorship Transaction #4.
On December 4, 2022, ASC obtains $7,000 by borrowing money from its bank. The effect of this transaction on the
accounting equation is:
The combined effect on the accounting equation from the first four transactions is:
Sole Proprietorship Transaction #5.
On December 5, 2022, Accounting Software Co. pays $600 for ads that were run in recent days.
The combined effect on the accounting equation from the first five transactions is:
Sole Proprietorship Transaction #6.
On December 6, 2022, ASC performed consulting services for its clients. The clients were billed for the agreed upon
amount of $900. The amounts are to be paid within 30 days.
The combined effect on the accounting equation from the first six transactions is :
Sole Proprietorship Transaction #7.
On December 7, 2022, ASC uses a temporary help service for 6 hours at a cost of $20 per hour. ASC will pay the
invoice when it is due in 10 days.
The combined effect on the accounting equation from the first seven transactions is :
Sole Proprietorship Transaction #8.
On December 8, 2022, ASC received $500 from the clients it had billed on December 6, 2022.
The combined effect on the accounting equation from the first eight transactions is :
RECALL
ASSETS = LIABILITIES + EQUITY
ASSETS = LIABILITIES + OWNER’S EQUITY+REVENUES-EXPENSES
ASSETS = LIABILITIES + OWNER’S CAPITAL + REVENUES-EXPENSES -
OWNER’S DRAWINGS
The eight transactions that we had listed under the basic accounting equation, are shown in the following
expanded accounting equation:
THE DOUBLE ENTRY BOOKEEPING AND THE
RULES OF DEBIT AND CREDIT
Recording transactions and keeping financial records are
an essential part of owning a business. One way you can
keep track of your finances is by using double-entry
accounting.
Double-entry bookkeeping is an accounting method where
you equally record a transaction in two or more accounts.
A credit is made in at least one account, and a debit is
made in at least one other account.
The double entry has two equal and corresponding sides
known as debit and credit. The left-hand side is debit and
right-hand side is credit
DEBITS AND CREDITS
In accounting, Debit means the left side of an account and Credit means the right side of an account.
We increase and decrease accounts by debiting them or crediting them.
Knowing whether to debit or credit an account depends on the Type of Account and that account’s Normal Balance.
An account’s Normal Balance is based on the Accounting Equation and where that account is in the equation.
The account types are Asset, Liability, Owner’s Equity, Revenue, and Expense.
To increase an Asset, , or Expense account, we debit. To decrease those accounts, we credit. To increase an
Owner’s Equity (Capital), Revenue, or Liability account, we credit. To decrease those accounts, we debit.
DEBITS AND CREDITS
To balance your books, use debits and credits. Debits and credits are equal but opposite entries in your accounting
books. If a debit decreases an account, you will increase the opposite account with a credit.
A debit is an entry made on the left side of an account while a credit is an entry on the right side.
Record credits and debits for each transaction that occurs. With double-entry in accounting, record two or more
entries for every transaction.
Credits and debits affect each account differently.
Check out this chart to see how each type of account is impacted:
Books of Accounts are the accounting books
where business transactions are recorded.
The books of accounts are composed of
GENER AL JOUR NAL an d th e GENER AL
LEDGER.
General Journal
This is called the book
of original entry because
this is the firs t b ook
whe r e t he b us ine s s
transaction are
recorded.
Journalizing is the
process of recording in
the journal.
WHAT ARE THE SPECIAL JOURNALS?
Aside from General Journal and Ledger, businesses also use Special
Journals. These are multi-column journals that have columns reserved
for specific transaction.
These accounting books are prescribed to ease the recording of the
business owner or their bookkeeper. The four (4) common special
journals are:
Cash Receipts
This is one of the books of accounts you use to record all cash received
by the business.
Cash Payment
This is one of the books of accounts you use to record all cash paid by
the business.
Sales
This is one of the books of accounts you use to record all sales including
sales of merchandise on account.
Purchase Journal
This is one of the books of accounts you use to record all purchases and
disbursements including purchase of merchandise on account.
General Ledger
This is called the book of final entry. In this book, you can see the
ending balance of each account you record in General Journal
and Special Journals.
Posting is the process of recording in the general ledger.
A general ledger is an accounting record that compiles every
financial transaction carried out by a firm to provide accurate
entries for financial statements.
In other words, it is a document containing accounting summaries
for accounts used by a company
T-account Ledger
The 3-column Ledger
The 4-column Ledger
T-account Ledger
Cash 100
Date Particulars PR Debit Date Particulars PR Credit
Looks like letter T
Three (3)-column Ledger
Cash 100
Date Particulars PR Debit Credit Balance
3 columns
Four (4)-column Ledger
Cash 100
Balance
Date Particulars PR Debit Credit Debit Credit
4 columns
Manual Books of Account
These method is done using a traditional books you find in a books and office supplies store.
Manual Books of Accounts are mostly used by micro and small businesses because it’s the
easiest to register in the BIR. Recording is hand written.
You are not required to renew and re-stamp your books to BIR annually. They are only
renewed if your books are already exhausted or used.
Loose-leaf Books of Account
This method is done using spreadsheet like Microsoft Excel. Some companies uses simple
Quickbooks for their bookkeeping and just export their reports in Microsoft Excel. Those
who uses this method are required to submit permanently bind loose-leaf forms within 15
days after the end of each taxable year or upon termination of its use.
Computerized Books of Account
This is mostly used by big companies. This method is done using complex accounting
software. Generation of Invoices and receipts are usually computerized.
Those who uses this method are required to submit reports in CD and other requirements
within 30 days after the end of each taxable year or upon termination of its use.
Computerized
Manual Loose-leaf
Accounting System
Nature Manual Manual Automated
Method of recording Handwritten Electronic Electronic
Bound books with Bound books with
Medium of Storage Electronic (DVD)
handwritten entries printed out entries
Annual Submission Not required Required Required
Requires Permit to
No Yes Yes
Use
