FINANCIAL ACCOUNTING AND REPORTING

LEARNING MODULES

Lesson 3 ACCOUNTING EQUATION

Did you know that?

LEARNING OBJECTIVES The Philippine Institute of Certified Public
1. Distinguish the elements of financial Accountants is the national accredited professional
statements; organization for CPAs in the Philippines. It has four
sub-organizations representing each sector namely,
2. Prepare a chart of accounts; and ACPACI for commerce and industry, GACPA for
3. Illustrate the effects of simple cases government, ACPAPP for public practice, and
NACPAE for education.
to the elements in the accounting
equation.

An account is the basic storage of information in accounting. It is a record of the increases and decreases in a
specific item of an asset, liability, equity, income, or expense, also known as the elements of financial statements.
Assets are the controlled economic resources that have resulted from past events and provide economic benefits.
Liabilities are present obligations that have resulted from past events and require giving up economic resources
when settling them. Equity is assets minus liabilities. Income is the increases in economic benefits during the
period in the form of increases in assets or decreases in liabilities, which result in increases in equity, excluding
those relating to investments by the business owner. Expenses are decreases in economic benefits during the
period in the form of decreases in assets, or increases in liabilities, that result in decreases in equity, excluding
those relating to distributions to the business owner. The difference between income and expenses represents
profit or loss.

A chart of accounts is a list of all the accounts used by a business and the account numbers that identify their
location in the ledger. These are grouped into balance sheet accounts (assets, liabilities, and equity) and income
statement accounts (income and expenses). Balance sheet accounts are permanent accounts or real accounts
because they are carried forward to the next accounting period. Income statement accounts are temporary
accounts or nominal accounts because they are closed at the end of the accounting period. The numbering system
of accounts usually starts from the balance sheet accounts and is followed by the income statement accounts.

Contra accounts are presented in the These are the common account titles used by economic entities.
financial statements as a deduction to Assets Income
their related accounts (e.g. Cash Service fees
Accounts receivable Sales
accumulated depreciation, allowance Allowance for bad debts Interest income
for bad debts). Notes receivable Gains
Prepaid supplies Expenses
Adjunct accounts are presented in the Prepaid rent Cost of sales (or Cost of goods sold)
financial statements as an addition to Prepaid insurance Freight-out
their related accounts (e.g. freight in). Land Salaries expense
Building Rent expense
Accumulated depreciation - building Utility expense
Accounts are also called account Equipment Supplies expense
titles and account names. Accumulated depreciation - equipment Bad debt expense
Liabilities Depreciation expense
Accounts payable Advertising expense
Notes payable Insurance expense
Interest payable Taxes and licenses
Please bear in mind that all the Salaries payable Transportation and travel expense
processes in the accounting Utilities payable Interest expense
Unearned income Miscellaneous expense
system must observe the equality
Owner’s Equity Losses
of the accounting equation. Owner’s capital
Owner’s drawings

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 FINANCIAL ACCOUNTING AND REPORTING
LEARNING MODULES

This accounting equation simply depicts that for every asset,

Assets = Equities there is corresponding equity. Equity is defined as the right,
claim, or interest of a person over the assets of the business.

Assets can be sourced through debt equity (borrowings) or

Assets = Debt Equity + Owner’s Equity
owner’s equity (owner’s contribution).

Debt equity is popularly known as liabilities. The owner’s equity

fits for sole proprietorship while owners’ equity fits for
Assets = Liabilities + Owner’s Equity partnerships and corporations. However, for partnerships, it is
also termed as partners’ equity and shareholders’ equity for
corporations.

This is an expanded equation which incorporates the income

Assets = Liabilities + Owner’s Equity + Income - Expenses
and expenses as an adjustment of owner’s equity.

Let us consider the following illustrations to analyze the relationship of the five elements in the accounting
equation. Let us denote A for assets, L for liabilities, OE for owner’s equity, I for income, and E for expenses.

1. If total assets are P20,000 and total liabilities are P5,000, how OE=A-L=P20,000-P5,000=P15,000
much is the total equity?
2. If total liabilities are P10,000 and total equity is P5,000, how A=L+OE=P10,000+P5,000=P15,000
much are the total assets?
3. If total assets are P20,000 and total equity is P5,000, how L=A-OE=P20,000-P5,000=P15,000
much are the total liabilities?
4. If total income is P20,000 and total expenses are P10,000, P/L=I-E=P20,000-P10,000=P10,000
how much is the profit or loss?
5. If total income is P30,000, total expenses are P20,000, total A=L+OE+I-E=P20,000+P15,000+P30,000-
liabilities are P20,000, and total equity (before profit or loss) is P20,000=P45,000
P15,000, how much are the total assets?

You can try the following exercise to further test your knowledge about the accounting equation. Find the
missing value.

2017 2018 2019 2020

Assets 200,000 (3) (6) 350,000
Liabilities (1) 120,000 110,000 100,000
Owner’s Equity (after profit & loss) (2) 140,000 (7) (9)
Owner’s Equity (before profit & loss) 80,000 (4) 140,000 (10)
Income 50,000 (5) 90,000 120,000
Expenses 30,000 40,000 (8) 50,000

Suggested Readings

1. Financial Accounting & Reporting (Fundamentals) 2nd Edition (2019) by Millan, pp. 68-84,
104-125.

References

1. Ballada, W. & Ballada, S. (2019). Basic Financial Accounting and Reporting 22nd Edition.
Manila, Philippines: DomDane Publishers.
2. Millan, Z. V. (2019). Financial Accounting & Reporting (Fundamentals) 2nd Edition. Baguio
City, Philippines: Bandolin Enterprise.

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LEARNING MODULES

3. Weygandt, J. J., Kimmel, P. D., & Kieso, D. E. (2018). Accounting Principles 13th Edition.
Asia: John Wiley & Sons (Asia) Pte Ltd.