COLLEGE OF ACCOUNTANCY

C-AE13: Financial Accounting and Reporting

First Semester | AY 2020-2021

Module 2

A. Course Code – Title : C-AE13: Financial Accounting and Reporting

B. Module No – Title : M02 – The Accounting Equation
C. Time Frame : 1 week (wk 2)– 6 hrs
D. Materials : Course Syllabus

1. Overview
This learning material provides a discussion of the accounting equation and
its elements. Illustrative transactions and their dual effects on the accounting
equation are also presented.
You should read clearly and understand well the topics explained herein.
It is also expected that you answer the assigned problems and exercises.

2. Desired Learning Outcomes

At the end of the learning session, you should be able to:
a) Discuss the accounting equation and its elements; and,
b) Analyze the dual effects of transactions or events on the accounting equation.

3. Content/Discussion
Lesson 1 – The Accounting Equation
Accounting is predicated on the concept that whatever the business owns,
it owes to others. What the business owns are its assets or resources; these resources
are owed to two sources: the suppliers or creditors and the owner/s. What is owed
to the suppliers or creditors is termed liabilities; what is owed to the owner is called
owner’s equity. This concept is expressed in the form of the accounting equation:

Assets = Liabilities + Owner’s Equity

Transactions may require additions (increases) to both sides (left and right
sides), subtractions (decreases) from both sides (left and right sides), or an addition
and subtraction on the same side (left or right side) (Ballada 2018). Every
transaction has a “dual effect”, which means that every transaction has at least two
self-balancing effects on the accounting equation, but in all cases, the assets must
always be equal to the liabilities + owner’s equity. In accounting, for every value
that is received, there is a corresponding or equal value that is parted with or given
up. These effects are analyzed in terms of “increases” and “decreases” in the assets,
liabilities and owner’s equity of the business entity.

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 COLLEGE OF ACCOUNTANCY
C-AE13: Financial Accounting and Reporting
First Semester | AY 2020-2021

Lesson 2 – Elements of the Accounting Equation

The elements of the accounting equation are:
a) Asset - a present economic resource controlled by the entity as a result of past
events. An economic resource is a right that has the potential to produce
economic benefits, such as the right to receive cash, goods or services, and rights
that do not correspond to an obligation of another party, such as rights over
physical properties and the right to use intellectual property.
An entity controls an economic resource if it has the ability to direct the use of
the economic resource and obtain the economic benefits that may flow from it.
It follows that, if one party controls an economic resource, no other party
controls that resource. (Ballada 2018) Examples are: Cash, Accounts Receivable,
Notes Receivable, Office Supplies, Store Supplies, Land, Building, Office
Equipment, Machinery, Furniture and Fixtures, Store Equipment, Service
Vehicles

b)Liability – a present obligation of an entity to transfer an economic resource as a

result of a past events. For a liability to exist, the entity must have an obligation
to transfer an economic resource, and the obligation exists as a result of past
events. An obligation is always owed to another party or parties, who could be
a person, a group of people, another entity or entities, or the society at large.
Obligations to transfer an economic resource may include, for example,
obligations to pay cash, to deliver goods or services, to exchange economic
resources with another party, among others. A present obligation exists as a
result of past events only if the entity has already obtained economic benefits
or taken an action, and, as a consequence, the entity may have to transfer an
economic resource that it would not otherwise have had to transfer. (Ballada
2018) Examples are: Accounts Payable, Notes Payable, Loans Payable, Taxes
Payable, Salaries Payable, Mortgage Payable. Note: Liability accounts often, but
not always, include the term “payable”, which means to be paid in the future.

c)Owner’s Equity – the residual interest of the owner in the enterprise after
deducting all its liabilities. In other words, they are claims against the entity that
do not meet the definition of a liability. The following elements affect owner’s
equity:
c.1) Income – increases in assets or decreases in liabilities that result in
increases in equity, other than those relating to contributions from
holders of equity claims. (Ballada 2018)Examples are: Tuition Fees
Income, Service Income, Professional Fees Earned, Sales, Admission
Fees Income, Rent Income, Interest Income

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 COLLEGE OF ACCOUNTANCY
C-AE13: Financial Accounting and Reporting
First Semester | AY 2020-2021

c.2) Expenses – decreases in assets or increases in liabilities that result in

decreases in equity, other than those relating to distributions to
holders of equity claims. (Ballada 2018) Examples are: Salaries
Expense, Taxes and Licenses, Repairs and Maintenance Expense,
Rent Expense, Water and Electricity Expense or Utilities Expense,
Advertising Expense, Communications Expense, Supplies Expense
or Supplies Used, Insurance Expense.

It follows from these definitions of income and expenses that contributions

from holders of equity claims or from the owners are not income, and
distributions to holders of equity claims or to the owners are not expenses.
(Ballada 2018)

Lesson 3 – Business Transactions and their Dual Effects on the Accounting

Equation
An accounting event is an economic occurrence that causes changes in an
entity’s assets, liabilities, and/ or equity. Events may be internal actions, such as
the use of materials for the production of goods or services, or the payment of
salaries to employees. It can also be an external event, such as the purchase of
equipment or supplies, or borrowing money from a bank. A transaction is an
exchange of values between two parties.

Illustrative example: The following transactions will be analyzed in terms of their

effects (increases or decreases) on the accounting equation.

Ms. Dina Abot decided to open a laundry shop and had it registered as “Labango
Laundromat” on June 01, 2020. During the month, various financial transactions
occurred. These transactions are described and the analysis of their effects on the
accounting equation are given.
Jun 1 – Ms. Abot started her new business by investing P300,000 cash in Labango
Laundromat.
The effects of this transaction are:

Explanation: An entity that is distinct and separate from Ms. Abot’s personal
affairs has been created. The business received a resource (asset) in the form of
cash, thus, there is an increase in the asset Cash. The source is the investment or
contribution of the owner, Ms. Abot; thus, there is an increase in the owner’s equity

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 COLLEGE OF ACCOUNTANCY
C-AE13: Financial Accounting and Reporting
First Semester | AY 2020-2021

account, Abot, Capital. The value received is the asset cash and the value parted
with is the owner’s claim or right. Ms. Abot now has a right or claim against the
assets of Labango Laundromat because she invested in or contributed cash to the
business.

Jun 2 – Three washing machine units costing P90,000 were bought at Home
Appliance Center. The business paid P45,000 and promised to pay the
balance in twenty days.

The effects of this transaction are:

Explanation: The transaction had three effects, a decrease of P45,000 in the asset
Cash because of the payment made, an increase of P90,000 in another asset
Laundry Equipment due to the acquisition of the washing machines, and the third
effect is the increase of P45,000 in the liability Accounts Payable (an oral promise
to pay made by the business to a third party, in this case, Home Appliance Center).
Observe that the net effect on the asset (left) side of the equation is P45,000
(P90,000-45,000), which is equal to the P45,000 effect on the right side. The value
received is the asset Laundry Equipment; the two values given up were the asset
Cash and the liability Accounts Payable. The supplier, Home Appliance Center
now has a claim or right against the business.

Jun 3 – Purchased laundry supplies, P10,000, for cash at WS Supermarket.

The effects of this transaction are:

Explanation: The effects of the transaction are both on the assets. The acquisition
of the laundry supplies caused an increase in the asset Laundry Supplies, while
the payment caused a decrease in the asset Cash. Therefore, the net effect on the
asset side is zero; the transaction did not affect the right side. The value received
is the asset Laundry Supplies, while the value given up is another asset, Cash.

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 COLLEGE OF ACCOUNTANCY
C-AE13: Financial Accounting and Reporting
First Semester | AY 2020-2021

Jun 6 – Received P15,000 cash for laundry services rendered to customers.

The effects of this transaction are:

Explanation: This transaction increased the asset Cash on the left side, because the
business received cash. The other effect is an increase in the owner’s equity, Abot,
Capital, because of the income earned, Service Income, when the business
rendered services. Always remember: The business earns its income whenever it
renders services and it is the income earned that causes the increase in the owner’s
equity account, not the receipt of cash. The value received is the asset Cash; the
value parted with is the services rendered that resulted in the income which
increased the owner’s claim or right against the business, Abot, Capital.

Jun 10- Rendered laundry services to a customer who promised to pay within five
days, P3,500.

The effects of this transaction are:

Explanation: This transaction increased the asset Accounts Receivable (oral

promise of a customer to pay at a future time); at the same time, because the
business rendered services again, service income was earned, thus increasing the
owner’s equity, Abot, Capital. The value received is the asset Accounts Receivable,
because the business now has a claim against the customer who promised to pay
within five days. The value parted with is the services rendered, which increased
the claim of the owner against the business.

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 COLLEGE OF ACCOUNTANCY
C-AE13: Financial Accounting and Reporting
First Semester | AY 2020-2021

Jun 15 – Received cash from the customer in the June 10 transaction because he
paid his account.

The effects of this transaction are:

Explanation: This transaction increased the asset Cash, because the business
received cash. The other effect is also on the assets, on Accounts Receivable, which
decreased because the customer in the Jun 10 transaction fulfilled his promise to
pay in five days, that is, today. Therefore, the business has no more claim against
this customer; this is the value parted with. Obviously, the value received is the
asset Cash.

Jun 17 – Bought another washing machine on credit, P30,000, from Home

Appliance Center, and promised to pay within thirty days.

The effects of this transaction are:

Explanation: This transaction increased the asset Laundry Equipment because the
business purchased an additional washing machine; hence, this is the value
received. On the other side, there was an increase in the liability Accounts Payable,
because the manner of acquisition of the washing machine is on credit. Therefore,
the business gave the supplier, Home Appliance Center, the right to or a claim
against the assets of the business; hence, this is the value parted with.

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 COLLEGE OF ACCOUNTANCY
C-AE13: Financial Accounting and Reporting
First Semester | AY 2020-2021

Jun 20 – A customer paid P4,000 for laundry services rendered by the business.

The effects of this transaction are:

Explanation: This transaction has exactly the same effects as the transaction on
June 6

Jun 22 – Paid its June 2 liability to Home Appliance Center.

The effects of this transaction are:

Explanation: This transaction caused a decrease in the asset Cash, because the
business made a payment; hence, this is the value parted with. The other effect is
a decrease in the liability Accounts Payable. This is the value received, because the
business received back the right it gave to Home Appliance Center in the June 2
transaction.

Jun 25 – A customer promised to pay after a week for laundry services rendered
by the business, P5,000.

The effects of this transaction are:

Explanation: The analysis of this transaction is the same as the June 10 transaction.

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 COLLEGE OF ACCOUNTANCY
C-AE13: Financial Accounting and Reporting
First Semester | AY 2020-2021

Jun 28 – Paid water and electric bills (utilities) for the month, P2,500.

The effects of this transaction are:

Explanation: This transaction caused a decrease in the asset Cash, because of the
payment; thus, this is the value parted with. The business already used or
consumed the electricity and water that it paid for, so this resulted in an expense,
Utilities Expense, which decreased the owner’s equity or claim against the
business. The utilities consumed is therefore the value received. (Remember: An
expense always decreases owner’s equity; in this case, Abot, Capital)

Jun 29 – Paid rent for the month, P3,000.

The effects of this transaction are:

Explanation: This transaction caused a decrease in the asset Cash, the value parted
with, because of the payment. The value received is the use of the space for the
whole month of June, but which has already expired; therefore, it is now
considered as an expense, Rent Expense, which caused a decrease in the owner’s
equity, Abot, Capital.

Jun 30 – The owner, Ms. Abot, withdrew P2,000 cash from the business for her
personal use.

The effects of this transaction are:

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 COLLEGE OF ACCOUNTANCY
C-AE13: Financial Accounting and Reporting
First Semester | AY 2020-2021

Explanation: This transaction caused a decrease in the asset Cash, the value parted
with, because of the cash taken by the owner. The value received is the decrease
in the claim or right of the owner against the business assets; thus, there is a
decrease in the owner’s equity, Abot, Capital.

Jun 30 – Of the laundry supplies bought, P4,000 was used in rendering laundry
services for the month.

The effects of this transaction are:

Explanation: This transaction caused a decrease in the asset Laundry Supplies, the
value parted with, because the laundry supplies were used or consumed in the
course of rendering laundry services, and therefore the entity does not expect to
benefit anymore from these used supplies. The value received is the use of the
laundry supplies, but which no longer have a value, and therefore, have now
become an expense, causing a decrease in the claim or right of the owner against
the business assets; thus, there is a decrease in the owner’s equity, Abot, Capital.

4. Progress Check
a) Define the accounting equation, and briefly describe its elements.
b) Explain the meaning of “dual effects of a transaction”.

5. Assignment
a) Read Chapter 2 of your textbook.
b) Answer the following end-of- Chapter 2 problems:
Probs. 1A, 1B & 1C, 6, 7, 8 & 10

6. Assessment

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 COLLEGE OF ACCOUNTANCY
C-AE13: Financial Accounting and Reporting
First Semester | AY 2020-2021

On May 1 of the current year, Mike Jordan established Luzon Bus Lines. The
following are the transactions for the month:
May 1 The owner invested P10,000,000 cash in the business
2 Secured business permit and paid taxes and licenses, P5,000.
Purchased five second-hand buses, P5,000,000, by giving a 50% down
4 payment, and signing a promissory note for the balance
6 Purchased for cash a computer set for use in the office, P35,000.
9 Bought office supplies for cash, P15,000 .
12 Acquired furniture and fixtures, P50,000, on credit from Home World.
13 Paid for advertisements, P12,000.
14 Passenger fares collected amounted to P235,000.
15 Paid the salaries of drivers, conductors and clerk, P125,000.
UA hired two buses for an educational trip to Bataan, P120,000. UA paid
18 50% and promised to pay the balance in ten days.
20 Paid for gas and oil of the buses, P30,000.
21 Passenger fares for one week, P 180,000.
23 Paid one-half of its liability to Home World.
The owner withdrew or took P10,000 from the cash of the business for
25 his personal use.
27 UA paid in full its remaining balance of P60,000.
28 Received and paid the electric and water bills for the month, P8,000.
29 Paid for the rental of its terminal, P15,000.
30 Paid the salaries of the clerk, drivers and conductors.
31 Passenger fares until the end of the month, P310,000.

Required:
a) Analyze the given transactions and determine their effects on the
accounting equation, using the tabular form similar to that in the illustrative
problem. Use the following account titles: Cash; Accounts Receivable; Office
Supplies; Furniture and Fixtures; Office Equipment; Transportation
Equipment; Accounts Payable; Notes Payable; Jordan, Capital; Jordan,
Drawing; Passenger Fares Income; Taxes and Licenses; Advertising
Expense; Salaries Expense; Gas and Oil Expense; Rent Expense; Utilities
Expense.
b) Determine the balances of all the accounts after the last transaction. Prove
the accounting equation.
c) Submit the requirements within an hour.

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 COLLEGE OF ACCOUNTANCY
C-AE13: Financial Accounting and Reporting
First Semester | AY 2020-2021

7. References

Manuel, Zenaida Vera-Cruz (2018) 21st Century Accounting Process, Basic Concepts
and Procedures, Manila, Philippines: Zenaida Vera-Cruz Manuel.

Ballada, Win. (2020) Basic Financial Accounting and Reporting, Cavite, Philippines:
Dom Dane Publishers & Made Easy Books.

Cabrera, Ma. Elenita B. & Cabrera, Gilbert Anthony B. (2018) Financial Accounting
and Reporting, Manila, Philippines: GIC Enterprises & Co., Inc.

Ferrer, Rodiel C. & Millan, Zeus Vernon B. (2017) Fundamentals of Accountancy,

Business and Management, Part 1, Baguio City, Philippines: Bandolin Enterprise.

Warren, Carl S., Reeve, James M., & Duchac, Jonathan E. ((2015) Accounting 25th
Edition, Pasig City, Philippines: Cengage Learning Asia Pte Ltd (Philippine
Branch).

Gilbertson, Claudia B., Lehman, Mark W., & Gentene, Debra H. (2017) Century 21
Accounting Multi-column Journal 10th Edition, Boston, MA 02210 USA: Cengage
Learning.

Wild, John; Kwok, Winston; Venkatesh, Sundar; Shaw, Ken W. & Chiappetta,
Barbara. (2016) Fundamental Accounting Principles 2nd Edition, 2 Penn Plaza, New
York: McGraw-Hill Education.

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