THE ACCOUNTING EQUATION

 The whole of financial accounting is based on the accounting equation.

 For a firm to operate it needs resources (ASSETS) and those resources have to be supplied to the firm by outsider (LIABILITIES) or the
owner himself (EQUITY).
 Based on the accounting equation, we can describe the financial position of an organization.

ASSETS = LIABILITIES + EQUITY

PAID-IN CAPITAL + RETAINED EARNINGS
(REVENUE – EXPENSES)

 The left side of the equation represents what the company owns. Assets are resources that the entity controls in order to attain future
benefits.
 The right side represents the claims of the different parties to the company’s assets. Liabilities represent the claims of the entity’s
creditors while Equity represents the residual interest of the owners of the entity.
 Contributed capital (Paid-in Capital): Amount invested by its owners.
 Retained Earnings: Accumulated amount earned by income-producing activities and kept for use in the business.
 Revenue are items that increase in retained earnings resulted from delivering goods or services to customers (such as sales).
 Expenses are items that decrease retained earnings resulted from business operations (such as cost of goods sold, electricity
and water, rent and rates, salaries and wages, etc.)
 Both sides of the equation has to be equal.
 The effects is shown by the use of (+) or (-) placed against the elements affected. i.e. increase in cash by PHP1,000 is shown as
+PHP1,000 in assets of the equation and increase in trade payables by PHP800 is shown as +PHP800 in liabilities.

Example 1:
You want to buy a cellphone at a price of PHP10,000. You have only PHP3,000 in the pocket, therefore, you borrow PHP7,000 from your brother to
buy the smartphone.

Assets (Cellphone) = Liabilities (Owe to Brother) + Equity (From your pocket)

+P10,000 +P7,000 +P3,000

Exercise 1
Compute the missing amounts in the following table.

Assets = Liabilities + Equity

a. 47,000 32,000 ?
b. ? 21,000 34,000
c. 52,100 ? 17,600
d. 123,400 65,400 ?
e. 39,800 ? 22,700
f. ? 43,420 11,730

Example 2
a. Initial Investment
Manang Rosie has been well known for her delicious variety of barbecues. As such, she decided to open up a barbecue store in her
neighbourhood. The store would be a sole proprietorship business. In order to do so, she invested P25,000 as initial capital.

Assets = Liabilities + Equity

Cash Manang Rosie, Capital
+P25,000 +P25,000

b. Purchase of Equipment
To actually create her famous barbecue, she would need the proper equipment to cook it. Thus, she went to the local hardware store and
bought the necessary equipment such as grills and utensils for P20,000.

Assets = Liabilities + Equity

Cash PPE Manang Rosie, Capital
+P25,000 +P25,000
-20,000 +20,000
P25,000 P0 P25,000
 c. Purchase of Inventories through credit or on account
Manang Rosie’s barbecues require only the freshest meat which can be bought from Ate Shayne’s store in the market. Since it cost
P10,000, Manang Rosie does not have enough money to purchase this. Despite that Manang Rosie is already a trusted suki of this store.
As such, Ate Shayne decided to give the meat to Manang Rosie on the condition that she will have to pay her in 30 days.

Assets = Liabilities + Equity

Cash PPE Inventories Accounts Payable Manang Rosie, Capital
+P25,000 +P25,000
-20,000 +20,000
+P10,000 +P10,000
P35,000 P10,000 P25,000

d. Payment of Expenses
To actually set up a business, one of her friends told her that she has to obtain business and other permits from the local government. As
such, she paid P1,000 to obtain such permits.

Assets = Liabilities + Equity

Cash PPE Inventories Accounts Payable Manang Rosie, Capital Expenses
+P25,000 +P25,000
-20,000 +P20,000
+P10,000 +P10,000
-1,000 -P1,000
P34,000 P10,000 P24,000

e. Sale of Barbeques
With everything in place, Manang Rosie can now sell her famous barbeques. During the first day of her new business venture, she
was able to sell 1,000 barbeques with a selling price of P20,000. Half of which was paid in cash. The other half was to be paid in 5
days. Correspondingly, the 1,000 barbeque account for half of the total supply of barbeques of Manang Rosie.

Assets = Liabilities + Equity

Cash Accounts PPE Inventories Accounts Manang Rosie, Revenue Expenses
Receivable Payable Capital
+P25,000 +P25,000
-20,000 +P20,000
+P10,000 +P10,000
-1,000 -P1,000
+10,000 +P10,000 +P20,000
-5,000 -5,000
P49,000 P10,000 P39,000

Example 3.
a. Janet Reyes invests cash in a Beauty Parlor.
b. J. Reyes purchases furniture and fixtures for P3,000 cash.
c. J. Reyes buys parlor supplies agreeing to pay P1,000 within 30 days.
d. Janet Reyes earns service revenue by providing various services for her customers. Assume she earns P3,000 and collects this amount in
cash.
e. During the week, Janet pays P500 in rent; employee’s salary (part-time assistant) P500; and total utilities, P300.
f. J.Reyes pays P500 to the store from which she purchased P1,000 worth of parlor supplies.

Nature of Transaction Assets = Liabilities + Equity

Cash + Parlor + Furniture & = Accounts + J. Reyes, Capital
Supplies Fixtures Payable
a. Investment +10,000 +10,000
b. Purchase of F&F -3,000 +3,000
c. Purchase of Parlor +1,000 +1,000
supplies
d. Earns Revenue +3,000 +3,000
e. Expenses paid -1,300 -1,300
f. Settle of debt -500 -500
New balance 8,700 1,000 3,000 500 11,700

12,200 12,200
Exercise 2. What elements of the accounting equation are affected by the following transactions?

1) Gabriel Company purchased inventory on credit for P20,000.

o Inventory +P20,000 = Accounts Payable +P20,000
2) Gabriel Company deposited cash worth P5,000 which it has kept in its locker to its local bank.
o Cash +P5,000 = Equity +P5,000
3) Gabriel Company received interest from its deposit in the bank. The interest amounts to P200.
o Cash +P200 = Interest Income +P200
4) A fire broke in the warehouse of Gabriel Company. Luckily, only P2,000 worth of inventory was affected.
o Inventory –P2,000 = Loss on fire –P2,000
5) Gabriel Company offered merchandise to one of its big time customers. The merchandise is worth P4,000.
o No sale transaction yet. Only proposal to sell (Offer to sell).
6) Gabriel Company sold goods to a major customer. A quarter of the goods were paid in cash while the rest was to be paid in a month. The goods are sold for P10,000
although they only cost Gabriel Company P4,000.
o Cash +P2,500, Accounts Receivable +P7,500, Inventory –P4,000 = Revenue +P10,000, Cost of Goods Sold –P4,000
7) Gabriel Company paid income taxes worth P5,000.
o Cash –P5,000 = Income taxes –P5,000
8) Gabriel Company paid P40,000 to advertise its merchandise to the public.
o Cash –P40,000 = Advertising Expense –P40,000
Exercise 2.
Listed below are ten business transactions for Puring Company during its first month of operations:

a. Owner invested cash in the business amounting to P300,000.

b. Purchased equipment for cash amounting to P50,000.
c. Purchased inventories through credit amounting to P35,000.
d. Purchased furniture amounting to P30,000. Made partial payment with cash of P10,000 and incurred an accounts payable for the balance of P20,000.
e. Paid cash to the local government for business permit for P9,000.
f. Made sales of P17,000-P12,000 cash sales, P5,000 credit sales.
g. The cost of the sales made in (f) amounted to P8,500.
h. Paid the accounts payable in (d).
i. Collected P2,500 out of the P5,000 credit sales in (f).
j. Paid employees of P12,000.

Assets = Liabilities + Owner’s Equity

Accounts Accounts Revenue
Cash Inventories PPE = + Puring, Capital
Receivable Payable (Expenses)
a. +P300,000 +P300,000
b. -50,000 +P50,000
c. +P35,000 +P35,000
d. -10,000 +30,000 +20,000
e. -9,000 -P9,000
f. +12,000 +P5,000 +17,000
g. -8,500 -8,500
h. -20,000 -20,000
i. +2,500 -2,500
j. -12,000 -12,000
213,500 2,500 26,500 80,000 = 35,000 300,000 -12,500

322,500 322,500
Exercise 2. Analyzing the Effect of Business Transactions on the Accounting Equation

Company Background

Santy Ramos, an experienced appliance mechanic opens his own appliance repair business. He has taken several courses in accounting and maintenance. RARS accounting
records himself. He knows that small businesses such as his are not required to prepare formal financial statements, but he prepares them anyway. He believes they will be useful
to him in running the business. In addition, if RARS is successful, substantial amount of capital from investors and creditors. He believes that the financial statements will be helpful
in attracting investment capital.

RARS’s transactions during January, 2019 are presented as follows:

January 2 S. Ramos started the business by depositing, P50,000 of his personal funds in RARS Company bank account.
January 10 Purchased repair tools and equipment, P20,000 paying cash.
January 12 Purchased shop supplies, P5,000, from MNO Company, payable within 30 days.
January 15 Sold some of the tools to X Company at a price equal to their cost, P2,000 collectible within 10 days.
January 25 Received P2,000 cash representing collection of the account receivable from the sale of the tools.
January 27 Paid P2,000 in partial settlement of an account payable.
January 31 Recorded P7,000 of sales of repair services received in cash.
January 31 Paid P3,500 of operating expenses in cash – P1,000 for utilities and P2,500 for wages.
Recognized the usage of shop supplies amounting to P1,000.

Required: Present the effects of transactions in a table. The effect of each transaction on the accounts are indicated by a plus (+) or a minus (-) sign. Note that accounting equation
should always remain balance.

Assets = Liabilities + Owner’s Equity

Accounts Shop Tools and Accounts Revenue
Cash = + S. Ramos, Capital
Receivable Supplies Equipment Payable (Expenses)
January 2 +50,000 +50,000
January 10 -20,000 +20,000
January 12 +5,000 +5,000
January 15 +2,000 -2,000
January 25 +2,000 -2,000
January 27 -2,000 -2,000
January 31 +7,000 +7,000
January 31 -3,500 -3,500
-1,000 -1,000
33,500 - 4,000 18,000 = 3,000 50,000 2,500

55,500 55,500