ACCOUNTING

EQUATION AND
THE FIVE MA JOR
ACCOUNTS
LESSON 2
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 MOST ESSENTIAL LEARNING
COMPETENCIES
Discuss the five major accounts
Illustrate the accounting equation
Perform operations involving simple cases with the use of accounting equation
Analyze common business transactions using the rules of debit and credit
Solve simple problems and exercises in the analyses of business transaction

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 The Five Major Accounts

• Asset
• Liability
• Owner’s Equity
• Income
• Expenses
 ASSET

It is a resource controlled by the enterprise as a result of past events

and from which future economic benefits are expected to flow to the
enterprise.
Examples:
a. Cash and cash equivalents
b. Trade and other receivables
c. Inventories
d. Property, plant and equipment

Current Asset
 Expected to be realized within the entity’s normal operating
cycle or within 12 months after balance sheet date
 For trading
 Unrestricted cash and cash equivalents for at least 12
months after the balance sheet date.

Non-current Asset
 All other assets – Noncurrent Assets
 LIABILITY

It is a present obligation of the enterprise arising from past events.

The settlement of which is expected to result in an outflow of
resources from the enterprise embodying economic benefits.
Examples:
a. Trade and other payables
b. Provisions
c. Financial liabilities
d. Liabilities for taxes

Current Liability
 Expected to be settled in the entity’s normal operating cycle
or within 12 months after the balance sheet date
 For trading
 No unconditional right to defer settlement for at least 12
months after the balance sheet date.

Non-current Liability
 All other liabilities – Noncurrent Liabilities
 EQUITY

It is the residual interest or remainder of the asset of the enterprise

after deducting all its liabilities.
Examples:
a. Owner’s Capital
b. Withdrawals
c. Income Summary
INCOME
These are increases in economic benefits during the accounting
period in the form of inflows or enhancements of assets or decreases
of liabilities that result in increases in equity; other than those relating
to contributions from equity participants.

EXPENSES
These are decreases in economic benefits during the accounting
period in the form of outflows or depletions of assets or incidences of
liabilities that result in decreases in equity; other than those relating to
distribution to equity participants.
 The Basic Accounting Equation

Financial statements tell us how a business is performing. They are the

final products of the accounting process. But how do we arrive at the
items and amounts that make up the financial statements? The most
basic tool of accounting is the accounting equation This equation presents
the resources controlled by the enterprise, the present obligations of the
enterprise and the residual interest in the assets. It states that assets
must always equal liabilities and owner's equity.
The Basic Accounting Equation
 The Basic Accounting Equation

ASSET = LIABILITIES + OWNER’S EQUITY

Note that the assets are on the left side of the equation opposite the
liabilities and owner's equity. This explains why increases and decreases
in assets are recorded in the opposite manner ("mirror image") as
liabilities and owner's equity are recorded. The equation also explains why
liabilities and owner's equity follow the same rules of debit and credit.

The logic of debiting and crediting is related to the accounting equation.

Transactions may require additions to both sides (left and right sides),
subtractions from both sides left and right sides), or an addition and
subtraction on the same side (left or right side but in all cases the equality
must be maintained as shown below:
EXERCISE:

Asset Liability Equity

1. 500,000 200,000 ?
2. 850,000 ? 400,000
3. ? 600,000 300,000
4. 1,800,000 1,850,000 ?
5. 2,300,000 ? 1,300,000
DEBITS AND CREDITS - THE DOUBLE-
ENTRY SYSTEM
• Accounting is based on a double-entry system which means that the dual effects of a business
transaction is recorded.
• A debit side entry must have a corresponding credit side entry. For every transaction, there
must be one or more accounts debited and one or more accounts credited.
• Each transaction affects at least two accounts.
• The total debits for a transaction must always equal the total credits.
• An account is debited when an amount is entered on the left side of the account and credited
when an amount is entered on the right side.
• The abbreviations for debit and credit are Dr. (from the Latin debere) and Cr. (from the Latin
credere), respectively.

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DEBITS AND CREDITS - THE DOUBLE-
ENTRY SYSTEM
• The account type determines how increases or decreases in it are recorded. Increases in assets are recorded as
debits (on the left side of the account) while decreases in assets are recorded as credits (on the right side).

• Conversely, increases in liabilities and owner's equity are recorded by credits and decreases are entered as debits.

• The rules of debit and credit for income and expense accounts are based on the relationship of these accounts to
owner's equity. Income increases owner's equity and expense decreases owner's equity. Hence, increases in income
are recorded as credits and decreases as debits. Increases in expenses are recorded as debits and decreases as
credits.These are the rules of debit and credit.

• SHORTCUT!! “DEAD-CLIC”

• Normal balance is DEBIT: DEAD (DEBIT: Expenses,Asset, Drawings)

• Normal balance is CREDIT: CLIC (CREDIT: Liability, Income, Capital)

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TYPES AND EFFECTS OF
TRANSACTIONS
• It will be beneficial in the long-term to be able to understand a classification approach that
emphasizes the effects of accounting events rather than the recording procedures involved.
• This approach is quite pioneering. Although business entities engage in numerous transactions,
all transactions can be classified into one of four types, namely:
1. Source of Assets (SA). An asset account increases and a corresponding claims (liabilities or
owner's equity) account increases. Examples: (1) Purchase of supplies on account; (2) Sold goods
on cash on delivery basis.
2. Exchange of Assets (EA). One asset account increases and another asset account
decreases. Example: Acquired equipment for cash.

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TYPES AND EFFECTS OF
TRANSACTIONS
3. Use of Assets (UA). An asset account decreases and a corresponding claims (liabilities or
equity) account decreases. Example: (1) Settled accounts payable; (2) Paid salaries of employees.

4. Exchange of Claims (EC). One claims liabilities or owner's equity) account increases and
another claims liabilities or owner's equity) account decreases. Example: Received utilities bill but
did not pay.

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• Every accountable event has a dual but self-balancing effect on the accounting equation.
Recognizing these events will not in any manner affect the equality of the basic accounting
model. The four types of transactions above may be further expanded into nine types of effects
as follows:
• 1 Increase in Assets = Increase in Liabilities (SA)
• 2. Increase in Assets = Increase in Owner's Equity (SA)
• 3. Increase in one Asset = Decrease in another Asset (EA)
• 4. Decrease in Assets = Decrease in Liabilities (UA)
• 5. Decrease in Assets = Decrease in Owner's Equity (UA)
• 6. Increase in Liabilities = Decrease in Owner's Equity (EC)
• 7. Increase in Owner's Equity = Decrease in Liabilities (EC)
• 8.Increase in one Liability = Decrease in another Liability (EC)
• 9. Increase in one Owner's Equity = Decrease in another Owner's Equity (EC)

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EXAMPLES:

• 1. Abby started her new business named ABC Store, she invested P350,000.
• 2. ABC Store purchase a computer equipment costing P145,000 paid in cash.
• 3. ABC store purchased on account a computer supplies in the amount of P25,000.
• 4. ABC store paid salaries to their employees in the amount of P30,000.
• 5. ABC Store received their electric bill amounting to P10,000 to be paid next week.

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ANSWERS:
Type of Asset Liability Equity
Transaction
1. Source of +350,000 No effect +350,000
Asset (SA)
2. Exchange of +145,000 No effect No effect
Assets (EA) -145,000
3. Source of +25,000 +25,000 No effect
Asset (SA)
4. Use of Asset -30,000 -30,000 No effect
(UA)
5. Exchange of No effect +10,000 -10,000
Claims (EC)
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REFERENCES AND WEBSITE LINKS USED
IN THIS LESSON:
• Ballada, Win; Ballada, Susan. (2015). Basic Accounting. Ballada, Win and Ballada, Susan.
• Frias, S., & Pefianco, E. (2016). Fundamentals of Accounting, Business and Management 2. Quezon:
The Phoenix Publishing House, Inc.

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