COLLEGE OF ACCOUNTANCY AND BUSINESS ADMINISTRATION

FINANCIAL ACCOUNTING AND

REPORTING

PROF. ADRIAN A. ILAGAN, CPA, MBA

FINANCIAL ACCOUNTING AND REPORTING 1

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Lesson 2
THE ACCOUNTING EQUATION

Learning Objectives:
At the end of the lesson, you should be able to:
 Use with proficiency the accounting equation.
 Explain the fundamental accounting concepts and principles.

Lesson Overview:

The most basic tool of accounting is the accounting equation. It presents the
resources controlled by the entity, its present obligations and the residual interest in
the asset. The accounting equation states that assets must always equal liabilities
and owner’s equity.

FINANCIAL ACCOUNTING AND REPORTING 2

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Engagement

How much money do you have in your wallet? Can you write it down on the blank
above the “asset” portion?

Asset = Liabilities + Equity

How did you get the money? Did you owe it from someone? Or did you earned it?
The manner you get the money will determine which part of the equation you have
to fill in to make it equal.

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Explore
Elements of Financial Statements
The elements of financial statements defined in the Conceptual Framework
for Financial Reporting are:
 Assets, liabilities and equity – relate to a reporting entity’s financial
position; and
 Income and expenses – relate to a reporting entity’s financial performance.

Element Definition or Description

Asset A present economic resource controlled by the entity as a result of
past events. An econimic resource is a right that has the potential to
produce economic benefits.
Liability A present obligation of the entity to transfer an econimic resource as
a result of past events.
Equity The residual interest in the assets of the entity after deducting all its
liabilities.
Income Increases in assets, or decreases in liabilities, that result in increases
in equity, other than those relating to contributions from holders of
equity claim.
Expenses Decreases in assets, or increases in liabilities, that result in decreases
in equity, other than those relating to distributions to holders of equity
claim.

The Rules of Debit and Credit

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. Each transaction affects at least two accounts and
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.

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The illustrations below summarize the rules on debits and credits:

Normal Balance of an Account

The normal balance of an account refers to the side of the account – debit or
credit – where increases are recorded. Assets and expense accounts normally have
debit balances while liabilities, owner’s equity and income accounts normally have
credit balances.

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Explain and Extend

NAME: _______________________________________________ SCORE: ______________
COURSE: _____________________________________________ DATE: _______________
In your own words, answer briefly the following questions.
1. What are assets?
________________________________________________________________________
________________________________________________________________________
________________________________________________________________________
__________________.

2. What are liabilities?

________________________________________________________________________
________________________________________________________________________
________________________________________________________________________
__________________.

3. Describe the normal balance of an account.

________________________________________________________________________
________________________________________________________________________
________________________________________________________________________
__________________.

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EVALUATE

NAME: _______________________________________________ SCORE: ______________

COURSE: _____________________________________________ DATE: _______________

True or False
1. Assets need not arise from past events.
2. The normal balance refers to the side of an account where
increases are recorded.
3. In applying the accounting equation, it can be said that
liabilities equal assets minus equity.
4. An account is credited when an amount is entered on the left
side of the account.
5. In double-entry system, each transaction affects at least two
accounts.
6. Liabilities are present obligations of the entity and are a
result of past events.
7. The normal balance of an account can either be debit or
credit.
8. When an asset account is credited, the account is being
decreased.
9. Assets, liabilities and equity relate to a reporting entity’s
financial position.
10.Assets must be owned by the entity.

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