Fundamentals of

Accountancy,
Business and
Management 1
 Lesson 7:
ACCOUTING
EQUATION
 The accounting equation
• Every business transactions affects two or more
accounting elements.

Basic Rule to Remember

 The accounting equation

ASSETS LIABILITIES EQUITY

 Example:
• Jocelyn, the proprietor of the laundry shop
bought laundry equipment to be used in the
business amounting to 50,000.00 in cash.
ASSETS EQUITY
LIABILITIES
(50,000.00) (50,000.00)
 Example:
• Lets assume , however Jocelyn will make a down payment of
20,000.00 and the balances is payable in 3 equal installment
payments.

In equation, the transaction will appear as follows;

ASSETS LIABILITIES EQUITY

(50,000.00) (30,000.00) (20,000.00)
 Example:
• Hence, if Jocelyn bought the laundry equipment on
credit, then the equipment is basically owned by the
creditor.

In equation, the transaction will appear as follows;

ASSETS LIABILITIES
EQUITY
(50,000.00) (50,000.00)
• If one of the equation is unknown, the missing element
maybe computed by manipulating the equation as
follows:
ASSETS
LIABILITIES EQUITY

ASSETS EQUITY LIABILITIES

 The expanded
accounting equation
 The expanded accounting equation
• When the business is initially formed through the initial
investment of the owner or owners, the accounting
equation is very simple, that is the assets of the business is
equal to the investment of the owner or owners.
ASSETS EQUITY
 The expanded accounting equation
• Once the business has acquired its legal personality, it’s
start to carry different business transactions which
ultimately affect the 3 major accounting elements – the
ASSETS, LIABILITIES and CAPITAL. Because of the different
transactions, the fundamental accounting equation will
expand as a result of the following transactions:
 The expanded accounting equation
• Incurrence of liability
• Realization of revenue
• Incurrence of expenses and losses
• Additional investment of the owners
• Temporary withdrawal of capital of owner
 1. Incurrence of liability
• when the business incurs liability, the
accounting equation will appear as
follows:
ASSETS LIABILITIES CAPITAL
 2. Realization of revenue
• A business entity undertakes transactions
that promotes realization of revenue by
selling products or rendering services.
INCOME/
ASSETS CAPITAL
REVENUE
 3. Incurrence of expenses and losses
• After the formation of business, it starts to
incur expenses related to its operation like
payments of salaries, light and water.
ASSETS CAPITAL EXPENSES
 4. Additional investment of the owners
• A business normally grows and expand its
operation. This usually requires additional funds to
support the growth and expansion.
ADDITIONAL
ASSETS CAPITAL
INVESTMENTS
 5. Temporary withdrawal of capital of owner
• Business owners, most especially in sole
proprietorship and partnership, are the ones
handling the day to day operation of the
business.
ASSETS CAPITAL WITHDRAWAL
The expanded accounting equation
ASSETS

Additional Income/
LIABILITIES Capital
Capital revenue

Withdrawal Expense
The rules of debit
and credit
Business transactions are classified in the following manner
in relation to their effects on the accounting values
Classification 1: increase in asset may result in increase in
capital.
Classification 2: Increase in assets may increase in liabilities.
Classification 3: Increase in assets may increase in revenue.
Classification 4: Increase in assets may decrease in other forms
of assets.
Classification 5: Decrease in liability may result in decrease in
asset.
Business transactions are classified in the following manner
in relation to their effects on the accounting values
Classification 6: Decrease in capital may decrease in
assets.
Classification 7: increase in expense may result in
decrease in assets.
Classification 8: increase in expense may result in
increase in liabilities.
 By applying this basic accounting concept of eight
classifications of accounting transactions, the ff. rules may
be adopted.
RULE 1: increase in asset is debited and increase in capital is credited.
RULE 2: Increase in assets is debited and increase in liabilities credited.
RULE 3: Increase in assets is debited and increase in revenue is credited.
RULE 4: Increase in assets is debited and decrease in assets is credited.
RULE 5: Decrease in liability is debited and decrease in asset is credited.
 By applying this basic accounting concept of eight
classifications of accounting transactions, the ff. rules may
be adopted.
RULE 6: Decrease in capital is debited and decrease in assets
is credited.
RULE 7: increase in expense is debited and decrease in assets
is credited.
RULE 8: increase in expense is debited and increase in
liabilities is credited.
 To simplify the rules of debit and credit, a tabular presentation on
the effect of the business transaction to the five accounting
element is shown below:

Accounting Elements Elements of business transaction and the

accounting elements
To increase To Decrease
Assets DEBIT CREDIT
Liabilities CREDIT DEBIT
Capital CREDIT DEBIT
Income CREDIT DEBIT
Expense DEBIT CREDIT
Applications of The rules
of debit and credit
By applying this basic accounting concept of eight
classifications of accounting transactions, the ff.
rules may be adopted.
RULE 1: increase in asset is debited and increase in capital
is credited.

Sample Transaction:
The owner invests additional cash in the business.
RULE 2: Increase in assets is debited and increase
in liabilities credited.

Sample Transaction:
The business bought Office Supplies on
account.
RULE 3: Increase in assets is debited and increase
in revenue is credited.

Sample Transaction:
The business sold goods or rendered services
to customer.
RULE 4: Increase in assets is debited and decrease
in assets is credited.

Sample Transaction:
The business bought furniture and fixtures on
cash 10,000.00 in cash.
RULE 5: Decrease in liability is debited and decrease
in asset is credited.

Sample Transaction:
The business paid its financial obligation to
the supplier of services.
RULE 6: Decrease in capital is debited and
decrease in assets is credited.

Sample Transaction:
Jocelyn Gantes withdrew 10,000.00 cash
for her business for her personal use.
RULE 7: increase in expense is debited and
decrease in assets is credited.

Sample Transaction:
The business paid rent for the month
5,000.00
RULE 8: increase in expense is debited and
increase in liabilities is credited.

Sample Transaction:
The business received the light bill for the
month, 3,000.00.
Transactions affecting
more than two
accounting values
 Sample transaction
Purchase additional Machinery for
50,000.00 and made a down payment of
20,000.00