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TAGBILARAN CITY COLLEGE

College of Business and Industry
Tagbilaran City, Bohol

Course Code ABM101 Instructor Cristie G. Claro, CPA

Fundamentals of
Course Title Accounting, Business E-mail Address cclaro.tcc@gmail.com
and Management
Course Credits 3 units Contact Number 0946-239-6579
Course Consultation Monday, Wednesday & Friday
Bridging
Classification Hours – 5pm onwards
Consultation
Pre-requisite(s) None Online via MS Teams
Venue

Learning Module 3: The Accounting Equation

Duration of Delivery: September 5 – 9, 2022
Due Date of Deliverables: September 12, 2022

Intended Learning Outcomes:

• Define each of the elements of financial statements and use those definitions in
determining the existence of an asset, liability, equity, income or expense.
• Use the accounting equation in solving accounting problems.

THE ACCOUNTING EQUATION

The Basic Accounting Equation

All the processes in an accounting system must observe the equality of the accounting
equation, which is basically an algebraic equation. The basic accounting equation is
shown below:

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ASSETS – are the resources you control that have resulted from past events and can
provide you with future economic benefits.
Control – means you have the exclusive right to enjoy those benefits and the ability to
prevent others from enjoying those benefits.
Past events – the control over an economic resource have resulted from a past event or
transaction. Therefore, resources for which control is yet to be obtained in the future do
not qualify as assets in the present.
Economic benefits – to be an asset, the economic resource must have the potential to
provide you with economic benefits in at least one circumstance

Example
You acquired a cellphone from a telecommunications company on a 2-year installment
plan. The agreement states that if you miss an installment payment, the
telecommunications company can get the cellphone back.
Analysis: Upon taking possession, the cellphone becomes your asset even if you do not
actually own it yet until you have fully paid the installment price. This is because you
control the right over the economic benefits of the cellphone through exclusive use.

LIABILITIES – are your present obligations that have resulted from past events and can
require you to give up resources when settling them.
Obligation – means a duty or responsibility. An obligation is either;
a. Legal obligation – an obligation that results from contract, legislation, or other
operation of law; or
b. Constructive obligation – an obligation that results from your past actions (e.g.,
past practice or published policies) that have created a valid expectation on
others that you will accept and discharge certain responsibilities.
Example
You purchased a cellphone on credit. You took possession over the cellphone but have
not yet paid the purchase price.
Analysis:
You have a present obligation, and hence a liability, because:
a. You have already purchased and received the cellphone; and
b. As a consequence, you are required to pay for the purchase price.

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EQUITY – is simply assets minus liabilities. Other terms for equity are “capital,” “net
assets,” and “net worth.”
Illustration 1:
You decided to put up a barbeque stand and have estimated that you will be needing
₱2,000 as start-up capital
You then went to your close and broke Mr. Piggy Bank which you have been saving for
quite some time now. Alas! You only have ₱800. You went to your Mama and asked her
to give you ₱1,200 but she told you that she has been feeding you for far too long. Oh
man! But don’t give up hope yet, Mr. Bombay is just around the corner.
❖ As of this point, your accounting equation is as follows:
Assets = Liabilities + Equity

800 = 0 + 800

Notes:
✓ Your total assets are ₱800 – the amount of economic resources that you control.
✓ You don’t have any liability yet because you are still negotiating with Mr.
Bombay.
✓ Your equity is also ₱800 (800 assets – 0 liabilities = 800 equity).
After a lengthy negotiation, Mr. Bombay agreed to lend you ₱1,200.
❖ As of this point, your accounting equation is as follows:
Assets = Liabilities + Equity

2,000 = 1,200 + 800

Notes:
✓ Your total assets are now ₱2,000 – total amount of economic resources that you
control (₱800 from Mr. Piggy plus ₱1,200 from Mr. Bombay).
✓ Of your total assets of ₱2,000:
a. ₱1,200 represents your liability, the amount you are obligated to pay Mr.
Bombay in the future.
b. ₱800 represents your equity (i.e., ₱2,000 assets - ₱1,200 liabilities).

❖ Liabilities represent the creditors’ claim, while equity represents the owner’s
claim, against the total assets of the business.
Notice that from Piggy to Bombay, the accounting equation remains balanced. Please DO NOT forget this
concept. The equality of the accounting equation must be maintained in all the accounting processes of
recording, classifying and summarizing. If the accounting equation doesn’t balance, there is something
wrong.

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As mentioned earlier, the accounting equation is basically an algebraic equation.

Therefore, we can make variations from it. Analyze the variations below:
Original from of the equation:

Assets = Liabilities + Equity

2,000 = 1,200 + 800

Variation #1:

Assets - Liabilities = Equity

2,000 - 1,200 = 800

Variation #2:

Assets - Equity = Liabilities

2,000 - 800 = 1,200

The Expanded Accounting Equation

We can expand the basic accounting equation by including two more elements –
income and expenses. The expanded accounting equation shows all the financial
statement elements. The expanded accounting equation is as follows:

Assets = Liabilities + Equity + Income - Expenses

Notice that income is added while expenses are deducted in the equation. These are
because income increases equity while expenses decrease equity.
INCOME – is increases in the economic benefits during the period in the form of inflows
or enhancements of assets or decreases of liabilities that result in increases in equity,
excluding those relating to investments by the business owners.
EXPENSES – are decreases in economic benefits during the period in the form of
outflows or depletions of assets or increases of liabilities that result in decrease in
equity, excluding those relating to distributions to the business owners.
The difference between income and expenses represents profit or loss.
➢ Income > Expenses, the difference is profit.
➢ Income < Expenses, the difference is loss.

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We can make another variation to the equation above as follows:

Assets = Liabilities + Equity + Profit/ - Loss

Profit increases equity while loss decreases equity.

Illustration 2: (Continuation of Illustration 1 above)
During the period, you earned income of ₱10,000 and incurred expenses of ₱6,200.
At the end of the period, your total assets increased from ₱2,000 to ₱5,000 and your
total liabilities decreased from ₱1,200 to ₱400.
❖ Your expanded accounting equation is as follows:

Assets = Liabilities + Equity + Income - Expenses

5,000 = 400 + 800 + 10,000 - 6,200

Your profit for the period is ₱3,800 (₱10,000 income minus ₱6,200 expenses.) there is
profit because income is greater than expenses.
Income and expenses (profit or loss) are closed to equity at the end of each accounting
period. Thus, the adjusted ending balance of equity is computed as follows:
Equity, beginning 800
Add: Income 10,000
Less: Expenses (6,200)
Equity, ending 4,600

OR
Equity, beginning 800
Add: Profit 3,800
Equity, ending 4,600

❖ Your basic accounting equation as of the end of the accounting period is as

follows:
Assets = Liabilities + Equity
5,000 = 400 + 4,600

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Applications of the accounting equation

Before we move on, let us master first how the accounting equation works. I encourage
you to diligently study the following drills:

Case #1: Total assets

If you have total liabilities of ₱1,200 and equity of ₱800, how much are your total
assets?

Solution:
Assets = Liabilities + Equity
? = 1,200 + 800

Answer: Total assets = (1,200 + 800) = 2,000

Case #2: Total liabilities

If you have total assets of ₱2,000 and equity of ₱800, how much are your total
liabilities?

Solution:
Assets = Liabilities + Equity
2,000 = ? + 800

Answer: Total liabilities = (2,000 – 800) = 1,200

Case #3: Total equity

If you have total assets of ₱2,000 and total liabilities of ₱1,200, how much is your total
equity?

Solution:
Assets = Liabilities + Equity
2,000 = 1,200 + ?

Answer: Total equity = (2,000 – 1,200) = 800

Case #4.1: Profit or loss

If you have total income of ₱5,000 and total expenses of ₱2,000, how much is your
profit (or loss)?

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Solution:

Total income 5,000

Less: Total expenses (2,000)
Profit 3,000

Case #4.2: Profit or loss

If you have total income of ₱6,000 and total expenses of ₱11,000, how much is your
profit (or loss)?

Solution:
Total income 6,000
Less: Total expenses (11,000)
Loss (5,000)

❖ In accounting, amounts in parenthesis are negative amounts.

Case #5: Income

If you have total expenses of ₱2,000 and a profit of ₱3,000, how much is your total
income?

Solution:
Total income ?
Less: Total expenses (2,000)
Profit 3,000

Answer: Total income = (3,000 + 2,000) = 5,000

Case #6: Expenses

If you have total income of ₱5,000 and a profit of ₱3,000, how much is your total
expenses for the period?

Solution:
Total income 5,000
Less: Total Expenses ?
Profit 3,000

Answer: Total expenses = (5,000 – 3,000) = 2,000

Case #7: Income

You have ending total assets of ₱4,800, ending total liabilities of ₱1,000 and beginning
equity is ₱800. If your total expenses for the period amount to ₱2,000, how much is you
total income?

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*(in accounting parlance, the term ‘beginning’ means ‘at the start’ of an accounting period while ‘ending’
means ‘at the end’ of an accounting period.)

Solution:
Assets = Liabilities + Equity + Income - Expenses
4,800 = 1,000 + 800 + ? - 2,000

Answer: Total income = (4,800 – 1,000 – 800 + 2,000) = 5,000

Case #8: Expenses for the period

You have ending total assets of ₱4,800, ending total liabilities of ₱1,000 and beginning
equity of ₱800. If your total income for the period amounts to ₱5,000, how much is your
total expenses?

Solution:
Assets = Liabilities + Equity + Income - Expenses
4,800 = 1,000 + 800 + 5,000 - ?

Answer: Total expenses = (4,800 – 1,000 – 800 – 5,000) = 2,000

Case #9.1: Ending equity

Your beginning equity is ₱5,000. If your total income for the period is ₱8,000 while your
total expenses are ₱6,000, how much is the ending balance of your equity?

Solution:

Equity, beginning 5,000

Add: Income 8,000
Less: Expenses (6,000)
Equity, ending 7,000

OR

Equity, beginning 5,000

Add/Less: Profit or Loss (8,000 – 2,000) 2,000
Equity, ending 7,000

Case #9.2: Ending equity

Your beginning equity is ₱12,000. If your total income for the period is ₱5,000 while
your total expenses are ₱8,000, how much is the ending balance of your equity?

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Solution:

Equity, beginning 12,000

Add: Income 5,000
Less: Expenses (8,000)
Equity, ending 9,000

OR

Equity, beginning 12,000

Add/Less: Profit or Loss (5,000 – 8,000) (3,000)
Equity, ending 9,000

Notice that profit is an addition to equity while loss is a deduction.

Case #10.1: Profit for the period

If your beginning equity is ₱5,000 while your ending equity is ₱7,000, how much is your
profit or loss for the period?

Solution:
Equity, beginning 5,000
Add: Profit ?
Equity, ending 7,000

Answer: Profit = (7,000 – 5,000) = 2,000

Case #10.2: Loss for the period

If your beginning equity is ₱6,000 while your ending equity is ₱2,000, how much is your
profit or loss for the period?

Solution:
Equity, beginning 6,000
Add: Loss ?
Equity, ending 2,000

Answer: Loss = (2,000 – 6,000) = (4,000)

Case #11: Ending total assets

You have total assets, liabilities, and equity of ₱10,000, ₱7,000 and ₱3,000,
respectively, at the beginning of the period. During the period, your total liabilities
decreased by ₱4,000 while your profit is ₱5,000. How much is your ending total assets?

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Solution:
Assets = Liabilities + Equity

Beginning 10,000 = 7,000 + 3,000

Decrease in liabilities/Profit _____ (4,000) 5,000
Ending ? = 3,000 + 8,000

Answer: Ending total assets = (3,000 liabilities, end. + 8,000 equity, end.) = 11,000

Case #12: Ending total assets

You have total assets, liabilities, and equity of ₱10,000, ₱7,000 and ₱3,000,
respectively, at the beginning of the period. During the period, your total liabilities
decreased to ₱4,000 while your profit is ₱5,000. How much is your ending total assets?

Solution:

Assets = Liabilities + Equity

Beginning Irrelevant* = Irrelevant + 3,000
Decrease in liabilities/Profit = Irrelevant 5,000
Ending ? 4,000** + 8,000
*Irrelevant: These amounts are not needed in computing for the requirement in the problem.)
**The phrase “decreased to ₱4,000” means that ₱4,000 is the ending balance of liabilities. Notice the
difference between the phrases “decreases by” (Case #11) and “decreased to” (Case #12).

Answer: Ending total assets = (4,000 liabilities, end. + 8,000 equity, end.) = 12,000

References:
• Financial Accounting and Reporting (Fundamentals) by Zues Vernon B. Millan
• Lopez, R. (2016). Fundamentals of Accounting (Simplified Procedural Approach). MS
LOPEZ Printing and Publishing
• Valix, C., and Valix, C. (2019). Practical Financial Accounting 1. GIC Enterprises & Co.,
Inc.

Cristie Claro, CPA