1 Financial Accounting I: The Accounting Equation

Desired Learning Outcomes

 Understand the basic and expanded accounting equation.

 Analyze the different business transactions.
 Identify the effects of different transactions on the elements of financial
statements.
 Provide examples of common account titles used in the financial statements.
 Utilize a T-account in analyzing the movements of a specific account.
 Explain the double entry bookkeeping system.

The Basic Accounting Equation

The basic tool of accounting is the accounting equation. The left side
of the equation shows how much the business owns, and the right side of the
equation shows how much resources do the outside creditor and owner supplied
to the business.

The logic of debiting and crediting is related to the accounting equation.

Transactions may require addition to both sides (left or sides), subtractions
from both sides (left and right sides), or an addition and subtraction on the
same side (left or right sides). But in all cases the equality must be
maintained as shown above.

Accounting is based on a double-entry system which means that the dual

effects of business are recorded. A debit side entry must have a corresponding
credit side entry. For every transaction, there must be one or more accounts
debited and one or more accounts credited and must be equal both sides. Each
transaction affects at least two accounts.
2 Financial Accounting I: The Accounting Equation

The rules of debit and credit in accounts.

ACCOUNTING EVENTS AND TRANSACTIONS

An accounting event is an economic occurrence that causes changes in an

enterprise’s assets, liabilities, and/or equity. A transaction is a particular
kind of event that involves the transfer of something of value between two
entities.

Accountants observe many events that they identify and measure in

financial terms. A business transaction is the occurrence of an event or a
condition that affects financial position and can be reliably recorded

Financial Transaction Worksheet

Every financial transaction can be analyzed or expressed in terms of its

effects on the accounting equation. The financial transactions will be
analyzed by means of a financial transaction worksheet which is a form used
to analyze increases and decreases in the assets, liabilities or owner’s
equity of a business entity.

When a specific asset, liability or owner’s equity item is created by a

financial transaction, it is listed in the financial transaction worksheet
using the appropriate accounts.
3 Financial Accounting I: The Accounting Equation

To illustrate:

Mr. Wagmalito Kayayan wants to open an accounting firm this year. The following
transactions are made during the month.

May 1. Mr. W. Kayayan invested P100, 000 to start an accounting office.

W. Kayayan Accounting Firm

Financial Transaction Worksheet
Month of May 2021

ASSETS = LIABILITIES + OWNER’S EQUITY

May
Accounts Office Office Accounts Notes W. Kayayan
2021 Cash = +
Receivable Supplies Equipment Payable Payable Capital
1 100,000 100,000

The financial transaction is analyzed as follows:

 An entity separate and distinct from Kayayan’s personal financial

affairs is created.

 An economic resource – cash of P 100,000 is invested in the business

entity. The source of this asset is the contribution made by the owner,
which represents owner’s equity. The owner’s equity account is W.
Kayayan, Capital.

 The dual nature of the transaction is that cash is invested and owner’s
equity created. The effects of this transaction on the accounting
equation are as follows: increase in asset – cash from zero to P100, 000
and increase in owner’s equity from zero to P100, 000.
4 Financial Accounting I: The Accounting Equation

May 3. Purchased office supplies worth P20, 000 on account.

ASSETS = LIABILITIES + OWNER’S EQUITY

May
Accounts Office Office Accounts Notes W. Kayayan
2021 Cash = +
Receivable Supplies Equipment Payable Payable Capital
1 100,000 100,000
3 20,000 20,000
100,000 0.00 20,000 0.00 = 20,000 0.00 + 100,000
120,000 = 120,000

 The effect of transaction is increase in asset and increase in

liabilities. Take note that the equality of the two sides of the equation
is maintained.

May 5. Purchased additional office supplies for cash, P10, 000.

ASSETS = LIABILITIES + OWNER’S EQUITY
May
Accounts Office Office Accounts Notes W. Kayayan
2021 Cash = +
Receivable Supplies Equipment Payable Payable Capital
1 100,000 100,000
3 20,000 20,000
5 (10,000) 10,000
90,000 0.00 30,000 0.00 = 20,000 0.00 + 100,000
120,000 = 120,000

 The effect of transaction is increase in asset and decrease in another

asset form of asset. After posting the transaction, total asset amounts
to P120, 000 and total liabilities and capital amount to P120, 000.
5 Financial Accounting I: The Accounting Equation

May 6. Paid the accounts payable in full.

ASSETS = LIABILITIES + OWNER’S EQUITY
May
Accounts Office Office Accounts Notes W. Kayayan
2021 Cash = +
Receivable Supplies Equipment Payable Payable Capital
1 100,000 100,000
3 20,000 20,000
5 (10,000) 10,000
6 (20,000) (20,000)
70,000 0.00 30,000 0.00 = 0.00 0.00 + 100,000
100,000 = 100,000

 Transaction reduces both sides of the equation by P20, 000 resulting to

the equality of the equation after posting.

May 8. Purchased 2 units of computer with printer for P50, 000, 30 days.

ASSETS = LIABILITIES + OWNER’S EQUITY

May
Accounts Office Office Accounts Notes W. Kayayan
2021 Cash = +
Receivable Supplies Equipment Payable Payable Capital
1 100,000 100,000
3 20,000 20,000
5 (10,000) 10,000
6 (20,000) (20,000)
8 50,000 50,000
70,000 0.00 30,000 50,000 = 50,000 0.00 + 100,000
150,000 = 150,000

 The effect of transaction is increase in asset and increase in

liabilities. Take note that the equality of the two sides of the equation
is maintained.
 6 Financial Accounting I: The Accounting Equation

The Expanded Accounting Equation

ASSETS = LIABILITIES + EQUITY + INCOME - EXPENSES

Whenever a company sells its goods to customers or renders services to its

clients, it shall recognize earned income. Consequently, when the company
avails the services of another company, or incurs other costs in order to do
business, it shall recognize expenses.

May 10. Rendered accounting services for cash, P25, 000.

ASSETS = LIABILITIES + OWNER’S EQUITY + INCOME

May
Accounts Office Office Accounts Notes W. Kayayan
2021 Cash = + + Revenue
Receivable Supplies Equipment Payable Payable Capital

1 100,000 100,000
3 20,000 20,000
5 (10,000) 10,000
Professional Fee
6 (20,000) (20,000)
8 50,000 50,000
10 25,000 25,000

95,000 0.00 30,000 50,000 = 50,000 0.00 + 100,000 + 25,000

175,000 = 175,000

 The effect of transaction is increase in asset and increase in income.

Take note that the equality of the two sides of the equation is
maintained.
 7 Financial Accounting I: The Accounting Equation

May 15. Rendered accounting services on account, P 30,000.

ASSETS = LIABILITIES + OWNER’S EQUITY + INCOME

May
Accounts Office Office Accounts Notes W. Kayayan
2021 Cash = + + Revenue
Receivable Supplies Equipment Payable Payable Capital

1 100,000 100,000
3 20,000 20,000
5 (10,000) 10,000
6 (20,000) (20,000)
8 50,000 50,000
10 25,000 25,000
15 30,000 Professional Fee 30,000

95,000 30,000 30,000 50,000 = 50,000 0.00 + 100,000 + 55,000

205,000 = 205,000

 The effect of transaction is increase in asset (Accounts Receivable) and

increase in income. Take note that the equality of the two sides of the
equation is maintained.

May 15. Paid Meralco bills, P 3,500.

ASSETS = LIABILITIES + OWNER’S EQUITY + INCOME - EXPENSES

May
Accounts Office Office Accounts Notes W. Kayayan
2021 Cash = + + Revenue - Expenses
Receivable Supplies Equipment Payable Payable Capital

1 100,000 100,000
3 20,000 20,000
5 (10,000) 10,000
6 (20,000) (20,000)
8 50,000 50,000
10 25,000 25,000 Utility Expense

15 30,000 30,000
15 (3,500) 3,500

91,500 30,000 30,000 50,000 = 50,000 0.00 + 100,000 + 55,000 - 3,500

201,500 = 201,500
 8 Financial Accounting I: The Accounting Equation

 The effect of transaction is decrease in asset (Cash) and increase in

expense. Take note that the equality of the two sides of the equation is
maintained.

May 15. Paid salaries for the period, P15, 000.

ASSETS = LIABILITIES + OWNER’S EQUITY + INCOME - EXPENSES

May
Accounts Office Office Accounts Notes W. Kayayan
2021 Cash = + + Revenue - Expenses
Receivable Supplies Equipment Payable Payable Capital

1 100,000 100,000
3 20,000 20,000
5 (10,000) 10,000
6 (20,000) (20,000)
8 50,000 50,000
10 25,000 25,000
15 30,000 30,000
15 (3,500) 3,500
15 (15,000) Salaries Expense 15,000

76,500 30,000 30,000 50,000 = 50,000 0.00 + 100,000 + 55,000 - 18,500

186,500 = 186,500

 The effect of transaction is decrease in asset (Cash) and increase in

expense. Take note that the equality of the two sides of the equation is
maintained.
 9 Financial Accounting I: The Accounting Equation

May 20. Collected P10, 000 from customer.

ASSETS = LIABILITIES + OWNER’S EQUITY + INCOME - EXPENSES

May
Accounts Office Office Accounts Notes W. Kayayan
2021 Cash = + + Revenue - Expenses
Receivable Supplies Equipment Payable Payable Capital

1 100,000 100,000
3 20,000 20,000
5 (10,000) 10,000
6 (20,000) (20,000)
8 50,000 50,000
10 25,000 25,000
15 30,000 30,000
15 (3,500) 3,500
15 (15,000) 15,000
20 10,000 (10,000)

86,500 20,000 30,000 50,000 = 50,000 0.00 + 100,000 + 55,000 - 18,500

186,500 = 186,500

May 22. A Short term loan from a local bank was granted in the amount of
P50, 000, less P5, 000 financing charges. Mr. W. Kayayan issued 1 year
promissory note.
ASSETS = LIABILITIES + OWNER’S EQUITY + INCOME - EXPENSES
May
Accounts Office Office Accounts Notes W. Kayayan
2021 Cash = + + Revenue - Expenses
Receivable Supplies Equipment Payable Payable Capital

1 100,000 100,000
3 20,000 20,000
5 (10,000) 10,000
6 (20,000) (20,000)
8 50,000 50,000
10 25,000 25,000
15 30,000 30,000
15 (3,500) 3,500
15 (15,000) 15,000
20 10,000 (10,000)
22 45,000 50,000 Interest Expense
5,000

131,500 20,000 30,000 50,000 = 50,000 50,000 + 100,000 + 55,000 - 23,500

231,500 = 231,500
 10 Financial Accounting I: The Accounting Equation

May 25. Paid telephone bill amounting to P 6,000.

ASSETS = LIABILITIES + OWNER’S EQUITY + INCOME - EXPENSES

May
Accounts Office Office Accounts Notes W. Kayayan
2021 Cash = + + Revenue - Expenses
Receivable Supplies Equipment Payable Payable Capital

1 100,000 100,000
3 20,000 20,000
5 (10,000) 10,000
6 (20,000) (20,000)
8 50,000 50,000
10 25,000 25,000
15 30,000 30,000
15 (3,500) 3,500
15 (15,000) 15,000
20 10,000 (10,000)
22 45,000 50,000 5,000
25 (6,000) Telephone Expense 6,000
125,500 20,000 30,000 50,000 = 50,000 50,000 + 100,000 + 55,000 - 29,500
225,500 = 225,500

May 27. Mr. Kayayan withdrew P20, 000 for personal use.

ASSETS = LIABILITIES + OWNER’S EQUITY + INCOME - EXPENSES

May
Accounts Office Office Accounts Notes W. Kayayan
2021 Cash = + + Revenue - Expenses
Receivable Supplies Equipment Payable Payable Capital

1 100,000 100,000
3 20,000 20,000
5 (10,000) 10,000
6 (20,000) (20,000)
8 50,000 50,000
10 25,000 25,000
15 30,000 30,000
15 (3,500) 3,500
15 (15,000) 15,000
20 10,000 (10,000)
22 45,000 50,000 5,000
25 (6,000) 6,000
27 (20,000) (20,000)

105,500 20,000 30,000 50,000 = 50,000 50,000 + 80,000 + 55,000 - 29,500

205,500 = 205,500
 11 Financial Accounting I: The Accounting Equation

May 30. At the end of the month, physical count of the office supplies
revealed that P 5,000 had been consumed.

ASSETS = LIABILITIES + OWNER’S EQUITY + INCOME - EXPENSES

May
Accounts Office Office Accounts Notes W. Kayayan
2021 Cash = + + Revenue - Expenses
Receivable Supplies Equipment Payable Payable Capital

1 100,000 100,000
3 20,000 20,000
5 (10,000) 10,000
6 (20,000) (20,000)
8 50,000 50,000
10 25,000 25,000
15 30,000 30,000
15 (3,500) 3,500
15 (15,000) 15,000
20 10,000 (10,000)
22 45,000 50,000 5,000
25 (6,000) 6,000
27 (20,000) (20,000)
30 (5,000) 5,000

105,500 20,000 25,000 50,000 = 50,000 50,000 + 80,000 + 55,000 - 34,500

200,500 = 200,500

USE OF T-ACCOUNTS

Analyzing and recording transactions using the accounting equation is

useful in conveying a basic understanding of how transactions affect the
business. However, it is not an efficient approach once the number of
accounts involved increases. Double-entry system provides a formal system of
classification and recording business transactions.
12 Financial Accounting I: The Accounting Equation
13 Financial Accounting I: The Accounting Equation

May 22. A short term loan from a local bank was granted in the amount of
P50, 000, less P5, 000 finance charges. W. Kayayan issued 1 year promissory
note.