Chapter 7 – The Accounting Equation and Rules of Debit and Credit

CHAPTER 7
THE ACCOUNTING EQUATION AND RULES OF DEBIT
AND CREDIT
Topic Overview:
1. Basic Accounting Equation
2. Duality Principle
3. The Rules of Debit and Credit
4. Expanded Accounting Equation

Chapter Objective:
At the end of this chapter, students must be able to:
1. Explain the Basic Accounting Equation.
2. Explain the Duality Principle.
3. Apply the rules of Debit and Credit in recording business transactions.
4. Recognize the effect of business transactions to the accounting equation.

THE ACCOUNTING EQUATION

Accounting revolves around one simple and basic truism: The properties of the business are either
borrowed from creditors or contributed by the owner/s.

This may be graphically illustrated as:

Properties

Debts
Creditors

Owner/s Capital

This may be written in an equation as:

Properties = Debts + Capital

Claims to properties

In accounting, this is translated as:

ASSETS = LIABILITIES + EQUITY

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The assets are claims of creditors and claims of the owner/s. When the business dissolves, its assets will
go to creditors and the owner/s. Creditors are given priority in liquidation.

Entity objectives and the elements

Profit oriented entities such as businesses would focus on increasing capital or equity by earning profits.
Non-profit entities would not be interested in earning profits but in maximizing donation sources and
spending to achieve their benevolent objectives.

Entities alter their assets, liabilities and equity by entering into various transactions to meet their
objectives. Some events may also cause alterations in assets, liabilities and equity which may contribute
or interfere with the entity objectives.

INHERENT RELATIONSHIP IN THE ACCOUNTING EQUATION

The accounting equation reveals the following possible changes in the elements:

Scenario 1: An asset increase coupled with an increase in either or both liability and equity

Asset = Liability + Equity Possibilities:

= AND / OR 1. Assets increase = Liability increase
2. Assets increase = Equity increase
3. Assets increase = Liability and
equity increase

Scenario 2: An asset decrease coupled with a decrease in either or both liability and equity

Asset = Liability + Equity Possibilities:

= AND / OR 1. Assets decrease = Liability decrease
2. Assets decrease = Equity decrease
3. Assets decrease = Liability and
equity decrease

Scenario 3: Liabilities increase coupled with an offsetting decrease in equity

Asset = Liability + Equity

(No change) =

Scenario 4: Liabilities decrease coupled with an offsetting increase in equity

Asset = Liability + Equity

(No change) =

Scenario 5: An item of an element increase while another item of the same element decrease

Asset = Liability + Equity

= (No change) (No change)

Note: This occurs when an item of asset is exchanged for another item of asset. This scenario may occur for items of
liabilities when a liability is replaced by another liability. This may also occur with items of equity for partnership
or corporate businesses but not with sole proprietorship.

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CLASS ACTIVITY – Matching of the changes

Indicate which change could go simultaneously with the change indicated in the left. Indicate an upward
arrow ( ) for an increase and a downward arrow ( ) for a decrease.

Change in an element Asset Liability Equity Expense Drawings Income

Increase in asset =
1. Decrease in asset =
2. Increase in liability =
3. Decrease in liability =
4. Increase in equity =
5. Decrease in equity =
6. Increase in drawings =
7. Decrease in drawings =
8. Increase in expense =
9. Decrease in expense =
10. Increase in income =
11. Decrease in income =

THE DUALITY PRINCIPLE

Because of the accounting equation, transactions and events have to be reported in a balancing two-fold
effect in the elements of financial statements. Transactions are always reflected as effects on at least two
elements. This is the duality principle in accounting.

Note to readers
The equality of the accounting equation must always be maintained. The failure to observe this rule will
result to an accounting error. If that occurs, financial statements could not be accurately prepared.

Illustration: Application of the Duality Principle – Elements of Financial Position

1. The owner contributed ₱100,000 cash to the business and borrowed additional ₱50,000 cash from a
friend by issuing a promissory note due in one year.

ASSETS = LIABILITIES + EQUITY

₱150,000 cash = ₱ 50,000 promissory notes + ₱ 100,000 capital

2. The business purchased a ₱30,000 equipment on account (i.e., on credit)

ASSETS = LIABILITIES + EQUITY

+₱30,000 equipment = +₱ 30,000 accounts payable + No effect

3. The business purchased ₱20,000 supplies for cash.

ASSETS = LIABILITIES + EQUITY

₱20,000 supplies = No effect + No effect
- ₱20,000 cash

4. The business paid half of the promissory note given to a friend (i.e. ₱50,000/2).

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ASSETS = LIABILITIES + EQUITY

- ₱25,000 cash = - ₱25,000 promissory note + No effect

5. The business failed to pay the credit purchase of equipment on due date; hence, it was required to
submit a promissory note due in 30 days.

ASSETS = LIABILITIES + EQUITY

No effect = + ₱30,000 notes payable + No effect
- ₱30,000 accounts payable

6. The owner of the business paid the notes payable to suppliers out of his personal cash.

ASSETS = LIABILITIES + EQUITY

No effect = - ₱30,000 notes payable + + ₱30,000 capital

Note: under the accounting entity concept, the cash of the owner is separate from the cash of the
business. Since the cash used is not that of the business, this must be treated as an indirect capital
investment from the owner.

Summary of Effects:
The effects of the foregoing transactions may be depicted in the accounting equation as follows:

ASSETS = LIABILITIES + EQUITY

No. Cash Supplies Equipment Accounts Notes Owner’s
Payable payable equity
1. + ₱150,000 = - + ₱ 50,000 + + ₱ 100,000
2. + ₱ 30,000 = + ₱ 30,000 +
3. - ₱20,000 + ₱20,000 = +
4. - ₱25,000 = - ₱ 25,000 +
5. - ₱ 30,000 + ₱ 30,000 +
6. - ₱ 30,000 + ₱30,000
Total ₱105,000 ₱ 20,000 ₱ 30,000 = ₱ 0 ₱ 25,000 + ₱ 130,000

₱ 155,000 = ₱ 155,000

The accountant summarizes the foregoing transactions into an accounting report as follows:
Assets Liabilities & Equity
Cash ₱ 105,000 Accounts payable ₱ -
Supplies 20,000 Notes payable 25,000
Equipment 30,000 Equity 130,000
Total assets ₱ 155,000 Liabilities and Equity ₱ 155,000

The basic accounting equation can be expressed in percentage as follows:

ASSETS = LIABILITIES + EQUITY
In amount ₱ 155,000 = ₱ 25,000 + ₱ 130,000
In fraction ₱ 155,000/₱150,000 = ₱ 25,000/ ₱150,000 + ₱ 130,000/₱155,000
In percentage 100% = 16.13% + 83.87%

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Illustration:
₱155,000
ASSETS

Creditors ₱ 25,000 or
16.13%

Owner/s ₱ 130,000 or
83.87%

This means that out of the 100% assets, 16.13% of it is financed by the creditors while 83.87% is financed
by the owner of the business.

THE RULES OF DEBIT AND CREDIT

The increases and decreases in the sides of the accounting equations are recorded in the accounting
journals by accountants using debit and credit entries.

To provide you a basic introduction of how debit and credit works in accounting, let us first review the
concept of an account previously discussed in Chapter 6.

The term debit originated from the Latin term “debere or debitum”, often abbreviated as “Dr” means left
side. Credit also originated from the Latin term “credere or creditum”, often abbreviated as “Cr” which
means right side.

Remember in your study of accounts that each account has a debit side and a credit side:

Account name
Debit Credit

The debit and credit sides of an account are used to record changes to that account. Which side to use in
recording a change depends on the type of the account and its location in the accounting equation.

In the simple accounting equation, the left side of the equation is the DEBIT side while the right side of the
equation is the CREDIT:

ASSET = LIABILITIES + EQUITY

Debit Credit

The rules of debit and credit:

1. Debits must always equal credits. The two-fold effect of a transaction or an event is always recorded
in accounting as a debit and a credit. For every debit, there must be a matching credit. Hence, this
recording method is called the “double entry system”.
2. An increase in asset must be recorded as a debit. An increase in either liability or equity must be
recorded by a credit.

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3. A decrease in an asset must also be recorded on the opposite side, credit. A decrease in either
liabilities or equity must be recorded on the opposite side, debit.

To emphasize:

ASSET ACCOUNTS = LIABILITY ACCOUNTS + EQUITY ACCOUNTS

Debit Credit Debit Credit Debit Credit

For recording INCREASES

For recording DECREASES

RECORDING AND CLASSIFYING OF TRANSACTIONS

The recording and classifying procedures will be respectively discussed in Chapters 8 and 9. The
recording of journal entries and classifying of transactions are merely presented here to complete your
understanding of the rules of debit and credit and its connection to the accounting equation.

Accounting records transactions in the journal. For each of the foregoing six sample transactions, let us
prepare the accounting entries and summarize them:

RECORDING:

1. The owner invested ₱100,000 cash to the business and borrowed additional ₱50,000 cash from a friend
by issuing a promissory note due in one year.

Debit side = Credit side

ASSETS = LIABILITIES + EQUITY
+₱150,000 cash = +₱ 50,000 promissory notes + +₱ 100,000 capital

(debit side) (credit side) (credit side)

This is recorded as:

Date Account Debit Credit

XXXX Cash ₱ 150,000
Note payable ₱ 50,000
Owner’s equity ₱ 100,000
To record the investment of the owner

2. The business purchased a ₱30,000 equipment on account (i.e., on credit)

Debit side = Credit side

ASSETS = LIABILITIES + EQUITY
+₱30,000 equipment = +₱ 30,000 accounts payable + No effect

(debit side) (credit side)

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This is recorded as:

Date Account Debit Credit

XXXX Equipment ₱ 30,000
Accounts payable ₱ 30,000
To record the purchase of equipment on credit

3. The business purchased ₱20,000 supplies for cash.

Debit side Credit side

ASSETS = LIABILITIES + EQUITY
+ ₱20,000 supplies = No effect + No effect
- ₱20,000 cash

(debit side) (credit side)

This is recorded as:

Date Account Debit Credit

XXX Supplies ₱ 30,000
Cash ₱ 30,000
To record the purchase of supplies for cash

4. The business paid half of the promissory note given to a friend.

Debit side Credit side

ASSETS = LIABILITIES + EQUITY
- ₱25,000 cash = - ₱25,000 promissory note + No effect

(credit side) (debit side)

This is recorded as:

Date Account Debit Credit

XXXX Notes payable ₱ 25,000
Cash ₱ 25,000
To record the payment of notes payable

Note: Decreases are recorded on the opposite side.

5. The business failed to pay the credit purchase of equipment on due date; hence, it was required to
submit a promissory note due in 30 days.

Debit side Credit side

ASSETS = LIABILITIES + EQUITY
No effect = + ₱30,000 promissory notes + No effect
- ₱30,000 accounts payable

(credit side) (debit side)

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This is recorded as:

Date Account Debit Credit

XXXX Accounts payable ₱ 30,000
Notes payable ₱ 30,000
To record the conversion of accounts payable into notes

6. The owner of the business paid the notes payable to suppliers out of his personal cash.

Debit side Credit side

ASSETS = LIABILITIES + EQUITY
No effect = - ₱30,000 notes payable + + ₱30,000 capital

(debit side) (credit side)

This is recorded as:

Date Account Debit Credit

XXXX Notes payable ₱ 30,000
Owner’s equity ₱ 30,000
To record the payment by owner of business notes

Classifying
The debit and credit entries in each account in the journals are transferred and posted in each T-account
we call the ledger.

Take for example the journal entries affecting the cash account and their transfer to the cash ledger as
follows.

Entry No. 1:
Date Account Debit Credit
XXXX Cash ₱ 150,000
CASH
Notes payable ₱50,000 Debit Credit
Owner’s equity ₱ 100,000 150,000
Entry No. 3: 20,000
Date Account Debit Credit 25,000
XXXX Supplies ₱ 20,000 105,000
Cash ₱ 20,000

Entry No. 4:
Date Account Debit Credit
XXXX Notes payable ₱ 25,000
Cash ₱ 25,000

All entries in the journals are posted to the respective ledger accounts. This posting procedure is done
individually for each account of the business.

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Shown below is a complete overview of the posted entries from the foregoing transactions. For
convenience, all amounts are posted to their respective account titles at rounded values in thousands
(‘000s):

ASSETS = LIABILITIES + EQUITY

Accounts Notes + Owner’s
Cash Supplies Equipment Payable payable equity
Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr. + Dr. Cr.
1. 150 = 50 + 100
2. 30 = 30 +
3. 20 20 = +
4. 25 = 25 +
5. = 30 30 +
7. = 30 + 30
105 20 30 = 0 25 130

A list of the balances of each account is then listed to check the accuracy of the posting procedure. This
list is what we call the Trial Balance.

A sample trial balance from the account is shown below:

Debit Credit
Cash ₱ 105,000
Supplies 20,000
NOTE:
Equipment 30,000
- Debits of ₱155,000 = Credits of ₱155,000
Accounts payable ₱ 0 - The accounting equation is:
Notes payable 25,000
Assets = Liabilities + Capital
Owner’s equity ___________ 130,000 ₱155,000 = ₱25,000 + ₱130,000
Total ₱ 155,000 ₱ 155,000

THE ACCOUNTING EQUATION IN EXPANDED FORM

When the business operates, it will incur income and expenses. During operations, the owners may also
withdraw or invest additional funds into the business. Let us take into consideration the effects of
operations into the accounting equation.

Remember the following table:

From transactions with

Owner/s of the business Customers or clients
Increase in equity Additional investment (not income) Income
Decrease in equity Withdrawal of capital (not expense) Expense

The accounting equation can be expanded as follows:

ASSETS = LIABILITIES + EQUITY + INCOME – EXPENSES – DRAWINGS

Note: There is no separate account for additional investment. This is recorded directly to the capital account.

Income is directly proportional to equity

Income increases and decreases with equity. It has a normal credit balance similar to equity. Hence,
increases in income are likewise recorded as credit. Decreases in income are recorded by debit.

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Expense accounts and owner’s drawing are inversely proportional with equity
Expense and owner’s drawings are inversely related to equity. It has a normal debit balance. Hence,
increases in expense or drawings are recorded by debit. Decreases are recorded by a credit.

To emphasize:

INCOME ACCOUNTS EXPENSE ACCOUNTS DRAWINGS ACCOUNT

Debit Credit Debit Credit Debit Credit

For recording INCREASES

For recording DECREASES

To summarize:

Accounting Equation
Debit side Credit side
Asset Liability
Drawings Income
Expense Owner’s Equity

For an efficient analysis, we will restate the expanded accounting equation as follows:

ASSET + DRAWINGS + EXPENSE = LIABILITIES + INCOME + OWNER’S EQUITY

Normal Balance of Accounts

Assets, expense and drawings have normal debit balance. Increases on them are
recorded as a debit. Decreases on them are recorded via credit. The mnemonics for
debit accounts is ADE.

Liability, equity and income have normal credit balance. Increases in them are recorded as credit.
Decreases in them are recorded as a debit. The mnemonics for credit accounts is LIE.

Illustration: Application of the Duality Principle – Elements of Financial Performance

1. The owner of the business made ₱50,000 investment into the business.
Debit side = Credit side
ASSETS + DRAWINGS + EXPENSE = LIABILITIES + INCOME + EQUITY
+₱50,000 No effect No effect = No effect No effect + 50,000
cash capital

(debit side) (credit side)

This is recorded as:

Date Account Debit Credit
XXXX Cash ₱ 50,000
Owner’s equity ₱ 50,000
To record the investment of the owner

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2. The business rendered services to a client. The client paid ₱30,000 cash for the services rendered.

Debit side = Credit side

ASSETS + DRAWINGS + EXPENSE = LIABILITIES + INCOME + EQUITY
+₱30,000 No effect No effect = No effect +₱30,000 No effect
cash fees

(debit side) (credit side)

This is recorded as:

Date Account Debit Credit

XXXX Cash ₱ 30,000
Service fees ₱ 30,000
To record service fees earned

3. The business billed a client ₱20,000 for rental of a vacant business office space.

Debit side = Credit side

ASSETS + DRAWINGS + EXPENSE = LIABILITIES + INCOME + EQUITY
+₱20,000 No effect No effect = No effect +₱20,000 No effect
receivable rent

(debit side) (credit side)

This is recorded as:

Date Account Debit Credit

XXXX Accounts receivables ₱ 20,000
Rent income ₱ 20,000
To record the bill on rent income earned

4. The business paid ₱8,000 for the salaries of employees.

Debit side = Credit side

ASSETS + DRAWINGS + EXPENSE = LIABILITIES + INCOME + EQUITY
-₱8,000 No effect +₱8,000 = No effect No effect No effect
cash salaries

(credit side) (debit side)

This is recorded as:

Date Account Debit Credit

XXXX Salaries expense ₱ 8,000
Cash ₱ 8,000
To record the bill on rent income earned

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5. The business received a ₱2,000 bill for electricity and water.

Debit side = Credit side

ASSETS + DRAWINGS + EXPENSE = LIABILITIES + INCOME + EQUITY
No effect No effect + ₱2,000 = + ₱2,000 No effect No effect
utilities payable

(debit side) (credit side)

This is recorded as:

Date Account Debit Credit

XXXX Utilities expense ₱ 2,000
Utilities payable* ₱ 2,000
To record the bill on rent income earned

*Alternatively, this may be called accrued utilities expense

6. The owner of the business took ₱5,000 for his personal expenses.

Debit side = Credit side

ASSETS + DRAWINGS + EXPENSE = LIABILITIES + INCOME + EQUITY
- ₱5,000 + ₱5,000 No effect = No effect No effect No effect
cash

(credit side) (debit side)

This is recorded as:

Date Account Debit Credit

XXXX Owner’s drawings ₱ 5,000
Cash ₱ 5,000
To record the owner’s withdrawals

Similar to what was previously illustrated, the journal entries are posted into T-accounts to determine
the balances of each account.

For convenience the balance of the accounts are roughly tallied as follows with debits indicated as (+)
and credits indicated as (-):

Accounts Utilities Owner’s Owner’s Rent Service Salaries Utilities

No. Cash Rec. payable equity drawings income fees expense expense
1. +₱50,000 - -₱50,000
2. +₱30,000 -30,000
3. + ₱20,000 -₱20,000
4. -₱8,000 +8,000
5. -₱2,000 +2,000
6. -₱5,000 +₱ 5,000
Total +₱67,000 +₱20,000 -₱ 2,000 -₱50,000 + ₱5,000 -₱20,000 -₱30,000 +₱8,000 +₱2,000

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To check the equality of debits and credits, a trial balance shall be prepared as follows:

Debit Credit
Cash ₱ 67,000
Accounts receivables 20,000
Utilities payable ₱ 2,000
Owner’s equity 50,000
Owner’s drawings 5,000
Rent income 20,000
Service fees 30,000
Salaries expense 8,000
Utilities expense 2,000 ___________
Total ₱ 102,000 ₱ 102,000

Observe that the trial balance itself is merely a report format of the expanded accounting equation. Note
that the Assets + Drawings + Expense are the debits which equal the Liabilities + Income + Owner’s
equity as credits.

Summarizing results of operations

Let us forgo the adjustment phase of accounting in the meantime to fully finish our illustration. The results
of operations are then summarized wherein income, expense and drawings accounts are closed into the
equity accounts.

The objective of summarizing is to zero-out or close-out temporary accounts expense, drawings and
income into equity. Remember again that income adds up to equity whereas expenses and drawings are
deducted from capital. Thus, the equation: Assets = Liabilities + Equity + Income – Expense –
Drawings.

Accounting closes income and expense to a temporary summary accounts as:

Date Account Debit Credit

XXXX Service fees ₱ 30,000
Rent income 20,000
Salaries expense ₱ 8,000
Utilities expense ₱ 2,000
Profit or loss summary ₱ 40,000
To close income and expense accounts

Note:
1. This procedure matches or offset expense with income. This is done at the end of the accounting period before
reporting.
2. By debiting income accounts and crediting expense accounts, their account balance will become zero in their
respective ledger T-accounts.
3. A net credit balance in the closing procedure means income is greater than expense which means a “net income”.
A debit balance means expenses are greater than income which means a “net loss”. In our illustration, the
business earned a net income of ₱40,000.

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Accountants report this in an Income Statement, also called the Statement of Financial Operations:

Income:
Service fees ₱ 30,000
Rent income 20,000
Total ₱ 50,000
Less: Total Expenses
Salaries expense ₱ 8,000
Utilities expense 2,000 10,000
Net income ₱ 40,000

The profit or loss summary account together with the drawings account is subsequently closed to the
equity account as follows.

Date Account Debit Credit

XXXX Profit or loss summary accounts ₱ 40,000
Owner’s drawings ₱ 5,000
Owner’s equity ₱ 35,000
To close income and expense accounts

Note:
1. By debiting summary account, and crediting the drawings accounts, their account balance will also become zero
in their respective T-accounts. This summarizes and transfers the changes (increase or decrease) to equity.
2. Remember that equity has a credit balance. This net credit adjustment to equity means an increase in equity. A
debit adjustment would be a decrease. Our illustration results to a ₱35,000 increase in equity.

Accountants report the changes in a Statement of Changes in Equity:

Beginning equity ₱ 50,000

Add: Net income 40,000
Less: Owner’s drawings ( 5,000 )
Increase (decrease) in equity 35,000
Ending owner’s equity ₱ 85,000

In our simplified ledger where we indicate (+) as debits and (-) as credits, the posting of the closing entries
would be seen as follows:

Utilities Owner’s Owner’s Rent Service Salaries Utilities Income

No. Cash A/R payable equity drawings income fees expense expense summary
1. +₱50K - -₱50K
2. +₱30K -30K
3. + ₱20K -₱20K
4. -₱8K +8K
5. -₱2K +2K
6. -₱5K +₱ 5K
Total +₱67K +₱20K -₱ 2K -₱50K + ₱5K -₱20K -₱30K +₱8K +₱2K
+20K +30K - 8K - 2K -40K
- 5K +5K
Closing
₱0 ₱0 ₱0 ₱0 ₱0 -35K
-35K +35K
+₱67K +20K -2K -₱85K ₱0 ₱0 ₱0 ₱0 ₱0 ₱0
Note that after the summarizing or closing the books, the expanded accounting equation contracts back
to the basic accounting equation as follows:

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ASSETS + DRAWINGS + EXPENSE = LIABILITIES + INCOME + EQUITY

₱ 87,000 ₱0 ₱0 = ₱ 2,000 ₱0 ₱ 85,000

Accountants then report the ending balances of the accounts in the basic accounting equation in a report,
Balance Sheet which is also called Statement of Financial Position.

Cash ₱ 67,000 Utilities payable ₱ 2,000

Accounts receivables 20,000 Owner’s equity 85,000
Total assets ₱ 87,000 Total liabilities and equity ₱ 87,000

Accountants also reports changes to the cash account of the business because this is very relevant to users.
This is reported in the Cash Flow Statement:

Cash balance, beginning ₱ 0

Cash inflows
Investment of owner ₱ 50,000
Collection of cash from customers 30,000
Total cash inflows ₱ 80,000
Less: Cash outflows
Payment for salaries ₱ 8,000
Drawings of owner 5,000
Total cash outflows 13,000
Net cash inflow ₱ 67,000
Ending cash balance ₱ 67,000

THE ACCOUNTING EQUATION AND THE FINANCIAL STATEMENTS

The following table illustrates the compilation of the transactions into the four basic financial statements:

The Basic Financial Statements

ASSETS = LIABILITIES + EQUITY
Accounts Accrued Owner’s Drawings Income Expense
Cash Receivable = expense equity (–) (+) (–)
+₱50,000 = - + +₱50,000
+₱30,000 = + +₱30,000
+ ₱20,000 = + +₱20,000
-₱ 8,000 = + -₱8,000
+₱2,000 + -₱2,000
-₱ 5,000 + -₱5,000
+₱50,000 -₱10,000

Income Statement

Cash Flow ₱50,000 -₱5,000 ₱40,000

Statement
Statement of Change in Equity

₱ 67,000 ₱ 20,000 = ₱ 2,000 + ₱ 85,000

Balance sheet
Note to readers
The illustrations herein are just intended to show you a bird’s eye view of how accounting works and
revolves around the basic accounting truism: Asset = liabilities and equity. It’s fascinating, right?

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The preparation of financial statements in actual practice is more organized and follows a systematic
process we call the Accounting cycle. This will be discussed and illustrated in the following chapters are
you excited now?

CHAPTER 7: REVIEW QUESTIONS- THEORETICAL AND COMPUTATIONAL

PROBLEM 7-1 ACCOUNTING EQUATION

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In each of the following cases, supply the missing items (use the Accounting equation):

Atoy Co Bobby Co Chenz Co Daisy Co Eve Co

Assets 50,000 (2) 100,000 600,000 (6)
Liabilities 60,000 70,000 (3) (20% of the 40% of the
total asset) total asset
(4) (7)
Capital (1) 100,000 50,000 (5) 60,000

Indicate the amounts here:

1. ______________________
2. ______________________
3. ______________________
4. ______________________
5. ______________________
6. ______________________
7. ______________________

PROBLEM 7-2 ACCOUNTING EQUATION

At the beginning of the year, Gilas Company had total assets of ₱2,000,000 and total liabilities of
₱500,000.

Answer the following questions:

1. If total assets increased by ₱300,000 during the year and total liabilities decreased by ₱120,000,
what is the amount of owner’s equity at the end of the year?
2. During the year, total liabilities increased by ₱200,000 and owner’s equity decreased by
₱140,000. What is the amount of total assets at the end of the year?
3. If total assets decreased by ₱160,000 and owner’s equity increased by ₱200,000 during the year,
what is the amount of total liabilities at the end of the year?

PROBLEM 7-3 ACCOUNTING EQUATION

In each of the following cases, supply the missing items (use the Accounting equation):

Cash Accounts Furniture Accounts Notes Trinidad,

receivable and Fixture payable payable capital
ABC Co 50,000 20,000 (20% of total 40,000 (20% of 3
asset) 1 total asset) 2
DEF Co 60,000 70,000 4 100,000 50,000 150,000
GHI Co (50% of 100,000 50,000 6 100,000 (40% of total
total asset) 5 asset) 7
JKL Co 8 (20% of total (50% of total 150,000 250,000 10
asset) asset) 9
₱200,000
Indicate the amounts here:
1. ______________________ 6. _______________________
2. ______________________ 7. _______________________

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3. ______________________ 8. _______________________
4. ______________________ 9. _______________________
5. ______________________ 10. _______________________

PROBLEM 7-4 ACCOUNTING EQUATION

In each of the following cases, supply the missing items (use the Accounting equation):

PEREZ, ACCOUNTS ACCOUNTS NOTES CASH MACHINERY

CAPITAL PAYABLE RECEIVABLE PAYABLE
A (1) 20,000 220,000 80,000 100,000 50,000
B 1/2 (2) 50,000 60,000 (3) 200,000 40,000
C 400,000 40% of total Liab 300,000 (5) 30% (6) 40% (7)
(4)
D 60% (8) 200,000 5,000 70,000 (9) 40% (10)

Indicate the amounts here:

1. ______________________ 6. _______________________
2. ______________________ 7. _______________________
3. ______________________ 8. _______________________
4. ______________________ 9. _______________________
5. ______________________ 10. _______________________

PROBLEM 7-5 EXPANDED ACCOUNTING EQUATION

Use the expanded accounting equation to answer each of the following questions.
1. At the beginning of the year, the Owner’s capital of Matobato Company is ₱450,000 while its
liabilities at the end of the year are ₱270,000. During the year, the owner withdrew cash for his
personal use amounting to ₱120,000 and the results of operations showed revenues of
₱1,350,000 and expenses amounted to ₱960,000. What is the amount of Matobato Company’s
total assets at the end of the year? _______________

2. At the beginning of the year, the Owner’s capital of De Lima Company is ₱60,000 while its total
assets at the end of the year is ₱184,000. During the year, the owner withdrew cash for his
personal use amounting to ₱8,000 and the results of operations showed revenues of ₱150,000
and expenses amounted to ₱60,000. What is the amount of De Lima Company’s total liabilities at
the end of the year? _______________

3. The total assets of Trillanes Co. are ₱300,000 and its liabilities are equal to two-thirds of its total
assets. What is the amount of Trillanes Co.’s owner’s equity? ________________

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PROBLEM 7-6 EXPANDED ACCOUNTING EQUATION

In each of the independent cases given below, find the missing amount:

Aethan Co Bray Co Chenz Co Drenz Co Elmer Co

Beginning balances:
Assets 100,000 200,000 300,000 (4) 250,000
Liabilities 40,000 150,000 160,000 190,000 190,000
Ending balances:
Assets 215,000 258,000 283,000 284,000 (5)
Liabilities 90,000 130,000 170,000 170,000 80,000
During the year:
Net Income (Net Loss) (1) 50,000 25,000 (58,000) 30,000
Additional Investment 50,000 (2) 8,000 6,000 3,000
Drawings 5,000 12,000 (3) 60,000 40,000

Indicate the amounts here:

1. ________________
2. ________________
3. ________________
4. ________________
5. ________________

PROBLEM 7-7 ANALYZING TRANSACTIONS

Indicate whether the following statement is TRUE or FALSE:

______________1. Owner’s investment of cash to the business increases both asset and liability accounts.
______________2. Withdrawal of cash by the owner for personal use will decrease cash and owner’s
capital.
______________3. Rendering service to a client for cash will increase cash and revenue.
______________4. Rendering service to a client on credit will increase asset and liability at the same time.
______________5. Collection of accounts for a client previously billed increases asset.
______________6. Purchasing an equipment on credit will increase asset and expense.
______________7. Payment of expenses decreases both the cash and expenses.
______________8. Borrowing money from the bank increases both the cash and the revenue.
______________9. Payment of accounts payable decreases both the asset and liability.
______________10. Receipt of note from a client in settlement of his accounts receivable will have no effect
on the amount of the total asset of the business.
______________11. Issuance of a note to a supplier in settlement of the accounts payable decreases both the
notes payable and accounts payable at the same time.

PROBLEM 7-8 ANALYZING TRANSACTIONS-BASIC ACCOUNTING EQUATION

James Villamar Computer Company entered into the following transactions during April 2017:
______________1. Purchased computers for ₱200,000 from Enigma Co on account.
______________2. Paid ₱40,000 cash for April rent of the office space for the month.

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______________3. Received ₱150,000 cash from customers for contracts billed in March.
______________4. Performed computer services for Laranang Computer Company for ₱40,000 cash.
______________5. Paid the electric company ₱14,000 cash for energy usage in April.
______________6. James Villamar invested an additional ₱50,000 in the business.
______________7. Paid Enigma Co for the computers purchased in (1) above.
______________8. Incurred an advertising expense for April amounting to ₱21,000 on account.

Instruction: For each of the foregoing transactions, indicate the letter which best match the following
changes in the elements of financial statement of James Villamar Computer Company:

A. An increase in assets and a decrease in assets.

B. An increase in assets and an increase in owner’s equity.
C. An increase in assets and an increase in liabilities.
D. A decrease in assets and a decrease in owner’s equity.
E. A decrease in assets and a decrease in liabilities.
F. An increase in liabilities and a decrease in owner’s equity.
G. An increase in owner’s equity and a decrease in liabilities.

PROBLEM 7-9 ANALYZING TRANSACTIONS - BASIC ACCOUNTING EQUATION

Engineer Shackile Asuncion opened an engineering and design firm. His accountant prepared the
following transactions:
1 Shackile Asuncion, the owner, invested cash to the business, ₱150,000.
2 Shackile Asuncion, the owner, invested office equipment to the business amounting to, ₱60,000
Note: There is an unpaid balance to the supplier of the office equipment to which the company
assumed, ₱10,000.
3 Shackile Asuncion, invested additional cash to the business, ₱15,000
4 Paid the account in number 2, ₱10,000
Paid personal expenses of the owner because he is currently out of town. The owner will pay his
5 account when he returns in town, ₱3,000.
6 Bought two computer units for cash, ₱30,000.
7 Bought office furniture on credit, ₱12,000.
8 Rendered services to a client who paid in cash, ₱20,000.
9 Billed a client for services rendered, ₱12,000.
10 Rendered services to a client, ₱10,000. The client paid 40% cash and the balance in note.

Instruction: Identify the effect of the above transactions on the asset, liabilities and equity of the firm,
then indicate the appropriate amount. Use the following format:

Assets Liabilities Equity

Transactions Increase Decrease Decrease Increase Decrease Increase
No.
1
2
3
4
5
6

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Assets Liabilities Equity

Transactions Increase Decrease Decrease Increase Decrease Increase
No.
7
8
9
10

PROBLEM 7-10 ANALYZING TRANSACTIONS - EXPANDED ACCOUNTING EQUATION

Ghee Lando, a certified public accountant, opens an accounting firm. Transactions during the period
follow:
1 Gee Lando, the owner, invested cash to the business, ₱200,000.
2 Gee Lando, the owner, invested office equipment to the business, ₱60,000.
3 Borrowed money from a bank for the working capital of the business, ₱50,000.
4 Paid personal expenses of the owner because she is currently out of town. The owner will pay
her account when she returns in town, ₱5,000.
5 Bought office furniture on credit, ₱14,000.
6 Bought computer and printer costing ₱40,000, paying 30% of the total amount and the balance
on account.
7 Billed a client for services rendered, ₱30,000.
8 Rendered services to a client, ₱20,000. The client paid 40% cash and the balance on account.
9 The client in number 7 rendered repair services to the company’s computer equipment. The
amount is offset against his receivable, ₱30,000.
10 Billed another client for services rendered, ₱6,000.
11 The client in number 8 settled his balance, ₱12,000.

Instructions: Indicate the amount on the appropriate side of the affected elements of the above
transactions. Plus sign (+) for increase and minus sign (-) for decrease. Use the following format:

Assets Liabilities Capital Drawings Income Expenses

+ - - + - + + - - + + -
No. 1
No. 2
No. 3
No. 4
No. 5
No. 6
No. 7
No. 8
No. 9
No. 10
No. 11

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