ACCOUNTING EQUATION

In accounting system, business transactions are analysed, recorded, classified,

summarized, and interpreted. This paves way to the determination of the financial position and of
the result of operation of the business. These functions can be made possible by following the
basic accounting equation:
Assets = Liabilities + Owner’s Equity
Liabilities = Assets – Owner’s Equity
Owner’s Equity = Assets – Liabilities; and
Assets = Equity

 This equation sets the foundation of double-entry accounting and highlights the structure of
the balance sheet. Double-entry accounting is a system where every transaction affects both
sides of the accounting equation. For every change to an asset account, there must be an
equal change to a related liability or owner’s equity account. For every transaction, both sides
of this equation must have an equal net effect

 Equity is the residual interest of the owner of the business. Meaning, any assets left after
paying liabilities is the right of the owner of the business.

 There are four elements that affect equity: (1) Investment; (2) Withdrawal; (3) Revenue, and;
(4) Expenses.

ILLUSTRATION
Let us check the effects of some business transactions to the accounting equation. Observe that
for every transaction, the equation remains balance. Below is the firm’s chart of accounts:
Assets Liabilities Revenue
Cash Accounts Payable Service Revenue
Vehicles Loans Payable
Furniture
Equipment Capital Expenses
Reyes, Capital Gas and Oil Expense
Reyes, Drawing Repair Expense
Rent Expense
Salaries Expense

Assets invested by the owner

July 1 - Paolo Reyes started a delivery service on July 1, 2013. The following transactions
occurred during the month of July. He invested PHP 800,000 cash and cars amounting to PHP
200,000.
ASSETS = LIABILITIES + OWNER’S EQUITY
Accounts Loans
Date Cash Vehicles Furniture Equipment Reyes, Capital
Payable Payable
July 1 800, 000 200, 000 1, 000, 000
Assets = P 1, 000, 000 Liabilities + Owner’s Equity = P 1, 000, 000
 Borrowings from the bank
July 2 – Reyes borrowed PHP 100, 000 cash from PNB for use in his business.

ASSETS = LIABILITIES + OWNER’S EQUITY

Accounts Loans
Date Cash Vehicles Furniture Equipment Reyes, Capital
Payable Payable
Bal. 800, 000 200, 000 1, 000, 000
July 2 100, 000 100, 000
900, 000 200, 000 100, 000 1, 000, 000
Assets = P 1, 100, 000 Liabilities + Owner’s Equity = P 1, 100, 000

Asset purchased for cash

July 7 – Bought tables and chairs from Orocan and paid PHP 45,000 cash

ASSETS = LIABILITIES + OWNER’S EQUITY

Accounts Loans
Date Cash Vehicles Furniture Equipment Reyes, Capital
Payable Payable
Bal. 900, 000 200, 000 100, 000 1, 000, 000
July 7 (45, 000) 45, 000
855, 000 200, 000 45, 000 100, 000 1, 000, 000
Assets = P 1, 100, 000 Liabilities + Owner’s Equity = P 1, 100, 000

Assets purchased on account

July 15 – Various equipment were purchased on account from Fortune for PHP 55,000
ASSETS = LIABILITIES + OWNER’S EQUITY
Accounts Loans
Date Cash Vehicles Furniture Equipment Reyes, Capital
Payable Payable
Bal. 855, 000 200, 000 45, 000 100, 000 1, 000, 000
July 15 55, 000 55, 000
855, 000 200, 000 45, 000 55, 000 55, 000 100, 000 1, 000, 000
Assets = P 1, 155, 000 Liabilities + Owner’s Equity = P 1, 155, 000

Cash withdrawal by the owner

July 18 – Reyes made a cash withdrawal of PHP 5,000 for personal use
ASSETS = LIABILITIES + OWNER’S EQUITY
Accounts Loans
Date Cash Vehicles Furniture Equipment Reyes, Capital
Payable Payable
Bal. 855, 000 200, 000 45, 000 55, 000 55, 000 100, 000 1, 000, 000
July 18 (5, 000) (5, 000)
850, 000 200, 000 45, 000 55, 000 55, 000 100, 000 995, 000
Assets = P 1, 150, 000 Liabilities + Owner’s Equity = P 1, 150, 000
 Payment of liability
July 20 – The account due to Fortune was paid in cash

ASSETS = LIABILITIES + OWNER’S EQUITY

Accounts Loans
Date Cash Vehicles Furniture Equipment Reyes, Capital
Payable Payable
Bal. 850, 000 200, 000 45, 000 55, 000 55, 000 100, 000 995, 000
July 20 (55, 000) (55, 000)
795, 000 200, 000 45, 000 55, 000 - 100, 000 995, 000
Assets = P 1, 095, 000 Liabilities + Owner’s Equity = P 1, 095, 000

Received cash for revenue earned

July 21 – A customer hired the services of Reyes. Cash of PHP 15, 000 was received from the
customers.
ASSETS = LIABILITIES + OWNER’S EQUITY
Accounts Loans
Date Cash Vehicles Furniture Equipment Reyes, Capital
Payable Payable
Bal. 795, 000 200, 000 45, 000 55, 000 100, 000 995, 000
July 21 15, 000 15, 000
810, 000 200, 000 45, 000 55, 000 100, 000 1, 010, 000
Assets = P 1, 110, 000 Liabilities + Owner’s Equity = P 1, 110, 000

Paid cash for expenses incurred

July 22 – Cash was paid for the following: gas and oil, PHP 500 and car repairs, PHP 1, 000.

ASSETS = LIABILITIES + OWNER’S EQUITY

Accounts Loans
Date Cash Vehicles Furniture Equipment Reyes, Capital
Payable Payable

Bal. 810, 000 200, 000 45, 000 55, 000 100, 000 1, 010, 000
July 22 (1, 500) (1, 500)
808, 500 200, 000 45, 000 55, 000 100, 000 1, 008, 500
Assets = P 1, 108, 500 Liabilities + Owner’s Equity = P 1, 108, 500

Paid cash for expenses incurred

July 31 – Paid PHP 10, 000 for rental of office space, and salaries of PHP 9, 000

ASSETS = LIABILITIES + OWNER’S EQUITY

Accounts Loans
Date Cash Vehicles Furniture Equipment Reyes, Capital
Payable Payable

Bal. 808, 500 200, 000 45, 000 55, 000 100, 000 1, 008, 500
July 31 (19, 000) (19, 000)
789, 500 200, 000 45, 000 55, 000 100, 000 989, 500
Assets = P 1, 089, 500 Liabilities + Owner’s Equity = P 1, 089, 500
 Summary of the Illustration Showing the Effects of Business Transactions in the Accounting Equation

ASSETS = LIABILITIES + OWNER’S EQUITY Capital Notations

Accounts Loans
Date Cash Vehicles Furniture Equipment Reyes, Capital
Payable Payable

July 1 800, 000 200, 000 1, 000, 000 Investment by the owner
2 100, 000 100, 000
7 (45, 000) 45, 000
15 55, 000 55, 000
18 (5, 000) (5, 000) Withdrawal by the owner
20 (55, 000) (55, 000)
21 15, 000 15, 000 Service Revenue
Gas, Oil and Repair
22 (1, 500) (1, 500)
Expense
Rent and Salaries
31 (19, 000) (19, 000)
Expense
789, 500 200, 000 45, 000 55, 000 - 100, 000 989, 500

Total Assets = 789, 500 + 200, 000 + 45, 000 + 55, 000 = 1, 089, 500

Total Liabilities & Owners Equity = 100, 000 + 989, 500 = 1, 089, 500
References:
Haddock, M., Price, J., & Farina, M. (2012). College Accounting: A Contemporary Approach,
2nd ed. New York: McGraw-Hill/Irvin
Valencia, E.G.& Roxas, G.F. (2010). Basic Accounting 3rd ed., Mandaluyong City, Philippines:
Valencia Educational Supply.
Wild, J. (2009). Principles of Accounting 19th ed. McGraw Hill Publishing