ACCOUNTING EQUATION

BOOKKEEPING AND THE ACCOUNTING EQUATION

Practically all modern accounting systems make use of the “double-entry bookkeeping” method. The double-entry bookkeeping method is based on
the nature of a transaction. As there are two values involved in a transaction, i.e., value received and value parted with, there should also be two
parts for the recording of a transaction – a left side and a right-side. The accounting equation is fitted into this method of bookkeeping. It also has a
left-side and a right-side. The left-side is used to represent items recorded on the left side by the double-entry bookkeeping method and the right-
side is for the items normally recorded on the right side by the bookkeeping process.

IMPORTANCE OF ACCOUNTING EQUATION

Business transactions affect the assets, liabilities, and proprietorship of business. These effects can be expressed in the accounting equation.
ASSETS = EQUITIES
“Equities” include all the vested rights of persons in the assets of the business. Stated differently, equities include all the amounts owed by the
business to all persons which may be classified into the following:
1. Equities of outsiders or amounts owing to persons other than the owners of the business, technically known as “liabilities”
2. Equities of owners, known in the accountant’s language as “capital,” “proprietorship,” or “owners’ equity
LIABILITIES
EQUITIES
PROPRIETORSHIP

And since there are two sources of equities, one from the creditors (liabilities) and the other from the owner (proprietorship), then we can express
the accounting equation as:
ASSETS = LIABILITIES + PROPRIETORSHIP
The accounting equation may also be expresses as:
ASSETS – LIABILITIES = PROPRIETORSHIP
ACCOUNTING EQUATION ILLUSTRATED

Transaction 1
Oct 1 – Mr. Gil opened a motor repair shop and invested P100,000 cash.

Effects
The asset account (cash), is increased by Php100,000.
The proprietorship account (Mr. Gil, Capital) is also increased by Php100,000.

Accounting Equation Stage 1

ASSETS = LIABILITIES + PROPRIETORSHIP
Cash P100,000 = 0 + Mr. Gil, Capital P100,000

Analysis
Increase in Assets =Increase in Proprietorship

Note: This equation does not change until another transaction occurs. During the accounting period, regardless of the number of the
transaction, the two sides of the accounting equation will always be maintained equal.

Transaction 2
Oct 2 – He purchased repair supplies worth P25,000 on credit from De Mesa Trading.

Effects
The asset account (repair supplies), is increased by P25,000.
The liabilities account (due to De Mesa Trading) is also increased by P25,000.

Accounting Equation Stage 2

ASSETS = LIABILITIES + PROPRIETORSHIP
Cash P100,000 = Accnt Payable De Mesa Trading P25,000 + Mr. Gil, Capital P100,000
Repair supplies P25,000

Analysis
Increase in Assets = Increase in Liabilities
Transaction 3
Oct 5 – Billed M Manzano for repair work done on his automobile, P12,000.

Effects
The asset account (due from M Manzano), is increased by P12,000.
The proprietorship account (Mr. Gil, Capital) is also increased by P12,000.

Accounting Equation Stage 3

ASSETS = LIABILITIES + PROPRIETORSHIP
Cash P100,000 = Acct Payable De Mesa Trading P25,000 + Mr. Gil, Capital P112,000
Repair supplies P25,000
Accnt Receivable M Manzano P12,000

Analysis
Increase in asset = Increase in proprietorship

Transaction 4
Oct 7 – He bought a table and chairs for the business, P6,000.

Effects
The asset account (furniture), is increased by P6,000.
The asset account (cash) is decreased by P6,000.

Accounting Equation Stage 4

ASSETS = LIABILITIES + PROPRIETORSHIP
Cash P94,000 = Accnt Payable De Mesa Trading P25,000 + Mr. Gil, Capital P112,000
Repair supplies P25,000
Accnt Receivable M Manzano P12,000
Furniture P6,000

Analysis
Increase in one form of asset = Decrease in another form of asset
Transaction 5
Oct 12 – Issued a promissory note to De Mesa Trading to apply on his account (Transaction 2).

Effects:
The liability account (due from De Mesa), is decreased by P25,000.
The liability account (Notes payable) is increased by P25,000.

Accounting Equation Stage 5

ASSETS = LIABILITIES + PROPRIETORSHIP
Cash P94,000 = Accnt Payable De Mesa Trading 0 + Mr. Gil, Capital P112,000
Repair supplies P25,000 Note Payable De Mesa Trading P25,000
Accnt Receivable M Manzano P12,000
Furniture P6,000

Analysis
Increase in one form of liability = decrease in another form of liability

Transaction 6
Oct 15 – Paid the salary of the assistant, P1,900.

Effects
The asset account (cash), is decreased by P1,900.
The proprietorship account (Mr. Gil, Capital) is decreased by P1,900.

Accounting Equation Stage 6

ASSETS = LIABILITIES + PROPRIETORSHIP
Cash P92,100 = Accnt Payable De Mesa Trading 0 + Mr. Gil, Capital P110,100
Repair supplies P25,000 Note Payable De Mesa Trading P25,000
Accnt Receivable M Manzano P12,000
Furniture P6,000

Analysis
Decrease in asset = Decrease in proprietorship
Transaction 7
Oct 20 – Paid the note issued to De Mesa Trading (Transaction 5).

Effects
The asset account (cash), is decreased by P25,000.
The liability account (Note Payable De Mesa Trading) is decreased by P25,000.

Accounting Equation Stage 7

ASSETS = LIABILITIES + PROPRIETORSHIP
Cash P67,100 = Accnt Payable De Mesa Trading 0 + Mr. Gil, Capital P110,100
Repair supplies P25,000 Note Payable De Mesa Trading 0
Accnt Receivable M Manzano P12,000
Furniture P6,000

Analysis
Decrease in asset = Decrease in liabilities

Transaction 8
Oct 29 – Mr. Gil withdrew P15,000 from his business for his personal use.

Effects
The asset account (cash), is decreased by P15,000.
The proprietorship account (Mr. Gil, Capital) is decreased by P15,000.

Accounting Equation Stage 7

ASSETS = LIABILITIES + PROPRIETORSHIP
Cash P52,100 = Accnt Payable De Mesa Trading 0 + Mr. Gil, Capital P95,100
Repair supplies P25,000 Note Payable De Mesa Trading 0
Accnt Receivable M Manzano P12,000
Furniture P6,000

Analysis
Decrease in asset = Decrease in capital
SUMMARY
The foregoing illustrations show the most common effects of transactions in the accounting equation. They emphasize the fact that transactions do
not affect the equality of the sides of the equation.
In as much as there are only three major items (assets, liabilities, and proprietorship) in the accounting equation, and knowing that all transactions
may affect or involve only these values, then, it may be concluded that all transactions can be grouped into nine (9) types of effects as follows:
a. Increase in Assets = Increase in Proprietorship
b. Increase in Assets = Increase in Liabilities
c. Increase in some form of Assets = Decrease in other forms of Assets
d. Decrease in Assets = Decrease in Proprietorship
e. Decrease in Assets = Decrease in Liabilities
f. Increase in Liabilities = Decrease in Proprietorship
g. Increase in some form of Liabilities = Decrease in other forms of Liabilities
h. Increase in Proprietorship = Decrease in Liabilities
i. Increase in some forms of Proprietorship = Decrease in other forms of Proprietorship