*based on Sole Proprietorship [and partnership (Vicky)]

*cannot be applied sa Corporation [Vicky]

THE [BASIC] ACCOUNTING EQUATION

Assets = Liabilities + Owner’s Equity

[If Math has the basic arithmetic operations (addition, subtraction, division, and
subtraction), accounting has a foundation, which is the basic accounting
equation.]

 [The basic accounting equation illustrates that the two parties, liabilities and
owner’s equity, can claim the assets.]

• provides underlying framework for recording and summarising economic events

• assets are claimed by either creditors or owners [The creditors (liabilities) and
owners can make claims over the assets.]

• if a business is liquidated ([magsasara na]), claims of creditors (liabilities) must

be paid before ownership claims (owner’s equity) [kapag magsasara na ang
business, i-di-distribute na ang assets sa mga may-ari. Palaging mauunang
makakatanggap si creditors. The claims of creditors come first.]

Assets

- resources a business owns [These are the resources that we expect to provide
future benefits or services to the business.]

- provide future services or benefits

- e.g., cash [you can buy additional assets; that’s your benefit], supplies [like bond
papers where you print your business documents], equipment [like refrigerators in
sari-sari stores where the owner stores the beverages; therefore, refrigerator
brings the future benefit], etc.

Liabilities

- claims against assets (debts and obligations) [utang sa creditors]

- creditors (party to whom the money is owned [is called creditors])

- [Liabilities represent the portion of assets owned by the creditors.]

- e.g., accounts payable [trade payables usually from the operations of a company,
so it is a debt (i.e. a sari-sari store tells the customer to pay the products next
week)], notes payable [debts that have promissory notes in which the debt exceeds
a duration of one month (e.g. “I promise to pay after three months.”], salaries and
wages payable [if you are not yet paying the salaries of your employees], etc.

Owner’s Equity

[represents the claim of the owner itself doon sa assets of the business]

- ownership claim on total assets

- referred to as residual equity [“residual” because the owner gets to possess the
remaining or residual portion of the assets after distributing the assets to the
liabilities]

- investment by owner’s and revenues (+) [investment of the owner like cash or any
other asset to the business, h/she increases the ownership in the business (or
increases owner’s equity). Kapag kumite ang business, lumalaki ang kita ng
owner, so the effect of the revenue is positive.]

- drawings and expenses (-) [Drawings are the owner’s withdrawal of money from
the business (e.g. for personal use). Expenses happens when the business spends
for paying its expenses. They have negative effects in the owner’s equity.].

Expanded Accounting Equation

Assets = Liabilities + Owner’s Capital - Owner’s Drawings + Revenues - Expenses

[The Owner’s Equity is affected by investments, revenues, expenses, and

drawings.]
[The transactions that] Increase in Owner’s Equity

a. Investment by owner — assets owner puts into business [Owner’s capital;

Additional assets that the owner puts into the business (e.g. cash to the sari-sari
store)]

a. Revenues — increases in assets or decreases in liabilities resulting from sale of

goods or performance of services in normal course of business [i.e. nagbenta sa
sari-sari store mo ng chips (Php 50.00), ang binayad sa ‘yo na 50 increases the
cash of the business, thereby becoming a revenue that goes straight to the
owner’s equity.].

Decrease in Owner’s Equity

a. Drawings — withdrawal of cash or other assets for personal use [i.e. ‘yung ref
na ginagamit mo for the sari-sari store, nasira ang ref ng bahay n’yo at wala
kayong mapagbilihan ng ref dahil pandemic. So ‘yung ref ng business n’yo,
inilipat n’yo sa bahay. Vicky: ‘Yung printer ng business, inilipat mo sa bahay para
palitan muna ang nasirang printer kasi hindi mo naman siya binayaran. Any item
that you use in a shop for your own personal use is considered a withdrawal.].

b. Expenses — cost of assets consumed or services used in the process of earning

revenue [For example, your sari-sari store is operating with the ref. The ref
consumes electricity and you need to pay it (Vicky: utilities expense). Kapag
nagbayad, mababawasan ang cash; ibig sabihin, mababawasan ang pag-
mamay-ari mo o ang ownership claim sa business.].
Analyzing Business Transactions [determining which transactions should be
recorded by the business]

[The whole accounting cycle is shown in the image below where analyzing business
transactions is the first step.]

1. Analyze Business Transactions 6. Adjusted Trial Balance

2. Journalize 7. Financial Statements

3. Post 8. Closing Entries

4. Trial Balance 9. Post-Closing Trial Balance

5. Adjusting Entries

Transactions are a business’s economic events recorded by accountants

• may be internal or external [For example, you have a laundry shop. The external
transactions would be buying detergent supplies from suppliers or buying a
laundry machine. An internal transaction would be using the detergent supplies
to perform the service of washing clothes.]

• not all activities represent transactions [like the voluntary carrying of box in the
first lesson; not recorded in the business]

• [The characteristic of transactions is that they] have a dual effect on the

accounting equation
Illustration: Are the following events recorded in the accounting records?

Solution:

[Ang ni-re-record lang natin as business transactions in our accounting records

are events which have an effect in either assets, liabilities, or owner’s equity.]

Event Purchase Discuss product Pay rent

computer design with
potential
[Does this have an customer
effect in assets,
liabilities, or
owner’s equity?]
Criterion Is the financial position (assets, liabilities, or owner’s equity)
of the company changed? [This is the main criterion.]
Record/Don’t Yes No Yes
Record
[The asset of the [Using the [If you pay a rent,
business monetary unit the owner’s equity
increased by assumption, we decreases
purchasing the do not have a because you have
computer (Gen: transaction an expense.
computer gives expressed in Expenses is a
future benefit or terms of money.] ‘minus’ in our
 service) and, at owner’s equity
the same time, found in the
decreased accounting
because you have equation. Thus,
to pay w/ cash the assets also
(Vicky: …and cash decreased
is an asset itself. because you spent
Remember that) cash.]

Transaction Analysis

Dual Effect of Transactions on the Accounting Equation

- increase/decrease on one side, will have a corresponding effect on the other side
of the equation to maintain balance

- e.g., increase of asset by 50k, increase of OE (Vicky: Owner’s Equity) by 50k

Expense

- consumption of assets - use of services in the business

Summary of Transactions

1. Each transaction analysed in terms of effect on

a. Three components of basic accounting equation

• Assets

• Liabilities

• Owner’s Equity

b. Specific types of items, such as Cash, Receivables, etc.

2. Two sides of equation must always be equal

Practice: Dual Effect on Transactions, Accounting Equation