CHAPTER VII

THE ACCOUNTING EQUATION

Accounting is governed by a fundamental accounting equation that shows the relationship of the three accounting elements,
namely, ASSET, LIABILITY and EQUITY. This equation presents the resources of the business (Assets) and the sources or of the claims
to these resources (Equities).

Therefore, ASSET = EQUITY

Equities may be subdivided into two principal types:

1. The rights of Creditors (Liabilities)
2. The rights of Owners (Capital)

Therefore, ASSET = LIABILITY + CAPITAL

Note: For purposes of discussion, the accounting equation to be used will be:

ASSET = LIABILITY + EQUITY

Equity has four components:

Increased by (+) Decreased by (-)

Investments Withdrawals
Income/ Revenue Expense

Therefore, the EXPANDED ACCOUNTING EQUATION is:

ASSET = LIABILITY + INVESTMENT – WITHDRAWAL + REVENUE - EXPENSE

There are nine (9) possible two-fold effects on these elements, as follows
Legend:
A = Assets; L = Liabilities; E = Equity; ↑/↓ = Increase/ Decrease

↑A = ↑E
↑A = ↑L
↑A = ↓ other forms of A
↓A = ↓L
↓A = ↓E
↓L = ↑E
↓L = ↑ other forms of L
↓E = ↑L
↓E = ↑ other forms of E

RULES ON DEBIT AND CREDIT

I. DEBIT
- Came from the word debitum meaning “what is due”
- Abbreviated as DR
- Theories:
a) DR came from the latin past participle of debitum which is debere.
b) DR means “debit record”
II. CREDIT
- Came from the word creditum meaning “something entrusted to another or a loan”
- Abbreviated as CR
- Theories:
a) CR came from the latin past participle of creditum which is credere.
b) CR means “credit record”

The rules for debit and credit are designed so that every transaction is recorded by equal peso amounts each.
LEFT SIDE RIGHT SIDE
A = L+E
Normal Balance Vr = Vg Normal Balance
DEBIT (DR) = CREDIT (CR)
Notes:
1. To debit an account means to enter an amount on the left side of the account.
2. To credit an account means to enter an amount on the right side of the account.