CHAPTER 3

The Accounting Equation

LESSON 3-1: EFFECTS OF OWNER’S INVESTMENT/ WITHDRAWAL AND CASH ACQUISITION OF

ASSETS
Lesson Objective
 Identify the effects of transaction on the assets and owner’s equity as a result of
owner’s investment/ withdrawal and cash acquisition of assets
ILLUSTRATION
The effect of the following transactions on the asset and owner’s equity:
Transaction Asset Liabilities Owner’s Equity Analysis
1. Owner invests Assets Capital Cash increases because owner
cash in the Increase Increases invests cash in the business
business which is an asset. Owner’s
interest in the business
increases as represented by an
increase in capital.
2. Owner invests Assets Capital Assets increase because owner
furniture Increase Increases invests furniture in the
business which is an asset.
Owner’s interest in the
business increases because of
the investment as represented
by an increase in capital.
3. Owner withdraws Assets Capital Assets decrease because
cash for personal Decrease Decreases owner withdraws cash which is
use. an asset. Owner’s interest in
the business decrease because
of the withdrawal as
represented by a decrease in
capital.
4. Owner purchases Asset Increase Supplies increase because of
supplies using and Decrease the purchase but cash
cash decrease because of the
payment. Since both are
assets, one asset increases
while another asset
correspondingly decreases.
 5. Owner gets Asset Increase Cash increase because of the
refund for and Decrease refund but supplies decrease
returning because of the return. Since
damaged supplies both are assets, one asset
bought on cash. increases while another asset
correspondingly decreases.
6. Owner purchases Asset Increase Furniture increase because of
furniture using and Decrease the purchase but cash
cash decrease because of the
payment. Since both are
assets, one asset increases
while another asset
correspondingly decreases.
7. Owner makes Assets Capital Assets increase because owner
additional cash Increase Increases invests additional cash in the
investment business which is an asset.
Owner’s interest in the
business increases because of
the investment as represented
by an increase in capital.
8. Owner withdraws Asset Decrease Capital Assets decrease because
supplies for Decreases owner withdraws supplies
personal use from the business which is an
asset. Owner’s interest in the
business decrease because of
the withdrawal as represented
by a decrease in capital.

LESSON 3-2: EFFECTS OF INCOME EARNED AND PAYMENT OF EXPENSES

Lesson Objective
 Identify the effects of transactions on the assets and owner’s equity as a result of
income earned and payment of expenses
ILLUSTRATION
The effect of the following transactions on the asset and owner’s equity:
Transaction Asset Liabilities Owner’s Equity Analysis
1. Rendered services for Assets Capital Increases Assets increase because
cash. Increase owner collected cash as a
result of services
rendered. Owner’s equity
 increases because the
business earned income
for services rendered.
2. Rendered Services on Assets Capital Increases Assets increase because
credit Increase of account collectible
from the customer which
is an asset as a result of
services rendered.
Likewise, owner’s equity
increases because of
income earned from
services rendered.
3. Paid telephone bill Assets Capital Assets decrease because
Decrease Decreases owner pays cash for the
telephone bill. Owner’s
equity decreases because
the telephone bill
represents utilities
expense which decreases
capital.

LESSON 3-2: EFFECTS OF TRANSACTIONS ON THE ACCOUNTING EQUATION

Lesson Objective
 Identify the effects of transactions on the assets, liabilities, and owner’s equity as a
result of different transactions affecting the accounting equation
 Analyze the different transactions in the service type of business
The following table will illustrate the effect of transactions on the accounting equation. The
abbreviations in the examples shall mean the following:
INC – Increase
DEC – Decrease
NC – No Change
The following details will include the amount and the account affected in illustrating the effects
on the asset equation. Notice that the accounting equation is always balanced in every
transaction such that assets are always equal to liabilities and capital.
Transaction Assets Liabilities Capital Analysis
1. Ms. Go INC NC INC The P800,000 investments
invests cash. of Ms. Go increases the
CASH Ms. Go, Capital
P800,000 cash of the business and
 P800,000 P800,000 the capital of the owner.
2. Ms. Go INC NC INC The P50,000 equipment
invests increases the assets of the
Equipment Ms. Go, Capital
equipment. business. Since this is an
P50,000 P50,000 P50,000 investment of Ms. Go, her
capital correspondingly
increases.
3. Renders INC NC INC The business earns
P25,000 P25,000 by rendering
Cash Service Income
services for services and collecting
cash P25,000 P25,000 revenues in cash. The
effect in the accounting
equation is an increase of
P25,000 in cash for the
cash collected and a
P25,000 increase in capital
as revenue increases in
capital.
4. Renders INC NC INC Assets increase by P9,000
P9,000 which is the amount of
Accounts Service Income
services in revenue expected to be
Receivable
credit P9,000 collected from the
P9,000 customer to whom the
services were rendered.
Capital increased by
P9,000 since rendering of
service represents
revenue.
5. Collects INC NC NC Assets increase by P9,000
amount in as there is cash inflow in
Cash
transaction the amount of collection.
#4 P9,000 However, assets
DEC correspondingly decrease
by and equal amount since
Accounts the accounts receivable,
Receivable which is an asset account,
P9,000 decreases. This is because
the amount the customer
owes has already been
collected.
6. Purchases INC INC NC Supplies increase the
 P1,000 Supplies Accounts assets of the business by
supplies on Payable P1,000. Liabilities
P1,000
credit correspondingly increase
P1,000
by P1,000 as the supplies
were bought on account or
credit.
7. Returns DEC DEC NC Assets decrease by P120
P120 which is the amount of
Supplies Accounts
defective supplies returned.
Payable
supplies P120 Liabilities correspondingly
P120 decrease by P120 as the
returned supplies decrease
the amount owed.
8. Pays the DEC DEC NC The transaction is a
supplies payment of an account.
Cash Accounts
bought on Supplies purchased in
Payable
account or P880 transaction #6 amount to
credit P880 P1,000. However,
defective supplies in the
amount of P120 was
returned in transaction #7.
Hence, the remaining
liability to be paid is P880.
There is a cash outflow of
P880 upon payment.
Because of this, assets
decrease by P880.
Likewise, liabilities
decrease in the same
amount as the P880
liability on supplies was
paid.
9. Borrows INC INC NC Cash increases the asset of
P90,000 the business because the
Cash Notes Payable
cash issuing business borrowed
a note P90,000 P90,000 P90,000. Notes Payable
increases the liabilities of
the business by P90,000 as
it represents and
obligation on the part of
the business to pay
P90,000 at a future date.
10. Purchases INC NC NC Land increases the asset of
P500,000 the business by P500,000.
Land
land paying Cash correspondingly
cash P500,000 decreases by P500,000
DEC with the cash paid for the
purchase of land.
Cash
P500,000
11. Pays utilities DEC NC DEC Payment represents cash
expense for outflow decreasing the
Cash Utilities Expense
the month, asset of the business by
P800 P800 P800 P800. Likewise, expenses
decrease the capital by
P800 as they have
opposite effect on income.
12. Pays the DEC DEC NC The transaction is a
note in full P90,000 payment of
Cash Accounts
liability. Since there is cash
Payable
P90,000 outflow representing the
P90,000 payment of the note,
assets decrease by
P90,000. Liabilities likewise
decrease by P90,000 which
is the amount of cash
settlement for the notes
payable