Chap 3 – The Accounting Equation

The Basic Accounting Equation All the processes in an accounting system must observe the equality of
the accounting equation, which is basically an algebraic equation. The basic accounting equation is
shown below.

ASSETS - are the economic resources you control that have resulted from past events and can provide
you with economic benefits.

LIABILITIES - are your present obligations that have resulted from past events and can require you to
give up economic resources when settling them.

EQUITY- is simply assets minus liabilities. Other terms for equity are "capital," "net assets," and "net
worth."

The Expanded Accounting Equation

We can expand the basic accounting equation by including two more elements - income and expenses.
The expanded accounting equation shows all the financial statement elements. The expanded
accounting equation is as follows:
INCOME - is increases in economic benefits during the period in the form of increases in assets, or
decreases in liabilities, that result in increases in equity, excluding those relating to investments by the
business owner.

EXPENSES - are decreases in economic benefits during the period in the form of decreases in assets, or
increases in liabilities, that result in decreases in equity, excluding those relating to distributions to the
business owner.

Income less expenses equal profit or loss. If income is greater than expenses, there is profit. If income is
less than expenses, there is loss.

Income and profit increase equity while expenses and loss decrease equity.

Applications of the Accounting Equation

Case #1: Total Assets

If you have total liabilities of 1,200 and equity of 800, how much are your total assets?

Solution:

Total assets = (1,200 + 800) = 2,000

Case #2: Total Liabilities

If you have total assets of 2,000 and equity of 800, how much are your total liabilities?

Solution:

Total liabilities = (2,000 – 800) = 1,200

Case #3: Total Equity

If you have total assets of 2,000 and total liabilities of 1,200, how much are your total equity?

Solution:

Total equity = (2,00 – 1,200) = 800

Case #4.1: Profit or loss

If you have total income of 5,000 and total expense of 2,000, how much is your profit (or loss)?

Solution:

Total income 5,000

Less: Total expenses (2,000)

Profit 3,000

Case #4.2: Profit or loss

If you have total income of 6,000 and total expense of 11,000, how much is your profit (or loss)?

Solution:

Total income 6,000

Less: Total expenses (11,000)

Loss (5,000)

Case #5: Income

If you have total expense of 2,000 and a profit of 3,000, how much is your total income?

Solution:

Total income ?

Less: Total expenses (2,000)

Profit 3,000

Total income = (3,000 + 2,000) = 5,000

Case #6: Expense

If you have total income of 5,000 and a profit of 3,000, how much is your total expense for the period?

Solution:

Total income 5,000

Total expense ?

Profit 3,000

Total expense = (5,000 – 3,000) = 2,000

Case #7: Income

You have ending total assets of P4,800, ending total liabilities of P1,000 and beginning equity is P800. If
your total expenses for the period amount to P2,000, how much is your total income?

Solution:
Total income = (4,800 – 1,000 – 800 + 2,000) = 5,000

Case #8: Expense for the period

You have ending total assets of P4,800, ending total liabilities of P1,000 and beginning equity of P800. If
your total income for the period amounts to P5,000, how much are your total expenses?

Solution:

Total expenses = (4,800 – 1,000 – 800 – 5,000) = 2,000