Acctg.

Ed 1 - Financial Accounting & Reporting Unit 2 Module 4 Types of Major Accounts

Unit 2

General Concepts and Principles of Accounting

Module 4

TYPES OF MAJOR ACCOUNTS

Acctg. Ed 1 - Financial Accounting & Reporting Unit 2 Module 4 Types of Major Accounts

Unit 2 – Application of Accounting Concepts & Principles

Unit 2 applies accounting concepts and principles into real business transactions.
It will cover deeper discussion on accounting equation, types of major accounts, books
of accounts and double entry system, business transactions and their analysis, posting
to ledger and adjusting entries.

Module 4 – Types of Major Accounts

This module covers topics on five major accounts and examples of each
major type of account.

Objectives

At the end of the module, you should be able to:

1. Identify the five major accounts

2. Provide example of each major type of account

Account
is the basic storage of information in accounting. It is a record of the increase
and decrease in a specific item of asset, liability, capital, revenue or expense.

T-account
is a device form where the increase and decrease in a specific item is recorded.

Parts of T-account
1. Account title – describes the specific item of asset, liability, capital, revenue or
expense
2. Debit side – the left side of the account
3. Credit side – the right side of the account

The FIVE Major Accounts

1. Assets
are the economic resources you control that have resulted from past events and can
provide you with economic benefits

2. Liabilities
are your present obligations that have resulted from past events and can require you to
give up economic resources when settling them

3. Capital
is simply assets minus liabilities. It is also know as equity, net assets or networth
 Acctg. Ed 1 - Financial Accounting & Reporting Unit 2 Module 4 Types of Major Accounts

4. Revenue (Income)
is increases in economic benefits during the period in the form of increase in assets, or
decreases in liabilities, that result in increases in equity, excluding those relating to
investments by the business owner.

5. 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.

Classification of the Five Major Accounts

The five major accounts are classified according to the financial statement where
they appear:
BALANCE SHEET ACCOUNTS INCOME STATEMENT
ACCOUNTS
1. ASSETS 1. REVENUE (INCOME)
2. LIABILITIES 2. EXPENSES
3. CAPITAL (EQUITY)

Chart of Accounts
A Chart of accounts is a list of all the accounts used by a business.

Chart of Accounts
BALANCE SHEET ACCOUNTS INCOME STATEMENT ACCOUNTS
Account Account
No. No.
ASSETS REVENUE (INCOME)
110 Cash 410 Service fee
120 Accounts Receivable 420 Sales
125 Allowance for bad debt 430 Interest Income
130 Notes Receivable 440 Gains
140 Inventory
150 Prepaid Supplies EXPENSES
155 Prepaid Rent 510 Cost of Sales
160 Prepaid Insurance 515 Freight-out
170 Land 520 Salaries expense
180 Building 525 Rent expense
185 Accumulated depreciation-Building 530 Utilities expense
190 Equipment 535 Supplies expense
195 Accumulated depreciation-Equipment 540 Bad debt expense
545 Depreciation expense
LIABILITIES 550 Advertising expense
210 Accounts Payable 555 Insurance expense
220 Notes Payable 560 Taxes and licenses
Acctg. Ed 1 - Financial Accounting & Reporting Unit 2 Module 4 Types of Major Accounts

230 Interest Payable 565 Transportation and travel

expense
240 Salaries Payable 570 Interest expense
250 Utilities Payable 575 Miscellaneous expense
260 Unearned Income 580 Losses

CAPITAL (EQUITY)
310 Owner’s capital
320 Owner’s drawings

The account titles in the chart of accounts shown are number in the following manner:

1. The first digit in the 3-digit numbering refers to the major types of accounts:

Major types of accounts Assigned number

ASSETS 1
LIABILITIES 2
CAPITAL (EQUITY) 3
REVENUE (INCOME) 4
EXPENSES 5

110 Cash

The first digit signifies that this

account is an asset account

2. The second digit in the 3-digit numbering refers to the account titles and the
sequence on how they are listed in the chart of accounts

110 Cash
120 Accounts receivable

The second digits refer to specific account titles and

the sequence on how they are listed I the chart of
accounts

3. The third digit in the 3-digit numbering, if not zero, signifies that the account is a
contra account or an adjunct account to a related account.

180 Building
185 Accumulated depreciation – Bldg.

The second digit signifies that this account,

“Accumulated depreciation – Bldg.,” is a contra-account
to the “Building” account.
Acctg. Ed 1 - Financial Accounting & Reporting Unit 2 Module 4 Types of Major Accounts

Common Account Titles

BALANCE SHEET ACCOUNTS

ASSETS
• Cash – includes money or its equivalent that is readily available for unrestricted use,
e.g., cash on hand and cash I bank.
• Accounts receivable – receivables supported by oral or informal promises to pay.
• Allowance for bad debts – the aggregate amount of estimated losses from
uncollectible accounts receivable. Another term is “allowance for doubtful accounts.”
• Notes receivable – receivable supported by written or formal promises to pay in the
form of promissory notes.
• Inventory – represents the goods that are held for sale by a business. For a
manufacturing business, inventory also includes goods undergoing the process of
production and raw materials that will be consumed in the production process.
• Prepaid supplies – represents the cost of unused office and other supplies.
• Prepaid rent – rent paid in advance.
• Prepaid insurance – cost of insurance paid in advance.
• Land – the lot on which the building of the business has been constructed or a
vacant lot which is to be used as future plant site. Land is not depreciable.
• Building – the structure owned by a business for use in its operations.
• Accumulated depreciation – building – the total amount of depreciation of
depreciation expenses recognized since the building was acquired and made
available for use.
• Equipment – consists of various assets such as:
a. Machineries and other factory equipment
b. Transportation equipment, e.g., vehicles, delivery trucks
c. Office equipment, e.g., desks, cabinets, chairs
d. Computer equipment, e.g., server, personal computers, laptops
e. Furniture and fixtures, e.g., desks, cabinets, movable partitions
• Accumulated depreciation – equipment – the total amount of depreciation
expenses recognized since the equipment was acquired and made available for use.
Acctg. Ed 1 - Financial Accounting & Reporting Unit 2 Module 4 Types of Major Accounts

LIABILITIES
• Accounts payable – obligations supported by oral or informal promises to pay by
the debtor.
• Notes payable – obligations supported by written or formal promises to pay by the
debtor in the form of promissory notes.
• Interest payable – interest incurred but not yet paid. Interest payable arises from
interest-bearing liabilities. For example, you will incur interest on your bank loan.
• Salaries payable – salaries already earned by employees but not yet paid by the
business.
• Utilities payable – utilities (e.g., electricity, water, telephone, internet, cable TV,
etc.) already used but not yet paid.
• Unearned income – Items related to income that were collected in advance before
they are earned. After the earning process is completed, these items are transferred
to income.

EQUITY (Capital, Net Assets or Net worth)

• Owner’s capital (or Owner’s equity) – the residual amount after deducting
liabilities from assets.
• Owner’s drawings – this account is used to record the temporary withdrawals of the
owner during the period. At the end of the accounting period, any balance in this
account is closed to the “Owner’s capital” account.

INCOME STATEMENT ACCOUNTS

INCOME (REVENUE)
• Service fees – revenues earned from rendering services (e.g., services of a spa,
services of a beauty salon, etc.).
• Sales – revenues earned from the sale of goods (e.g., sale of barbecue, sale of
souvenir items, etc.).
• Interest income – revenues earned from the issuance of interest-bearing
receivables.
• Gains – income earned from the sale of assets (except inventory) or from
enhancements of assets or decreases in liabilities that are not classified as revenue.

EXPENSES
• Cost of sales (or Cost of goods sold) – represents the value of inventories that
have been sold during the accounting period.
• Freight-out – represents the sellers’ costs of delivering goods to customers. Other
terms for freight-out are “delivery expenses,” “transportation-out,” and “carriage
outwards.”
Acctg. Ed 1 - Financial Accounting & Reporting Unit 2 Module 4 Types of Major Accounts

• Salaries expense – represents the salaries earned by employees for the services
they have rendered during the accounting period.
• Rent expense – represents the rentals that have been used up during the
accounting period.
• Utilities expense – represents the cost of utilities (e.g., electricity, water, telephone,
internet, cable TV, etc.) that have been used during the accounting period.
• Supplies expense – represents the cost of supplies that have been used during the
period.
• Bad debt expense – the amount of estimated losses from uncollectible accounts
receivable during the period. Other term is “doubtful accounts expense.”
• Depreciation expense – the portion of the cost of a depreciable asset (e.g., building
or equipment) that has been allocated to the current accounting period.
• Advertising expense – represents the cost of promotional or marketing activities
during the period.
• Insurance expense – represents the cost of insurance pertaining to the current
accounting period.
• Taxes and licenses – represents the cost of business and local taxes required by
the government for the conduct of business (e.g., mayor’s permit, other percentage
taxes, community taxes). For corporations and partnerships, income taxes are
recorded in a separated account called “Income tax expense.”
• Transportation and travel expense.
- Transportation expenses represent the necessary and ordinary cost of
employees getting from one workplace to another which are reimbursable by the
business
- Travel expenses represents the costs incurred when travelling on business trips,
e.g., out-of-town travel costs of employees sent to seminars
• Interest expense – represents the cost of borrowing money. It is the price that a
lender charges a borrower for the use of the lender’s money. Other terms for interest
expense are finance costs and borrowing costs.
- Interest expense – represents the cost of borrowing money. It is the price that a
lender charges a borrower for the use of the lender’s money. Other terms for
interest expense on the money you borrowed from Mr. Bombay. On the other
hand, Mr. Bombay will earn interest income.
• Miscellaneous expense – represents various small expenditures which do not
warrant separate presentation.
• Losses -expense which may or may not arise from the ordinary course of business
activities. Losses may arise from :
a. Sale of assets, other than inventory, at a sale price that is less than the carrying
amount.
Acctg. Ed 1 - Financial Accounting & Reporting Unit 2 Module 4 Types of Major Accounts

b. Decreases in the value of assets due to destruction, damage, obsolescence and

other changes in values caused by market factors, e.g., loss on fire, earthquake,
storm, and other calamities, decrease in the value of foreign currencies held due
to changes in exchange rates.
Drills on Account Titles

ASSET ACCOUNTS

Accounts receivable
• A customer bought barbecue worth P500 from your barbecue business. He told you
that he will pay for it next week.
• The P500 collectible from the customer is recorded as accounts receivable.

Allowance for bad debts (Allowance for doubtful accounts)

• The customer with the P500 account receivable is broke. You have estimated that
you can only collect P420 from him.
• The P80 (500 – 420) uncollectible account is recorded as bad debts expense and
accumulated in the allowance for bad debts account.

Notes receivable
• Your friend borrowed P1,000 from your barbecue business. You required from him a
written promissory note to repay the money within 30 days plus 1% monthly interest.
• The P1,000 collectible from your friend is recorded as notes receivable.

Inventory
• You purchased pork worth P1,000 to be marinated and sold as barbecue.
• The cost of the pork purchased is recorded as inventory.

Prepaid supplies
• You purchased table napkins worth P2000 to be used in your barbecue operations
• The table napkins, while still unused, are assets recorded as prepaid supplies.
When used, they are recorded as supplies expense.

Prepaid rent
• You are renting a space for your barbecue stand. The lease contract required you to
pay P10,000 rent in advance
• The rent paid in advance is an asset recorded as prepaid rent. This amount will be
charged as rent expense when incurred (i.e. used up).

Equipment
• You purchased a barbecue grill worth P1,000.
• The barbecue grill is an asset recorded as equipment.
Acctg. Ed 1 - Financial Accounting & Reporting Unit 2 Module 4 Types of Major Accounts

Notes:
• The cost of equipment or similar item that is expected to be used over more than
one accounting period is initially recorded as an asset.
• The cost of this asset is then allocated over the period in which the equipment is
expected to be used.
• The portion of the cost that is allocated to the current period is called depreciation
expense.
• The total depreciation expenses recognized since the equipment was acquired is
piled up in the accumulated depreciation account.

Accumulated depreciation - Equipment

• You expect to use the barbecue grill for 5 years
• The cost of the barbecue grill will be allocated over the 5-year period that you will
be using it. The amount allocated each year is called the “depreciation expense.”
• The depreciation expense per year is P200 (P1,000 ÷ 5 years). Thus, after a year,
the accumulated depreciation of the equipment will be P200 (P200 x 1 yr.); after two
years, the accumulated depreciation will be P400 (P200 x 2 years.); after three
years, P600 (P200 x 3 yrs.), etc.
• In accounting, depreciation means an allocation of cost over the period where a
depreciable asset is used.

LIABILITY ACCOUNTS

Accounts payable
• You ran out of inventory of barbecue, so you went to Mr. Porky’s Meat Shop to buy
pork. You don’t have the available cash, so you promised orally that you will be
paying for the pork, worth P500, next week.
• The P500 payable is a liability recorded under accounts payable.

Notes payable
• Remember your P1,200 loan from Mr. Bombay? Well, he required you to write a
promissory note to repay the borrowed money at some future date.
• The P1,200 payable is a liability recorded under notes payable.

Interest payable
• Your loan from Mr. Bombay requires repayment within 30 days plus 20% monthly
interest (‘five-six’). At the end of 30 days, you will be incurring interest expense of
P240 (1,200 note payable x 20% interest rate).
• Prior to paying the interest, the accrued interest is recorded as interest payable.

Salaries payable
• By month-end, total salaries earned by an employee during the month amounted to
P8,000. However, the employee has not yet claimed the salary.
• The unpaid salary already earned by the employee is recorded as salaries payable.
Acctg. Ed 1 - Financial Accounting & Reporting Unit 2 Module 4 Types of Major Accounts

Utilities payable
• Your electricity bill for the month of January amounted to P2,000. The bill is not ye
paid.
• The unpaid utility already used but not yet paid is recorded as utilities payable.

Unearned income
• You received an order of barbecue worth P800. The customer paid the sale price but
instructed you to deliver the barbecue next week.
• Right now, the sale price collected is not yet earned (i.e., unearned) because the
barbecue is not yet delivered. Thus, the cash collection is initially recorded as
liability (i.e., unearned income) and will be transferred to income (i.e., sales) next
week when the barbecue is delivered.

EQUITY ACCOUNTS

Owner’s capital
• You invested P800 to your barbeque business.
• Your P800 investment is recorded in the Owner’s capital account.

Owner’s drawings
• You made temporary withdrawals of P200 from your barbeque business.
• Your P200 withdrawals are recorded in the Owner’s drawings account.

INCOME ACCOUNTS

Sales
• You sold barbecue worth P500
• The sale is recorded in the Sales account

For the rendering or services, as opposed to sale of goods, the income account
used is the Service fees account.

Interest income
• After a month, you will have earned the1% month interest on the loan you have
extended to your friend.
• The interest earned is credited to the interest income account.

EXPENSE ACCOUNTS

Cost of sales or Cost of goods sold

• The cost of the barbecue that was sold for P500 is P300.
• The P300 cost is expensed as Cost of sales or Cost of goods sold.
Acctg. Ed 1 - Financial Accounting & Reporting Unit 2 Module 4 Types of Major Accounts

Freight-out
• Your business has a hotline. Customers can order barbecue through phone call, text
message, or Facebook Messenger. No delivery charges. During the period, the cost
of gasoline for your motorcycle, attributable to delivering barbecue to customers,
amount to P100.
• The delivery costs of P100 are recorded as freight-out.

Salaries expense
• You hired a helper in your barbecue business. Your employee earns compensation
of P8,000 per month.
• At the end of each month, you will record the P8,000 earned by the employee as
salaries expense.

Rent expense
• You are renting a space for your barbecue stand. The rent if P5,000 per month.
• At the end of each month, you will record the rent expense of P5,000.

Utilities expense
• After a month of operations, your business received electricity bill of P2,000 and
water bill of P200.
• The electricity and water bills are recorded as utilities expense.

Supplies expense
• The cost of table napkins used during the period amounted to P50.
• The cost of the supplies used is recorded as supplies expense.

Bad debt expense

• Of your total accounts receivable of P500, you expect to collect only about P480.
• The P20 uncollectible balance is recorded as bad debt expense.

Depreciation expense
• The P1,000 cost of the barbecue grill will be allocated over the 5 years that you will
be using it. The amount allocated each year is called the “depreciation expense.”
The depreciation expense per year is P200 (P1,000 ÷ 5 years)..
• At the end of the year, you will record the allocated cost of the barbecue grill o P200
as depreciation expense.

Advertising expense
• You paid Justin Bieber P5,000 to endorse your barbecue business.
• The P5,000 payment is recorded as advertising expense.

Insurance expense
• You have obtained a one-year, fire insurance for your barbecue stand for P12,000.
• The used-up portion of the insurance is recorded as insurance expense.
Acctg. Ed 1 - Financial Accounting & Reporting Unit 2 Module 4 Types of Major Accounts

Taxes and licenses expense

• During the period, you paid local taxes amounting to P500
• The local taxes paid are recorded as taxes and licenses.

Interest expense
• (See ‘Notes payable’ and ‘Interest payable’ above)
• At the end of the month, you will record P240 interest expense.

Loss
• Your barbecue grill is stolen.
• The carrying amount of the stolen barbecue grill is charged as a loss. The carrying
amount is computed as “Acquisition cost minus Accumulated depreciation.” The cost
of the barbecue grill is P1,000. If the accumulated depreciation is P400, the carrying
amount is P600 (1,000-400).

SAQ#1

Identify the following:

1. An___________ is a record of the increases and decreases in a specific item of

asset, liability, equity, income or expense.
2. The three parts of T-account are: (a)______________, (b) ____________, and
(3) _______________.
3. ________ is the left side of an account, while __CREDIT___ is the right side.
4. _______________________ are classified as balance sheet accounts
5. ___________________ are classified as income statement accounts
6. _________________ __ is a list of all the accounts used by the business.
7. _________ is increases in assets, or decreases in liabilities resulting to
increases in Capital.

ASAQ # 1

Identify the following:

1. An__ACCOUNT__ is a record of the increases and decreases in a specific item

of asset, liability, equity, income or expense.
2. The three parts of T-account are: (a)__ACCOUNT TITLE___, (b) __DEBIT
SIDE___, and (3) ___CREDIT SIDE___.
3. _DEBIT__ is the left side of an account, while __CREDIT___ is the right side.
4. _ASSETS, LIABILITIES & CAPITAL__ are classified as balance sheet accounts
5. __REVENUE & EXPENSES___ are classified as income statement accounts
6. ___CHART OF ACCOUNTS __ is a list of all the accounts used by the business.
7. _REVENUE_ is increases in assets, or decreases in liabilities resulting to
increases in Capital
Acctg. Ed 1 - Financial Accounting & Reporting Unit 2 Module 3 Accounting Equations

Unit 2

General Concepts and Principles of Accounting

Module 3

Accounting Equations
Acctg. Ed 1 - Financial Accounting & Reporting Unit 2 Module 3 Accounting Equations

Unit 2 – Application of Accounting Concepts & Principles

Unit 2 applies accounting concepts and principles into real business transactions.
It will cover deeper discussion on accounting equation, types of major accounts, books
of accounts and double entry system, business transactions and their analysis, posting
to ledger and adjusting entries.

Module 3– Accounting Equations

This module covers topics like the basic accounting equation, the
expanded accounting equation and applications of the accounting equation.

Objectives

At the end of the module, you should be able to:

3. Identify and define accounting elements

4. Apply accounting equation in solving accounting problems

Accounting Elements

4. Assets

Are the economic resources you control that have resulted from past events and can
provide you with economic benefits.

Control
You don’t necessarily need to own the economic recourse for it to be considered
your asset. What is important is that you control the right over the economic benefits
that the resource may produce. “Control” means you have the exclusive right to
enjoy those benefits and the ability to prevent others from enjoying those benefits.

Example 1: Resource owned but not considered an asset

You own a building. However, you do not have the right to use, sell, lease, or
transfer (or other similar rights over) the building – another party does.

Analysis: The building is not your asset because you do not control the right over
the economic benefits from it, even if you are the legal owner.

Example 2: Resource not owned but considered an asset

You acquired a cellphone from telecommunications company on a 2-year installment
plan. The agreement states that if you miss an installment payment, the
telecommunications company can get the cellphone back.

Analysis: Upon taking possession, the cellphone becomes your asset even if you do
not actually own it yet until you have fully paid the installment price. This is because
Acctg. Ed 1 - Financial Accounting & Reporting Unit 2 Module 3 Accounting Equations

you control the right over the economic benefits of the cellphone through exclusive
use.

Past events
The control over an economic resource have resulted from a past event or
transaction. Therefore, resources for which control is yet to be obtained in the future
do not qualify as assets in the present.

For example, you have an intention of purchasing a cellphone next year. Right now,
the cellphone is not yet your asset. The cellphone becomes your asset only after
you have purchased it and have taken possession over it.

Physical possession, however, is not always necessary for control to exist. For
example, the money that you have deposited to a bank remains your asset despite
the transfer of physical possession. This is because you still control the right over
the money by withdrawing it or spending it through electronic means.

Economic benefits
To be an asset, the economic resource must have the potential to provide you with
economic benefits in at least one circumstance. For example, the economic
resource can be:
← Sold, leased, transferred or exchanged for other assets;
← Used singly or in combination with other assets to produce goods or provide
services;
← Used to enhance the value of other assets;
← Used to promote efficiency and cost savings; or
← Used to settle a liability.

3. Liabilities

Are your present obligations that have resulted from past events and can required
you to give up economic resources when settling them.

Obligation
Obligation means a duty or responsibility. An obligation is either:
← Legal obligation – an obligation that results from a contract, legislation, or other
operation of law; or
← Constructive obligation – an obligation that results from your past actions (e.g.,
past practice or published policies) that have created a valid expectation on
others that you will accept and discharge certain responsibilities.

Giving up of economic resources

Settling the obligation necessarily would require you to pay cash, to transfer other
non-cash asses, or to render a service.

Present obligation as a result of past events.

Acctg. Ed 1 - Financial Accounting & Reporting Unit 2 Module 3 Accounting Equations

A present obligation exists as a result of past events if:

4. You have already obtained economic benefits or taken an action; and
5. As a consequence, you are required to transfer an economic resource.

Analysis
You have no present obligation, and hence no liability, because you have not yet
purchased and received the cellphone, and therefore, you are not required to pay
for the purchase price.

You purchased a cellphone on credit. You took possession over the cellphone but
have not yet paid the purchase price.

Analysis
You have present obligation, and hence a liability, because:
5. You have already purchased and received the cellphone; and
6. As a consequence, you are required to pay for the purchase price.

Your obligation is a legal obligation because it arises from a contract (i.e.,

purchase contract)

You earned taxable income during the period but have not yet paid the tax due to
the government.

Analysis
You have present obligation, and hence a liability, because:
6. You earned taxable income; and
7. As a consequence, you are required to pay the corresponding tax due.

Your obligation is a legal obligation because it arises from legislation (i.e., tax law).

Although not stated in the sales contract, you have a publicly-known policy of
providing free repair services for the goods your business sells. You have
consistently honored this implied policy in the past

Analysis
You have present obligation to provide free repair services for the goods you have
already sold because:
3. You have already taken an action by creating valid expectation on your
customers that you will provide free repair services; and
4. As a consequence, you will have to provide those free services.

Your obligation is a constructive obligation.

Acctg. Ed 1 - Financial Accounting & Reporting Unit 2 Module 3 Accounting Equations

4. Equity

Is simply assets minus liabilities. Other terms for equity are “capital”, “net assets,”
and “net worth.”

Illustration 1:
You decided to put up a barbeque stand and have estimated that you will be
needing P2,000 as start-up capital.

You then went to your closet and broke Mr. Piggy Bank, which you have been saving for
quite some time now. Alas! You only have P800. You went to your Mama and asked her
to give you P1,200 but she told you that she has been feeding you for far too long. Oh
man! But don’t give up hope yet, Mr. Bombay is just around the corner.

As of this point, your accounting equation is as follows:

Assets = Liabilities + Equity
800 = 0 + 800

Notes:
• Your total assets are P800 – the amount of economic resources that your control.
• You don’t have any liability yet because you are still negotiating with Mr. Bombay.
• Your equity is also P800 (800 assets – 0 liabilities = 800 equity).

After lengthy negotiation, Mr. Bombay agreed to lend you P1,000.

As of this point, your accounting equation is as follows:

Assets = Liabilities + Equity
2,000 = 1,200 + 800

Notes:
• Your total assets are P2,000 – the amount of economic resources that your
control (P800 from Mr. Piggy plus P1,200 from Mr. Bombay).
• Of your total assets of P2,000:
← P1,200 represents your liability, the amount you are obligated to pay Mr.
Bombay in the future.
← P800 represents your equity (i.e., P2,000 assets – P1,200 liabilities)

Liabilities represent the creditors’ claim, while equity represents the owner’s claim,
against the total assets of the business.

Notice that from Piggy to Bombay, the accounting equation remains balanced. The
equality of the accounting equation must be maintained in all the accounting processes
of recording, classifying and summarizing.

As mentioned earlier, the accounting equation is basically an algebraic equation.

Therefore we can make variations from it. Analyze the variations below:
Acctg. Ed 1 - Financial Accounting & Reporting Unit 2 Module 3 Accounting Equations

Original form of equation:

Assets = Liabilities + Equity
2,000 = 1,200 + 800

Variation #1:
Assets = Liabilities + Equity
2,000 = 1,200 + 800

Variation #2:
Assets = Equity + Liabilities
2,000 = 800 + 1,200

The Expanded Accounting Equation

We can expand the basic accounting equation by including two more elements –
income (or revenue) and expenses. The expanded accounting equation shows all
the financial statement elements. The expanded accounting equation is as follows:

ASSETS = LIABILITIES + CAPITAL(EQUITY) + REVENUE(INCOME) - EXPENSES

Notice that income is added while expenses are deducted in the equation. These are
because income increases equity while expenses decrease equity.

• Income (Revenue)

Is increases in economic benefits during the period in the form of increases in

assets, or decreases in liabilities, that 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.

← If income is greater than expenses, the difference is profit.
← If income is less than expenses, the difference is loss.

We can make another variation to the equation above as follows:

ASSETS = LIABILITIES + EQUITY + PROFIT/-LOSS

Profit increases equity while loss decreases equity

Acctg. Ed 1 - Financial Accounting & Reporting Unit 2 Module 3 Accounting Equations

Illustration 2: (Continuation of “illustration 1”)

During the period, you earned income of P10,000 and incurred expenses of P6,200.

At the end of the period, your total assets increased from P2,000 to P5,000 and your
total liabilities decreased from P1,2000 to P400.

Your expanded accounting equation is as follows:

Assets = Liabilities + Equity + Income - Expenses
5,000 = 400 + 800* + 10,000 - 6,200

*This represent your equity from “Illustration 1” above.

We can also derive the following variation from the equation above:
Assets + Expenses = Liabilities + Equity + Income
5,000 + 6,200 = 400 + 800 + 10,000

Your profit for the period is P3,800 (P10,000 income minus P6,200 expenses). There is
profit because income is greater than expense.

A variation of the expanded accounting equation is shown below:

Assets = Liabilities + Equity + Profit
5,000 = 400 + 800* + 3,800

Income and expenses (or profit or loss) are closed to equity at the end of each
accounting period. Thus, the adjusted ending balance of equity is computed as follows:

Equity, beginning 800

Add: Income 10,000
Less: Expenses (6,200)
Equity, ending 4,600

OR

Equity, beginning 800

Add: Profit 3,800
Equity, ending 4,600

Your basic accounting equation at the end of the accounting period is as follows:
Assets = Liabilities + Equity
5,000 = 400 + 4,600

Notice that regardless of its form or variation, the accounting equation (basic or
expanded) remains balanced.
Acctg. Ed 1 - Financial Accounting & Reporting Unit 2 Module 3 Accounting Equations

Applications of the accounting equation

Case #1: Total assets

If you have total liabilities of P1,200 and equity of P800, how much are your total assets?

Solution:
Assets = Liabilities + Equity
? = 1,200 + 800

Answer: Total assets = (1,200 + 800) = 2,000

Case #2: Total liabilities

If you have total assets of P2,000 and equity of P800, how much are your total liabilities?

Solution:
Assets = Liabilities + Equity
2,000 = ? + 800

Variation #1 if the basic equation:

Liabilities = Assets - Equity
? = 2,000 - 800

Answer: Total liabilities = (2,000 - 800) = 1,200

Case #3: Total Equity

If you have total assets of P2,000 and liabilities of P800, how much are your total equity?

Solution:
Assets = Liabilities + Equity
2,000 = 1,200 + ?

Variation #1 if the basic equation:

Equity = Assets - Equity
? = 2,000 - 800

Answer: Total equity = (2,000 – 1,200) = 800

Case #4.1: Profit or Loss

If you have total income of P5,000 and total expenses of P2,000, how much is your
profit (or loss)?

Solution:
Total income 5,000
Less: Total expenses (2,000)
Profit 3,000
Acctg. Ed 1 - Financial Accounting & Reporting Unit 2 Module 3 Accounting Equations

Case #4.2: Profit or Loss

If you have total income of P6,000 and total expenses of P11,000, how much is your
profit (or loss)?

Solution:
Total income 6,000
Less: Total expenses (11,000)
Profit (5,000)

In accounting, amounts in parentheses are negative amounts.

Case #5: Income (or Revenue)

If you have total expenses of P2,000 and a profit of P3,000, how much is your total
income?

Solution:
Total income ? (squeeze)
Less: Total expenses (2,000)
Profit 3,000 (start)

The unknown (‘?’) is simply “squeezed.” In accounting, to “squeeze” means to come up

with an unknown amount in a given formula by performing basic arithmetic functions like
adding, subtracting, multiplying or dividing. When squeezing “upwards”, the arithmetic
function is simply reversed. Thus, the P2,000 amount which is deducted when solving
downwards is added when “squeezing” upwards.

Answer: Total income = (3,000 +2,000) = 5,000

When “squeezing” upwards, it is always advisable to recheck your answer by squeezing

downwards. This is done as follows:

Rechecking
(start)
Total income 5,000
Less: Total expenses (2,000)
Profit 3,000 (squeeze)

“Squeezing” simplifies the computation process because it eliminates the need to make
variations of a formula. If we did not squeeze the amount above, we would have made
the following variation to the formula:
• Original formula: Income – Expenses = Profit
• Variation: Profit + Expenses = Income
Acctg. Ed 1 - Financial Accounting & Reporting Unit 2 Module 3 Accounting Equations

Case #6: Expenses

If you have total income of P5,000 and a profit of P3,000, how much are your total
expenses for the period?

Solution:
Total income 5,000
Less: Total expenses ? (squeeze)
Profit 3,000

Answer: Total expenses = (5,000 – 3,000) = 2,000

Rechecking
Total income 5,000
Less: Total expenses (2,000)
Profit 3,000

Case #7: Income

You have ending* total assets of P4,800, ending total liabilities of P1,000 and
beginning* equity is P800. If your total expenses for the period amount to P2,000, how
much is your total income?

Solution
Assets = Liabilities + Equity + Income - Expenses
4,800 = 1,000 + 800 + ? - 2,000

Answer: Total income = (4,800 – 1,000 – 800 + 2,000) = 5,000

Rechecking:
Assets = Liabilities + Equity + Income - Expenses
4,800 = 1,000 + 800 + 5,000 - 2,000

Case #8: Expenses for the period

You have ending total assets of P4,800, ending total liabilities of P1,000 and
beginning equity is P800. If your total income for the period amounts to P5,000, how
much are your total expenses?

Solution
Assets = Liabilities + Equity + Income - Expenses
4,800 = 1,000 + 800 + 5,000 - ?

Answer: Total expenses = (4,800 – 1,000 – 800 + 5,000) = 2,000

Acctg. Ed 1 - Financial Accounting & Reporting Unit 2 Module 3 Accounting Equations

Rechecking:
Assets = Liabilities + Equity + Income - Expenses
4,800 = 1,000 + 800 + 5,000 - 2,000

Case #9.1: Ending equity

You have beginning equity is P5,000. If your total income for the period is P8,000,
while your total expenses are P6,000, how much is the ending balance of your equity?

Solution:
Equity, beginning 5,000
Add: Income 8,000
Less: Expenses (6,000)
Equity, ending 7,000

OR

Equity, beginning 5,000

Add/Less: Profit or Loss (8,000 – 2,000) 2,000
Equity, ending 7,000

Case #9.2: Ending equity

Your beginning equity is P12,000. If your total income for the period is P5,000, while
your total expenses are P8,000, how much is the ending balance of your equity?

Solution:
Equity, beginning 12,000
Add: Income 5,000
Less: Expenses (6,000)
Equity, ending 9,000

OR

Equity, beginning 12,000

Add/Less: Profit or Loss (5,000 – 8,000) (3,000)
Equity, ending 9,000

Notice that profit is an addition to equity while loss is a deduction.

Case #10.1: Profit for the period

If your beginning equity is P5,000, while your ending equity is P7,000, how much is your profit or
loss for the period?
Acctg. Ed 1 - Financial Accounting & Reporting Unit 2 Module 3 Accounting Equations

Solution:
Equity, beginning 5,000
Add: Profit(or Less: Loss) ? (squeeze)
Equity, ending 7,000

Profit=(7,000 – 5,000) = 2,000

Rechecking:
Equity, beginning 5,000
Add: Profit(or Less: Loss) 2,000 (squeeze)
Equity, ending 7,000

Case #10.2: Loss for the period

If your beginning equity is P6,000, while your ending equity is 2000, how much is your
profit or loss for the period?

Solution:
Equity, beginning 6,000
Add: Profit(or Less: Loss) ? (squeeze)
Equity, ending 2,000

Loss = (2,000 – 6,000) = (4,000)

Rechecking:
Equity, beginning 6,000
Add: Profit(or Less: Loss) (4,000) (squeeze)
Equity, ending 2,000

Case #11: Ending total assets

You had total assets, liabilities, and equity of P10,000, P7,000 and P3,000 respectively,
at the beginning of the period. During the period, your total liabilities decreased by
P4,000, while your profit was P5,000. How much are your ending total assets?

Assets = Liabilities + Equity

Beg. 10,000 = 7,000 + 3,000
Decrease in liabilities/Profit (4,000) 5,000
End. ? = 3,000 + 8,000

Answer: Ending total assets = (3,000 liabilities, end. + 8,000 equity, end.) = 11,000
Acctg. Ed 1 - Financial Accounting & Reporting Unit 2 Module 3 Accounting Equations

Rechecking: (Ending balances)

Assets = Liabilities + Equity
End. 11,000 = 3,000 + 8,000

Case #12: Ending total assets

You had total assets, liabilities, and equity of P10,000, P7,000 and P3,000 respectively,
at the beginning of the period. During the period, your total liabilities decreased to
P4,000, while your profit was P5,000. How much are your ending total assets?

Assets =
Liabilities + Equity
Beg. irrelevant =
irrelevant + 3,000
Decrease in liabilities/Profit irrelevant 5,000
End. ? = 4,000 + 8,000
*(Irrelevant: These amounts are not needed in computing for the requirement in the
problem.)

*The phrase “decreased to P4,000” means that P4,000 is the ending balance of
liabilities. Notice the difference between the “decreased by” (Case #11) and “decreased
to” (Case #12).

Answer: Ending total assets = (4,000 liabilities, end. + 8,000 equity, end.) = 12,000

Rechecking: (Ending balances)

Assets = Liabilities + Equity
End. 12,000 = 4,000 + 8,000
Acctg. Ed 1 - Financial Accounting & Reporting Unit 2 Module 3 Accounting Equations

SAQ#1

Identify the following:

• ______________________________________ is the basic accounting equation

• __________ are economic resources you control that have resulted from past
events and can provide you with economic benefits.
• ___________ are your present obligations that have resulted from past events
and can require you to give up economic resources when settling them.
• _________ is assets minus liabilities
• _________________________ Under this concept, some costs are initially
recognized as assets and charged as expenses only when the related revenue
is recognized.
• __________________________________________________________ the
expanded accounting equation.
• _______ is increases in assets, or decreases in liabilities resulting to increases
in capital, excluding those relating to investments by the business owner.
• _______________ are decreases in assets, or increase in liabilities, that result
in decreases in capital, excluding those relating to distributions to the business
owner.
• _________________ Revenue less expenses. If Revenue is greater than
expenses, there is ___________. If revenue is less than expense, there is
___________.
• Revenue and profit _____________ Capital while expenses ___________
Capital
Acctg. Ed 1 - Financial Accounting & Reporting Unit 2 Module 3 Accounting Equations

ASAQ # 1

Identify the following:

• _ASSETS = LIABILITIES + CAPITAL__ is the basic accounting equation

• __ASSETS___ are economic resources you control that have resulted from past
events and can provide you with economic benefits.
• _LIABILITIES__ are your present obligations that have resulted from past
events and can require you to give up economic resources when settling them.
• _CAPITAL__ is assets minus liabilities
• ____MATCHING PRINCIPLE___ Under this concept, some costs are initially
recognized as assets and charged as expenses only when the related revenue
is recognized.
• ___ASSETS = LIABILITIES + CAPITAL + REVENUE – EXPENSES__ the
expanded accounting equation.
• _REVENUE_ is increases in assets, or decreases in liabilities resulting to
increases in capital, excluding those relating to investments by the business
owner.
• __EXPENSES___ are decreases in assets, or increase in liabilities, that result in
decreases in capital, excluding those relating to distributions to the business
owner.
• __PROFIT OR LOSS__ Revenue less expenses. If Revenue is greater than
expenses, there is __PROFIT___. If revenue is less than expenses, there is
__LOSS___.
• Revenue and profit ____INCREASE___ Capital while expenses
___DECREASE__ Capital