UNIVERSITY OF SAINT LOUIS
Tuguegarao City
SCHOOL OF ACCOUNTANCY, BUSINESS and HOSPITALITY
First Semester
A.Y. 2020-2021
ACCT 1026 (Financial Accounting and Reporting)
Lesson 3: ACCOUNTING EQUATION AND MAJOR ACCOUNTS
Topic: a. The Accounting Equation-Basic and Expanded
b. The account, the five (5) major accounts
c. Chart of Accounts, Common Account Titles
Learning Outcomes: At the end of this module, you are expected to:
1. Define accounting equation.
2. Distinguish the basic accounting equation from the expanded accounting
equation.
3. Define and give examples of account
4. Explain briefly and give examples of the five (5) major accounts
5. Describe the nature of typical account titles used in recording business
transactions
6. Apply the concepts in solving accounting problems.
What is the Accounting Equation?
An accounting transaction is a business activity or event that causes a measurable change in the accounting
equation.
The accounting equation is a basic principle of accounting and a fundamental element of the balance sheet.
The equation is as follows:
Assets = Liabilities + Equity
ACCT 1026- Financial Accounting and Reporting | 1
This equation sets the foundation of double-entry accounting and highlights the structure of the balance sheet.
Double-entry accounting is a system where every transaction affects both sides of the accounting equation.
For every change to an asset account, there must be an equal change to a related liability or equity account. It
is important to keep the accounting equation in mind when performing journal entries.
NOTE: If an entity keeps accurate records, the accounting equation will always be "in balance," meaning the
left side should always equal the right side. The balance is maintained because every business transaction
affects at least two of an entity's accounts. For example, when an entity borrows money from a bank, the
entity's assets will increase and its liabilities will increase by the same amount. When an entity purchases
inventory for cash, one asset will increase and one asset will decrease. Because there are two or more
accounts affected by every transaction, the accounting system is referred to as double-entry accounting.
The balance sheet is broken down into three major sections and their various underlying items: Assets,
Liabilities and Equity.
ASSETS- are future economic benefits controlled by an organization/entity as a result of past transactions or
other past events.
-reflect the total value of the property that the business has, and which is in its turnover. In other words, it is
what it owns.
LIABILITIES- Liabilities are future sacrifices of economic benefits that an organization is presently obliged
to make to other organizations or individuals as a result of past transactions or events.
-reflect the size of the financing of an organization’s assets by third parties, banks, and private financial
institutions. This is what the company owes.
EQUITY- represents the residual (what is left) once all fixed claims have been satisfied or simply “assets
less/minus liabilities”.
-equity characterizes the value of investments made in this organization by its owner/s
Example 1:
Juan dela Cruz started his Coffee Shop business by investing his Cash savings amounting to P 500,000.00 and
borrowed P250,000.00 from ABC Bank.
Assets= Cash P 500,000.00 (owned) Assets = Liabilities + Equity
P 500,000.00 = P 250,000.00 + P 250,000.00
Liabilities= Loan P 250,000.00 (owed)
Assets - Liabilities= Equity
Equity= Assets – Liabilities (P 250,000.00) P 500,000.00 – P 250,000.00 = P 250,000.00
Assets – Equity = Liabilities
P 500,000.00 – P 250,000.00 = P 250,000.00
THE EXPANDED ACCOUNTING EQUATION
The expanded accounting equation provides more details for the owner's equity amount shown in the basic
accounting equation. The expanded accounting equation for a sole proprietorship is: Assets = Liabilities +
Equity (Owner's Capital) + Revenues – Expenses – Owner's Draws.
The expanded accounting equation allows you to see separately (1) the impact on equity from net income
(increased by revenues, decreased by expenses), and (2) the effect of transactions with owners (draws,
dividends, sale or purchase of ownership interest).
EQUITY- is the residual interest in the assets of the entity after deducting all the liabilities (IASB Framework).
- is what the owners of an entity have invested in an enterprise. It represents what the business
owes to its owners. It is also a reflection of the capital left in the business after assets of the
entity are used to pay off any outstanding liabilities.
REVENUE- is the income generated from normal business operations and includes discounts and deductions
for returned merchandise. It is the top line or gross income figure from which costs are subtracted to determine
net income.
- If the revenues earned are a main activity of the business, they are considered to be operating
revenues. If the revenues come from a secondary activity, they are considered to be non-
operating revenues.
- Normally increases ASSETS.
EXPENSE- An expense is the cost of operations that a company incurs to generate revenue. As the popular
saying goes, “it costs money to make money.”
- There are two main categories of business expenses in accounting: operating expenses and
non- operating expenses.
- Normally decreases ASSETS.
***The difference between revenue and expenses represents profit or loss.
- If revenue is greater than expenses, the difference is profit
- If revenue is less than expenses, the difference is loss
Example 2:
Juan dela Cruz, on the first month of operating his Coffee Shop, earned a Revenue (received cash) of P
50,000.00 and incurred total expenses (paid cash) of in the amount of P 30,000.00 (Wages of
crew/staff/cashier, Supplies, Rent, Utility Expenses).
Assets= P 500,000.00
Liabilities= P 250,000.00
Equity= P 250,000.00
Revenue= P 50,000.00
Expenses= P 30,000.00
ASSETS = LIABILITIES + EQUITY + REVENUE - EXPENSES
Example 1- Juan dela Cruz P 500,000.00 P 250,000.00 P 250,000.00 -0- -0-
started his Coffee Shop business
by investing his Cash savings
amounting to P 500,000.00 and
borrowed P250,000.00 from ABC
Bank.
Example 2- Juan dela Cruz, on P 50,000.00 P 50,000.00
the first month of operating his
Coffee Shop, earned a Revenue (P 30,000.00) P 30,000.00
(received cash) of P 50,000.00
and incurred total expenses
(paid cash) of in the amount of P
30,000.00 (Wages of crew/ staff/
cashier, Supplies, Rent, Utility
Expenses).
P 520,000.00 P 250,000.00 P 250,000.00 P 50,000.00 P 30,000.00
P 520,000.00 P 250,000.00 P 270,000.00
Next lesson, the major accounts.
Account is defined as a basic summary device in accounting. The account is also defined as a record of
increases and decreases in assets, liabilities, equity, income or revenues and expenses. Incidentally, these are
also our five major accounts and also called the elements of financial statements.
The account resembles the letter ‘T’ as it also being depicted as a T-account.
An account has three (3) parts:
1. Account Title
2. Debit
3. Credit
uble-entry bookkeeping. ... The title of the account is then entered just above the top horizontal line, while underneath debits are listed o
For better appreciation, here is a sample of entries using the T-account
https://www.pinterest.ph/pin/664562488742605626/
www.facebook.com/Accmondeifrs/photos/ifrs-sets-a-conceptual-framework-that-serves-as-a-base-for-the-overall-
https://
recording/1205966129570997/
Classification of the Five (5) Major Accounts
The five (5) major accounts are further classified based on the financial statement where they appear:
Balance Sheet Accounts Income Statement Accounts
1. ASSETS 1. INCOME
2. LIABILITIES 2. EXPENSES
3. EQUITY
The Balance Sheet or the Statement of Financial Position is one of the components of a complete set of
financial statements. The balance sheet shows the financial position of the business as of a given period of
time.
The Income Statement is a sub-component of the Statement of Comprehensive Income, is also one of the
major components of a complete set of financial statements. It is also known as statement of Profit or Loss,
shows financial performance for a given period of time.
The F/S is thoroughly discussed in Intermediate Accounting 3.
Chart of Accounts
A chart of accounts is a list of all accounts used by the business.
Sample chart of accounts is presented below:
Notes on the Chart of Accounts:
1. It follows a certain order of presentation, such that the Assets are presented first followed by the other
balance sheet accounts and then the income statement accounts;
2. All the asset accounts are preceded by the number 1, liabilities by the number 2 and so on.
3. The chart of accounts may be accompanied with a handbook containing the account titles, their
definition and uses, a sample is presented below;
4. You can design your own chart of accounts; and formulate the account titles to be used.
COMMON ACCOUNT TITLES USED
Balance Sheet Accounts - ASSETS
CASH Includes money or equivalent that is unrestricted . example is cahd on hand
and cash in bank
ACCOUNTS RECEIVALBE Oral or written promises to pay sums of money
ALLOWANCE FOR BAD DEBTS Estimated losses on uncollectible accounts receivable
NOTES RECEIVABLE Promises to pay supported by a promissory note
INVENTORY Goods held by the business intended for sale
PREPAID SUPPLIES Unused office and other supplies
PREPAID RENT Rent paid in advance
PREPAID INSURANCE Insurance paid in advance
BUILDING Structures owned by the business used in operations
ACCUMULATED DEPRECIATION Total amount of depreciation expenses recognized since the fixed asset
was made available for use
EQUIPMENT Consists of machineries, transportation equipment, office equipment like
table, chairs, cabinets, computer equipment like server, laptops, desktop
and furniture and fixtures
Balance Sheet Accounts - LIABILITIES
ACCOUNTS PAYABLE Obligations to pay sums of money oral or informal.
NOTES PAYABLE Obligations to pay sums of money supported by a promissory note
INTEREST PAYABLE Interest already due but not yet paid. Most common example is interest on bank
loan
SALARIES PAYABLE Already earned by employees but not yet paid as of balance sheet date
UTILITIES PAYABLE Electric, water, telephone, cable, internet already used but not yet paid
UNEARNED INCOME Income already collected but the related services will be done in the future
Balance Sheet Accounts - EQUITY
OWNER’S CAPITAL What is remaining after deducting liabilities from capital (A-L = OE)
OWNER’S DRAWING Record temporary withdrawals by the owner and it is closed to the owner’s
capital at the end of the accounting period
Income Statement Accounts - INCOME
SERVICE FEES Revenue earned after rendering services
SALES Revenue earned from selling goods
INTEREST INCOME Arises from interest bearing receivables
GAINS Income earned from the sale of assets other than Inventory.
Income Statement Accounts EXPENSES
COST OF SALES or COST OF GOODS SOLD Value of inventories sold for a certain accounting period
FREIGHT OUT or DELIVERY EXPENSE Seller’s expenses for delivering goods to customers
SALARIES EXPENSE Amounts paid to employees for services rendered
RENT EXPENSE Cost of rentals used during the accounting period
UTILITIES EXPENSE Cost of power and electricity, cable, telephone, etc. used during the
accounting period
DEPRECIATION EXPENSE A portion of the cost of a depreciable fixed asset for the accounting
period
BAD DEBTS EXPENSE or DOUBTFUL Estimated business losses arising from uncollected accounts
ACCOUNTS EXPENSE receivables
TAXES AND LICENSES Cost of local and business taxes required by the government for
operating a business. Examples are mayor’s permit, cedula, DTI
permit, percentage taxes
TRANSPORTATION and TRAVEL EXPENSES Transportation expense is within the locality like tricycle and taxi
fares while Travel expenses are incurred by employees while going
outside of the place of business like plane fares, bus fares, hotel
accommodations and food allowances while on business trip
INTEREST EXPENSE Represents the cost of borrowing money. This is the amount paid to
the banks when availing of a loan.
ADVERTISING EXPENSE Cost of promotional activities intended to increase product
awareness of the public
LOSSES Come from sale of assets other than inventory that is lesser than
book value or decreases in the value of assets due to damages
due to
natural calamities or other causes. An example of an ordinary loss is
the decrease in the market value of foreign currencies.
MISCELLANEOUS EXPENSE Small expenditures that are not required to be presented separately
*** END of LESSON 3***
REFERENCES
Textbooks
1. Ballada, W. (2019). Basic Financial Accounting and Reporting. Manila: DomDane Publishers.
2. Cabrera, E.(2017) Fundamentals of Accounting Volume I, GIC Enterprises & Co., Inc., Manila
3. Millan, Z. V. (2020). Financial Accounting and Reporting (Fundamentals). Baguio City: Bandolin
Enterprise.
4. Valencia, E. and Roxas, G. (2017), Basic Accounting, Valencia Educational Supply
5. Valix, C. and Peralta, J. (2018). Financial Accounting Volume I GIC Enterprises & Co., Inc., Manila
6. Porter, G. and Norton, C. (2017), Financial Accounting- The Impact on Decision Makers: Cengage
Learning.
Online Reference
1. https://corporatefinanceinstitute.com/resources/knowledge/accounting/accounting-equation/
2. https://bobsteelecpa.com/accounting-equation-account-types-and-the-double-entry-accounting-equation/
3. https://www.bookstime.com/what-is-the-accounting-equation
4. https://www.accountingcoach.com/blog/expanded-accounting-equation
5. https://accounting-simplified.com/equity.html
6. https://www.investopedia.com/
7. https://courses.lumenlearning.com/sac-finaccounting/chapter/the-basic-accounting-equation/
