Accounting 1 (ACC 1) – Fundamentals of Accounting

WEEK 7: The Accounting Equation

IV: Week 7 - PAS 19 PROPER

LESSON
LET’S BEGIN!

4.0: THE ACCOUNTING EQUATION

The accounting equation is the basis for all transactions in accounting. It provides
the foundation for the rules of debit and credit in the journalizing process, where for each
transaction total debits must equal total credits. As a result, the accounting equation must
be in balance at all times for a business’ financial records to be correct. It involves the
three types of accounts that do not appear on the income statement.

Assets = Liabilities + Stockholders’ Equity

Businesses own assets. These may be partially owned by the owners (stockholders)
and partially owned by outsiders (debtors).

When you purchase an asset, there are two ways to pay for it—with your own money
and with other people’s money. This concept is a simple description of the accounting
equation.

BUYING A TRUCK
When you buy a truck, you can pay cash for it, as shown in the following journal entry:
Date Account Debit Credit
1/1 Truck 30,000
Cash 30,000

If you pay in full, you own the entire vehicle and receive title to it.

Assets = Liabilities + Stockholders’ Equity

30,000 = 0 + 30,0000
As an alternative, you may purchase the truck by making a down payment for part of its cost
and taking out a loan for the remainder. This is summarized by the following journal entry.
Date Account Debit Credit
1/1 Truck 30,000
Cash 10,000
Note Payable 20,000

Assets = Liabilities + Stockholders’ Equity

30,000 = 20,000 + 10,000
This second scenario is a good illustration of the accounting equation using just one asset.
The buyer receives the entire asset – the truck. The buyer must pay for this asset. They do so
with two forms of payment: their own money (equity) and other people’s money (the loan). The
combined total of their down payment and the loan equal the cost of the truck.

The asset is the truck, the liability is the loan, and the down payment is the owner’s equity.
 Accounting 1 (ACC 1) – Fundamentals of Accounting
WEEK 7: The Accounting Equation

4.1 Lesson 1:PAS

Accounting
19 Equation Broken Out

Indirectly, revenue and expense accounts are part of this accounting equation since
they impact the value of stockholders’ equity by affecting the value of Retained Earnings.

The Retained Earnings account normally has a credit balance. Closing entries
move the credit balances of revenue accounts into Retained Earnings and cause that
account to increase. Closing entries also transfer the debit balances of expense accounts
into Retained Earnings, causing it to decrease.

EXPANDED ACCOUNTING EQUATION

Assets = Liabilities + Stockholders’ Equity

/ \
Common Stock Retained Earnings
/ \
Revenue Expenses

Common Stock Plus Retained Earnings equals total stockholders’ equity.

4.2 Lesson 2: Accounting Transaction Grid

The following grid illustrates how familiar transactions for a new business fit into the
accounting equation: ASSETS = LIABILITIES + STOCKHOLDERS’ EQUITY.

Each transaction in the first column impacts two accounts. For the asset, liability, and
stockholders’ equity amounts, positive numbers represent increases and negative
amounts indicate decreases. The ending balances prove that total assets of P1,900
(1,500 + 400) equal total liabilities and stockholders’ equity of P1,900 (100 +1,000 + 800).
 Accounting 1 (ACC 1) – Fundamentals of Accounting
WEEK 7: The Accounting Equation

Revenue PAS
and expense
19 accounts were used temporarily and were ultimately closed
to Retained Earnings. As a result, the income statement account balances were set to
zero and the Retained Earnings balance increased by the net income amount of P800.

.4.3 Lesson 3: Retained Earnings Statement

The retained earnings statement is a report that shows the change in the Retained
Earnings account balance from the beginning of the month to the end of the month due
to net income (or loss) and any cash dividends declared during the accounting period.
Pinoy Company Sample Retained Earnings Statement
Retained Earnings Statement
For the Month Ended August 31, 2023 1. Start with Retained Earnings balance
at the beginning of the month.
Retained Earnings, August 1, 2023 P30,000 2. Add net income for the current month’s
Net Income P13,000 income statement.
Less: Cash Dividends 3,000 3. Subtract from net income any
Increase in Retained Earnings 10,000
dividends declared during the month.
Retained Eranings, August 31, 2023 P40,000
4. End with new Retained Earnings
balance at the end of the month.

Profit is such an important concept in business that two financial statements are
devoted to talking about it. The income statement reports net income for one period, such
as a month or a year. The retained earnings statement deals with a company’s net income
over the entire life of the business.

The retained earnings statement is a bridge between the income statement and the
balance sheet. The net income amount that appears on the retained earnings statement
comes from the income statement (P13,000 in the sample above). The ending retained
earnings balance (P40,000 in the sample above) feeds to the stockholders’ equity section
of the balance sheet.

BALANCING YOUR BANK STATEMENT

The retained earnings statement includes elements similar to those in a

monthly bank statement Both statements report a beginning balance,
additions, subtractions, and an ending balance.
Bank Statement Retained Earnings Statement
(tracks your cash) (tracks a corporation’s accumulated profit)
Balance at the beginning of the month Balance at the beginning of the month
Deposits Net Income
Withdrawals Dividends
Balance at the end of the month Balance at the end of the month
 Accounting 1 (ACC 1) – Fundamentals of Accounting
WEEK 7: The Accounting Equation

4.4 Lesson 4:PAS

Balance
19 Sheet
The balance sheet is a report that summarizes a business’s financial position as of a
specific date. It is the culmination of all the financial information about the business—
everything else done in the accounting cycle leads up to it.
The balance sheet is an expanded version of the accounting equation:
Assets = Liabilities + Stockholders’ Equity. The balance sheet lists and
summarizes asset, liability, and stockholders’ equity accounts and their ledger balances
as of a point in time. Assets are listed first. Liabilities and stockholders’ equity accounts
follow, and these amounts are added together.
The only exception is that the amount reported on the balance sheet for Retained
Earnings comes from the ending balance on the retained earnings statement rather than
from its ledger. Note that Cash Dividends is not listed at all on the balance sheet.
BALANCE SHEET SAMPLE

Pinoy Company
Balance Sheet
August 31, 2023

ASSETS LIABILITIES
Cash P15,000 Accounts Payable P5,000
Account Receivable 10,000
Equipment 5,000 STOCKHOLDERS’ EQUITY
Truck 30,000 Common Stock P15,000
Retained Earnings 40,000
Total Stockholders’ Equity 55,000
TOTAL ASSETS P60,000 Total Liabilities and Stockholders’ Equity P60,000

BALANCE SHEET FORMATTING

Heading: Company Name, Name of Financial Statement, Date
Two columns: left for listing items to be subtotaled; right for results
Peso signs go at the top number of a list to be calculated
Category headings for each account category
Single underline below a list of numbers to be totaled
Double underline below the final results (total assets AND Total labilities and
stockholders’ equity)
Peso sign on final result number
 Accounting 1 (ACC 1) – Fundamentals of Accounting
WEEK 7: The Accounting Equation

PASReporting
Financial 19
Pinoy Company
The life of an ongoing business can be Income Statement
divided into artificial time periods for the For the Month Ended August 31, 2023
purpose of providing periodic reports on its Fees Earned P30,000
financial activities.
Operating Expenses:
Financial Statements Connected Three
Salaries expense P2,500
financial statements are prepared at the end of
Wages expense 2,200
each accounting period. First, the income
statement shows net income for the month. Rent expense 2,000

Next, the statement of retained earnings shows Insurance expense 1,900

the beginning and ending Retained Earnings Supplies expense 1,800
balances and the reasons for any change in this Advertising expense 1,700
balance. Finally, the balance sheet presents Maintenance expense 1,600
asset, liability, and stockholders’ equity account Utilities expense 1,400
balances. Vehicle expense 1,100
Miscellaneous expense 800
#1 The income statement is prepared first. It
Total operation expenses 17,000
summarizes revenue and expenses for the
Net Income P13,000
month. Amounts come from the ledger
balances. The result is either net income or net
loss.

Pinoy Company
#2 The retained earnings statement is next. It Retained Earnings Statement
adjusts the month’s beginning retained earnings For the Month Ended August 31, 2023
balance by adding net income from the income Retained earnings, June 1, 2018 P30,000
statement and subtracting out dividends Net income 13,000
declared. The net income of P13,000 comes
Less: cash dividends 3,000
from the income statement. The result is a new
Increase in retained earnings 10,000
retained earnings balance at the end of the
month. Retained earnings, June 30, 2018 P40,000

#3 The balance sheet is prepared last. It shows assets, liabilities, and stockholders’ equity
as of the last day of the month. All amounts except retained earnings come from the
ledger balances. The Retained Earnings amount comes from the ending amount on the
retained earnings statement - in this case P40,000. The balance sheet is an exploded
version of the accounting equation.
Pinoy Company
Balance Sheet
For the Month Ended August 31, 2023
Assets Liabilities
Cash P15,000 Accounts payable P5,000
Accounts receivable 10,000
Equipment 5,000 Stockholders’ Equity
Truck 30,000 Common stock P15,000
Retained earnings 40,000
Total stockholders’ equity 55,000
Total assets P60,000 Total liabilities and stockholders’ equity P60,000
 Accounting 1 (ACC 1) – Fundamentals of Accounting
WEEK 7: The Accounting Equation

4.5 Lesson 5:PAS

CHANGES
19 IN STOCKHOLDERS’ EQUITY
Any change in the Common Stock, Retained Earnings, or Cash Dividends
accounts affects total stockholders’ equity.
Common Stock + Retained Earnings = Total Stockholders’ Equity
Stockholders’ equity increases due to additional stock investments or additional net
income. It decreases due to a net loss or dividend payouts. Retained earnings increases
when revenue accounts are closed out into it and decreases when expense accounts and
cash dividends are closed out into it.
The following examples illustrate journal entries that can cause stockholders’ equity
to change.
1. Stockholders’ equity before a business opens:
Date Account Debit Credit
Common Stock + Retained Earnings =
Total Stockholders’ Equity
0+0=0

2. Stockholders’ equity after 30 stockholders invest P1,000 each, for a total of P30,000:
Date Account Debit Credit Common Stock + Retained Earnings =
6/1 Cash 30,000 Total Stockholders’ Equity
30,000 + 0 = 30,000
Common Stock 30,000 Each investor is now worth $1,000 in the business.

3. Stockholders’ equity after one month of operations in which Fees Earned is P65,000
and total expenses are P5,000 (so net income is P60,000)
Date Account Debit Credit Common Stock + Retained Earnings =
6/30 Fees Earned 65,000 Total Stockholders’ Equity
30,000 + 60,000 = 90,000
Retained Earnings 65,000
6/30 Retained Earnings 5,000 Each investor is now worth P3,000 in the business.
(The original P1,000 investments plus 1/30th of the
ALL Expenses 5,000
P60,000 profit, or P2,000)

4. Stockholders’ equity after one month of operations and after each of the thirty
investors receives a cash dividend payment of P500.
Date Account Debit Credit Common Stock + Retained Earnings =
7/10 Retained Earnings 15,000 Total Stockholders’ Equity
30,000 + 45,000 = 75,000
Cash Dividends 15,000 Each investor is now worth P2,500 in the business.
(The original P1,000 plus P2,000 profit - P500 dividends
paid out)

Stockholders’ equity can increase in two ways:

1. Owners invest in stock and Common Stock is credited and increases
2. Business generates net income and Retained Earnings is credited and increases
 Accounting 1 (ACC 1) – Fundamentals of Accounting
WEEK 7: The Accounting Equation

Stockholders’ PAS
equity
19can decrease in two ways:
1. Dividends are paid out and Retained Earnings is debited and decreases
2. Business experiences a loss and Retained Earnings is debited and decreases
The following calculation example shows how stockholders’ equity can change from
the beginning to the end of an accounting period.

Beginning stockholders’ equity 12,000

+ Additional investments in stock 6,000
+ Net income (or – Net loss) 3,000
- Dividends - 1,000
= Ending stockholders’ equity 20,000

The calculation below is the same as the one above except that net income is instead
presented as revenue minus expenses.

Beginning stockholders’ equity 12,000

+ Additional investments in stock 6,000
+ Revenue 5,000
- Expenses -2,000
- Dividends - 1,000
= Ending stockholders’ equity 20,000

If net income is not given, you can solve for it algebraically using the calculations
above. Assume net income is x in the first calculation above:

Beginning stockholders’ equity 12,000

+ Additional investments in stock 6,000
+ Net income (or – Net loss) x
- Dividends - 1,000
= Ending stockholders’ equity 20,000

Beginning stockholders’ equity + Additional investments in stock + Net income - Dividends = Ending stockholders’ equity
12,000 + 6,000 + x – 1,000 = 20,000
x = 20,000 – 12,000 – 6,000 + 1,000
x = 3,000
 Accounting 1 (ACC 1) – Fundamentals of Accounting
WEEK 7: The Accounting Equation

The highlighted accounts

PAS 19 are the new accounts you have learned.

Pinoy Company
Income Statement
For the Month Ended August 31, 2023
Accounting 1 (ACC 1) – Fundamentals of Accounting
WEEK 7: The Accounting Equation

PAS 19

Pinoy Company
Balance Sheet
For the Month Ended August 31, 2023

We had just finished the discussion about the Accounting Equation.

Let’s move on to the next higher level of activity/ies or exercise/s
that demonstrates your potential skills/knowledge of what you have
learned.