ACCOUNTING

EQUATION
MS. ESTER JOHANNES
Learning Objective
1. Summarize assets account types and characteristics
2. Summarize liability account types and characteristics
3. Relate equity accounts to revenue and expenses
4. Summarize the relationship between assets, liabilities, and
owner’s equity in the accounting equation
 KEY TERMS
Accounting Equation Fixed assets Owner’s equity

Accounts Intangible assets Prepaid insurance

Accounts Payable Land & Building Prepaid rent

Accounts receivable Inventory Revenue

Asset Investment Salaries and wages payable

Cash accounts Liability supplies

Current liabilities Liquidity

Equity Long-term assets

Expenses Long-term liabilities

Asset account types and characteristics
• The accounting equation is Assets = Liabilities + Owner’s Equity.
• This equation is the foundation of double-entry accounting.
• The equation indicates that a company can pay for a purchase
with assets (e.g., purchase a $400 phone with $400 in cash) or
the company can pay for the purchase by borrowing.
• Liabilities can also be paid with assets (cash) or by taking on
more liability (debt).
Asset account types and characteristics
• Accounts are records or statements that organize and
summarize transactions in the form of credits, debits, accruals,
and adjustments that have occurred and that have an effect on
assets, equity, liabilities, or revenue.
• Typically, an account is financial assets held by an organization
(bank, credit union, accounting service, financial advisory firm)
for a customer.
• In accounting, similar items or transactions are recorded in
accounts.
• Different account types help organize transactions.
Asset account types and characteristics
• An asset is a company-owned resource that has future
economic value that can be measured and expressed in dollars.
• Asset account categories include current assets and long-term
assets.
Asset account types and characteristics
• 1. Current assets are cash and other resources expected to be
converted into cash or be used up within one year.
• Current asset accounts are listed on the balance sheet in order of
liquidity.
• Liquidity is the degree to which an asset or security can be
quickly bought or sold (converted into cash).
• Following are some current accounts and related terms.
Asset account types and characteristics
a. A cash account is an account used to record the amount of money held in
bank accounts.
b. Accounts receivable are the amounts due as the result of selling goods or
services on credit (also called on account).
c. Inventory is items produced or purchased for resale.
d. Prepaid rent and prepaid insurance are the amount of future rent expense
and the amount of future insurance expense, respectively, paid in advance of
the rental or insurance period. The amount reported on the balance sheet is
the amount that has not yet been used or has not expired.
e. Supplies are consumable items that commonly have shorter life spans
than equipment and machines. Supplies are restocked for use as needed.
Examples of supplies are pens, copy paper, paper clips, staplers, and sticky
notes.
Asset account types and characteristics
2. Long-term assets are resources not intended to be turned into cash or to be consumed
within one year of the balance sheet date. Investments are part of a company’s assets (such
as stock in another company) purchased in hopes of generating future income. Investments
are not consumed today but used in the future to create wealth. Funds held for construction
are an example. Long term asset categories include fixed assets and intangible assets.
a. Fixed assets are tangible, long-term assets used in business operations: property, plant,
and equipment (PPE). Except for land, fixed assets are epreciated (devalued) over their
useful life. Among fixed assets are:
(1) Land
(2) Buildings
(3) Machinery
(4) Office equipment / computer equipment / furniture
Asset account types and characteristics
b. Intangible assets are intellectual property and typically not physical (tactile) in
nature. Intellectual property is a set of intangibles owned and legally protected by a
company from outside use or implementation without consent. Included are:
• (1) Copyrights
• (2) Patents
• (3) Goodwill
• (4) Trade names and trademarks
• (5) Trade secrets (e.g., the Coca-Cola formula)
• (6) Ideas
Liability account types and characteristics
A. A liability is an obligation or amount owed, usually to a lender or supplier. A liability often has
the word “payable” in the account title, signifying the amount is payable to another party.
1. Current liabilities are obligations coming due within one year. The amounts will be paid with
current assets (cash or accounts receivable that have been paid and thus converted to cash). Accounts
payable and salaries and wages payable are among current liabilities.
• a. Accounts payable are amounts owed to suppliers.
• b. Salaries and wages payable are amounts owed to employees for time worked.
• 2. Long-term liabilities are obligations coming due after one year. Examples of long-term liabilities
are:
• a. A five-year loan on a vehicle
• b. A 20-year mortgage on a building
• c. Pension obligations
Equity accounts
A. Equity is the value of an asset less the value of all liabilities on that asset. The
formula to calculate equity is Equity = Asset Value – Liabilities.
B. Owner’s equity is the proprietor’s investment in the business, item, or project. It
is the difference between assets and liabilities. Owner’s equity accounts include:
1. Capital account (tracks additions)
2. Drawing account (tracks withdrawals)
C. Revenue is the income generated from the sale of goods or services associated
with the main operations of an organization.
1. Revenue is essentially sales less any returns or sales discounts.
Equity accounts
2. Revenue increases owner’s equity.
D. Expenses are monies spent or costs incurred in an organization’s efforts to
generate revenue; they represent the cost of doing business.
1. Any item that represents the cost of doing business can have an expense account
associated with it. The business manager decides the level of detail necessary for
the organization. Examples are:
a. Advertising expense
b. Communication expense
c. Supplies expense
2. Expenses decrease owner’s equity.
The relationship between assets, liabilities, and owner’s
equity in the accounting
equation
A. The accounting equation’s relationship between assets, liabilities, and owner’s
equity must always remain in balance. The prior objectives in this lesson further
explain details of the accounting equation concept.
• B. The basic equation, as cited earlier, is Assets = Liabilities + Owner’s Equity.
• 1. Recall that revenue increases owner’s equity.
• 2. Recall that expenses decrease owner’s equity.
• 3. Like any equation, the accounting equation can be manipulated as long as it
stays in balance. For example, the following equation is also valid because it is in
balance: Assets – Liabilities = Owner’s Equity.
Practical Revision
1. Match the term with the correct definition
a. accounts receivable e. expenses
b. asset f. intangible assets
c. current assets g. inventory
d. current liabilities h. revenue
_____1. Monies spent or costs incurred in an organization’s efforts to generate
revenue; represent the cost of doing business
_____2. Obligations coming due within one year
_____3. Intellectual property and typically not physical (tactile) in nature
Practical Revision cont…
_____4. The amounts due as the result of selling goods or services on credit (also
called on account)
_____5. Cash and other resources expected to be converted into cash or be used up
within one year
_____6. A company-owned resource that has future economic value that can be
measured and expressed in dollars
_____7. Items produced or purchased for resale
_____8. The income generated from the sale of goods or services associated with
the main operations of an organization
Practical Revision
2. Write T for true or F for false.
1. The accounting equation is Assets = Liabilities + Owner’s Equity.
2. An example of an intangible asset is a patent.
3. A building is a current asset.
4. A cash account represents the amount of money a business has in the bank.
5. Revenue decreases owner’s equity.
6. It is expected that supplies will be used up within one year.
Practical Revision
3. Provide the word or words to complete the following
statements.
• 1. The degree to which an asset or security can be quickly bought or sold
(converted into cash) is called _________________________.
2. A set of intangibles owned and legally protected by a company from outside use
or implementation without consent is called _________________________.
3. The relationship between assets, liabilities, and owner’s equity must always
remain in _________________________.
4. Expenses cause an owner’s equity account to _________________________.
5. The amounts owed to employees for time worked are
_________________________.
6. Supplies are considered a/an _________________________ asset.
Label each asset account as a current
asset (CA) or a long-term asset (LT)
Accounts receivable_________ Investments________

Buildings________ Land________

Cash________ Machinery________

Copyrights________ Office equipment________

Furniture________ Patents________

Goodwill________ Supplies________

Inventory________ Trademarks________
 LIABILITIES
• A liability is an obligation or amount owed, usually to a lender or supplier.
• A liability often has the word “payable” in the account title, signifying the amount
is payable to another party.
• A current liability is an obligation coming due within one year.
• A long term liability is an obligation coming due after one year.
• What obligations, or payables, might a business have?
EQUITY: BUYING A NEW CAR
You buy a car—an asset—for $20,000.
You pay $15,000 in cash and take out a loan a
liability for $5,000.
What is your owner’s equity in the vehicle?
EQUITY: BUYING A NEW CAR—
SOLUTION
• Since you do not “fully” own the car, your ownership, or equity, in the car is not a
full $20,000.
• The ownership equity is the value of the car (an asset), $20,000, less the amount of
the loan (a liability), $5,000.
• So, your owner’s equity is $15,000.
SAMPLE TRANSACTIONS
INVOLVING THE ACCOUNTING
EQUATION
• Transaction 1. Your business purchases a car for $20,000. The business pays
$15,000 cash and takes out a loan for $5,000.
• How does this transaction affect the accounting equation?
Assets = Liabilities + Owner’s Equity
Assets Liabilities Owner’s Equity
The car increases The loan increases
assets by $20,000. liabilities by $5,000.
The cash payment
decreases assets by
$15,000.

• The equation is in balance: Balance of assets = $5,000;

• balance of liabilities and owner’s equity = $5,000.
• Transaction 2. The business makes a sale of $2,000. The business is paid in cash.
• How does this action affect the accounting equation?
Assets = Liabilities + Owner’s Equity
Assets Liabilities Owner’s Equity
Receiving cash A sale is considered
increases assets by revenue, so revenue
$2,000. increases owner’s
equity by $2,000.

• The equation is in balance: Balance of assets = $2,000;

• balance of liabilities and owner’s equity = $2,000.
 1. Match each account listed below to one
of the following types.
A = Asset L = Liability OE = Owner’s equity R = Revenue E = Expense
2. From the accounts you selected as assets and as liabilities, further classify each as
a current asset or a current liability.
_______ Accounts payable _______ Interest payable
_______ Accounts receivable _______ Investments
_______ Advertising expense _______ Land
_______ Capital _______ Patents
_______ Cash _______ Salaries and wages payable
_______ Communication expense _______ Sales
_______ Drawing _______ Sales discounts
_______ Furniture _______ Supplies
2. Read the list of asset-related terms
below.
• Accounts receivable • Buildings • Cash
• Copyrights • Current assets • Fixed assets
• Furniture • Goodwill • Intangible assets
• Inventory • Investments • Land
• Long-term assets • Machinery • Office equipment
• Patents • Property, plant, and equipment
• Supplies •Trademarks
SOLUTIONS
 Part One: Matching
1. e
2. d
3. f
4. a
5. c
6. b
7. g
8. h
 Part Two: True/False
1. T
2. T
3. F
4. T
5. F
6. T
 Part Three: Completion
1. liquidity
2. intellectual property
3. balance
4. decrease
5. salaries and wages payable
6. current
Label each asset account as a current
asset (C) or along-term asset (LT)
Accounts receivable: C Buildings: LT
Cash: C Copyrights: LT
Furniture: LT Goodwill: LT
Inventory: C Investments: LT
Land: LT Machinery: LT
Office equipment: LT Patents: LT
Supplies: C Trademarks: LT