Chapter 4

Equation Expanded to Show Operating Activities

 Accounting Equation Expanded

 The account is the basic summary device of accounting. A separate account is

maintained for each type of major accounts: Assets, Liabilities and Owner’s Equity
(accounts that appear in the statement of financial position), Capital and Drawing
(accounts that appear in the Statement of Owner’s Equity) and Revenues and
Expenses (accounts that appear in the income statement).

 Classes of Accounts
o Real Accounts also known as permanent accounts are accounts that
comprise the elements of the balance sheet - the assets, liabilities and
owner’s equity. These accounts are not closed or not put to zero balance
at the end of the accounting period.
o Nominal Accounts also known as temporary accounts are the accounts
that comprise the element of the income statement – revenues and
expenses. These accounts are closed or put to zero balance at the end of
the accounting period.

 The chart of accounts is a listing of all accounts used in the general ledger of an
organization.It is usually arranged in the financial statement order. That is - asset
accounts first, followed by liability accounts then equity accounts, revenues and
expense accounts. Below is an example of chart of accounts:

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Equation Expanded to Show Operating Activities

 Asset Accounts. Assets are the resources owned by a businessthat will provide
a futureeconomic benefit.The two main types of assets are current assets and non-
current assets.
o Cash – Money and any medium of exchange that a bank accepts at face
value. It includes coins, currency, checks, money orders and bank drafts.
o Cash Equivalents – Short-term, highly liquid investments that are readily
convertible to cash. Examples are three-month maturing treasury bills,
money market funds and commercial papers.
o Temporary Investments – Short-term investments with a term of more
than three months but within one year. Examples are current trading
securities and current available securities for sale.
o Accounts Receivable – Amounts collectible to the customers arising from
sale of goods or services on credit.
o Notes Receivable – Promissory note received from a customer to pay the
business fixed amount of money on a specified date.
o Interest Receivable – Interest earned on note receivable but not yet
received in cash.
o Inventories – Assets held for sale in the ordinary course of business, in the
form of materials or supplies to be consumed in the process of production
for sale or in rendering services.
o Prepaid Expenses – Expenses paid by the business in advance but not
consumed yet or used. It includes prepaid rent, prepaid insurance and
prepaid supplies.
o Long-Term Investments – Investments intended to be held for more than
one year. Some examples are investments in stocks and investments in
bonds.

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Equation Expanded to Show Operating Activities

o Land – Site owned by the business on which the building is constructed.

o Building – Structure owned by the business that is used in its operation.
o Furniture and Fixtures - Long-lived items used by the business like
counters, scales, containers, display racks, cabinets, desks and chairs.
o Equipment –Consists of what generally might be called the machinery used
in the business like computers.
o Intangible Asset - Non-physical asset that has a useful life of greater than
one year. Examples are goodwill, trademark, copyright, computer software,
motion pictures, franchise agreements and patent.

 Liability Accounts. Liabilities are the rights of creditors that represent debts of the
business.The two main types of liabilities are current liabilities and non-
current liabilities.
o Accounts Payable – Amounts that are due to vendors who have supplied
goods or services.
o Bank Overdrafts – Short-term advances made by the bank to offset any
account overdrafts caused by issuing checks in excess of available funding.
o Notes Payable – Promissory note issued by the business to its creditors
for money borrowed or merchandise bought on credit.
o Accrued Expenses – Amounts owed to others for unpaid expenses such
as wages payable.
o Interest Payable - Interest owned to lenders but not yet paid.
o SSS Premium Payable – represents the amount of employee and
employer contribution to SSS which are not yet remitted to SSS.
o Withholding Taxes Payable – amount of income tax withheld from salary
of employee that the employer has to remit to BIR on a specified due date.
o Income taxes payable – Income taxes owed to the government but not yet
paid.
o Dividends Payable– Dividends declared by the board of directors, but not
yet paid to shareholders.
o Customer Deposits – Also known as unearned revenue, these are
payments given by customers as an advance for future work that is
expected to be completed by the end of the next 12 months.
o Mortgage Payable – This account record records long-term debt of the
business entity for which it has pledged certain assets as security to the
creditor.
o Bonds Payable – Long-term debt, requiring interest and principal
payments according to contractual terms. This is used when a corporation
wants to raise additional funds by issuing bonds.

 Equity Accounts track owners’ contributions to the business as well as their share
of ownership. For proprietorship and partnership, equity is tracked using Capital
and Drawing Accounts.For corporation, ownership is tracked by the sale of
individual shares of stock because each stockholder owns a portion of the
business.

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Equation Expanded to Show Operating Activities

o Capital – The Capital account reflects the amount of initial money the
business owner contributed to the company as well as owner contributions
made after initial start-up. If a company has several different partners, then
each partner gets his or her own Capital account to track his or her
contributions.
o Drawing – The Drawing account tracks any money that a business owner
takes out of the business. If the business has several partners, each partner
gets his or her own Drawing account.

 Revenue Accounts. Revenue is the total amount received by abusiness or

recognized as earned when thebusiness sells something, usually services
andgoods. Revenues are typically separated into two different categories:
operating revenues and non-operating revenues or other income.Operating
revenuesare those that originate from main business operations.Non-operating
revenues or other Incomeare revenuesgenerated by a company outside of its main
operations.
o Service Revenue – Revenue earned from performing services to the
customers. Other account titles may be used depending on the industry of
the business, such as Professional Fees for professional practice
and Tuition Fees for schools.
o Interest Income – Revenue earned from lending money.
o Rent Income – Revenue earned from leasing out commercial spaces such
as office space, stalls, booths, apartments, condominiums, etc.
o Commission Income – Revenue earned by brokers and sales agents.
o Royalty Income – Revenue earned by the owner of a property, patent, or
copyrighted work for allowing others to use such in generating revenue.
o Franchise Fee – Revenue earned by a franchisor in a franchise agreement.
o Sales – Revenue from selling goods to customers. It is the principal
revenue account of merchandising and manufacturing companies.
o Dividend Revenue – Revenue earned on the stock of other companies
which is owned by the business.
o Gain on Sale of Assets – Revenue derived from the sale of assets used in
the business. There is gain on sale if the proceed exceeds the book value
of the disposed asset. Example is Gain on sale of equipment.

 Expense Accounts. Expenses are assets used up or services consumed in the

process of generating revenues.Expenses are often divided into two major
classifications: operatingand non-operating. Operating expensesinvolve a
company's main activities. Non-operating expenses pertain to its incidental
activities.
o Supplies Expense – The amount of supplies consumed or used during the
period.
o Salaries Expense – The amount paid to services rendered by the
employees in the operation of the business.
o Utilities Expense – Utilities costs include electricity, water, heat, and even
telephone services.

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Equation Expanded to Show Operating Activities

o Advertising Expense – Consists of payments made to another company

to promote products or services.
o Rent Expense – Expense for space, equipment and other asset rentals.
o Insurance Expense – Amount of insurance policy incurred during the
current period.
o Taxes and Licenses Expense – The cost of local and national taxes
incurred and required to be paid in connection with the conduct of the
business.
o Interest Expense – Interest is the cost of borrowing cash for a period of
time. Loans from banks or bonds usually require regular interest payments
to compensate the lender.
o Depreciation Expense – Represents the current periodic cost of using
depreciable plant assets.
o Doubtful Account Expense – The estimated amount of losses from
uncollectible accounts arising from credit sales of the current period.
o Cost of Goods Sold – The value of merchandise sold.
Note: There are many more types of accounts maintained for each type of major
accounts depending on the nature of the business, but these are the basic list.

 Illustrative Problem: Expanded Accounting Equation

Angelica Palmones began operating the Ange Couture with the following:
1) Ms. Angelica Palmones invested ₱25,000 cash in a tailoring business.
2) Borrowed money from lending company, ₱25,000.
3) Purchased sewing machine on account, ₱30,000.
4) Bought supplies for cash, ₱8,200.
5) Received cash for tailoring services rendered, ₱16,000.
6) Paid Electricity bill ₱4,700.
7) Billed J&J Company for tailoring services rendered, ₱12,000.
8) Paid ₱5,000 as partial payment to the lending Company.
9) Collected ₱6,000 from J&J Company.
10) Incurred ₱700 of advertising cost in the Weekly News on account.
No. Asset = Liability + Capital - Drawing + Revenue - Expense
1) 25,000 25,000
2) 25,000 25,000
3) 30,000 30,000
4) 8,200 (8,200)
5) 16,000 16,000
6) (4,700) (4,700)
7) 12,000 12,000
8) (5,000) (5,000)
9) 6,000 (6,000)
10) 700 (700)
Total 98,300 50,700 25,000 28,000 (5,400)
Assets = Liabilities + Owner’s Equity
98,300 50,700 47,600

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Equation Expanded to Show Operating Activities

Activity 1
Bess Quedan began operating the Ace Modeling Agency with the following:
1) Invested cash of ₱500,000, one half of which was paid for the lease
contract of a floor space in Makati.
2) She also borrowed ₱500,000 from PNB and issued to PNB a 180-day
promissory note.
3) One half of the amount borrowed was used to buy furniture and fixtures
₱100,000 and for a set of computer, printer and fax machine, ₱150,000.
4) She withdrew ₱50,000 for personal use.
5) She also bought a car for ₱400,000 from World Motors paying 50% in
cash, with the balance payable within a year.
6) She paid ₱100,000 of the amount due to World Motors.

No. Cash Advance Furniture Equipment Car Accounts Notes Quedan Quedan
Rental & Fixtures Payable Payable Capital Drawing
1) 250,000 250,000 500,000
2) 500,000 500,000
3) (250,000) 100,000 150,000
4) (50,000) (50,000)
5) (200,000) 400,000 200,000
6) (100,000) (100,000)
150,000 250,000 100,000 150,000 400,000 100,000 500,000 450,000

Assets = Liabilities + Owner’s Equity

1,050,000 600,000 450,000

Activity 2
By using the format provided below, indicate the effects of the following transactions on
the assets, liabilities and owner’s equity of Teresa’s ENT Clinic. Place a ( ) sign for a
minus figure. Extract the balances only after the last transaction and prove the accounting
equation.
May 1 Teresa Sison, a doctor, invested ₱100,000 cash and medical
equipment worth ₱500,000 to put up a clinic.
5 Purchased furniture worth ₱20,000 from Xavier’s Furnising Home.
Paid 50%, with the balance payable after thirty days.
6 Hired a nurse for a monthly salary of ₱10,000.
7 Returned a defective chair purchased on May 5. A credit memo was
received reducing the account by ₱1,500.
8 Withdrew cash from the business funds to purchase medical
supplies needed by the business, ₱5,000.
9 Purchased a car for personal use. Paid ₱50,000 from her personal
cash and issued a promisory note for ₱150,000.
10 Applied for a business loan from PNB. Signed a promissory note for
₱100,000.

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Equation Expanded to Show Operating Activities

17 The loan was approved and the cash received from the bank
deposited in the name of the clinic.
19 Half of the loan was used for the expansion of the clinic.
24 Paid cash of ₱75,000 for electronic equipment bought.
Date Cash Supplies Equipment Furniture Leasehold Accounts Notes Sison, Sison,
Improvement Payable Payable Capital Drawings
May 1 100,000 500,000 600,000
5 (10,000) 20,000 10,000
6
7 (1,500) (1,500)
8 (5,000) 5,000
9
10
17 100,000 100,000
19 (50,000) 50,000
24 (75,000) 75,000
60,000 5,000 575,000 18,500 50,000 8,500 100,000 600,000

Assets = Liabilities + Owner’s Equity

708,500 108,500 600,000

Manuel, Z. (2019). 21st Century Accounting Process (25thed.) Raintree Trading & Publishing Quezon City