The Accounting Equation and Expanded Accounting Equation
Learning Outcomes:
1. Describe accounting equation.
2. State the expanded accounting equation.
3. Identify the items affecting owner’s equity.
4. Solve simple problems on accounting equation.
5. Identify the elements of financial statements.
6. Illustrate the effects of each transaction on the accounting equation.
7. Prove the equality of the accounting equation.
TOPIC: ACCOUNTING EQUATION
The accounting equation is a basic principle of accounting and a fundamental element of the statement of
thefinancial position. The equation is as follows:
A = L + OE
Assets = Liabilities + Owner’s Equity
The equation means that the assets of an entity are financed by both the creditors and the owner.
When an entity is to be closed, the creditors are to be paid first using the assets of the entity, whatever is left is for
the owner. Therefore, another way of expressing the equation is: Assets – Liabilities = Owner’s Equity
Accounting Equation is the basic tool of accounting. This equation sets the foundation of double-entry accounting
and highlights the structure of the statement of financial position. Double-entry accounting is a system where every
transaction affects both sides of the accounting equation.
A – resources controlled by the enterprise.
L – present obligations of the enterprise.
OE – the residual interest in the assets.
The accounting equation can be expressed as: Assets = Owner’s Equity
Meaning, the assets of the business are contributed only by the owner.
Example 1:
Jan. 1, 2020 - X, the owner, invested money into a business, ₱100,000.
A = OE
Cash X, Capital
Jan. 1 ₱100,000 = ₱100,000
To continue: Example 2:
Jan. 2 - The business purchased office equipment on account, ₱10,000.
A = L + OE
Cash + Off. Eqpt. = Accounts Payable + X, Capital
Jan. 1 ₱100,000 = 0 + ₱100,000
2 ₱10,000 = ₱10,000 _______________
Total ₱100,000 + ₱10,000 = ₱10,000 + ₱ 100,000
=============================================================
Assets = Liabilities + Owner’s Equity
₱110,000 = ₱10,000 + ₱100,000
₱110,000 = ₱110,000
======== ========
Total assets is equal to total liabilities and owner’s equity.
Any idea of other derivation of the accounting equation? Please PM me within the week. The first PM I received
will have a free load of ₱30.00 (TM or Smart).
Exercises:
1-1. Solve the missing amount.
A = L + OE
₱770,000 ₱ 460,000 ?
₱ 660,000 ? ₱ 392,000
? ₱ 158,000 ₱ 460,000
₱ 426,000 ₱ 246,240 ?
? ₱ 500,000 ₱ 630,000
1-2. Worded Problems:
1. Jimmy Delgado Trading has assets of ₱ 600,000 and Owner’s Equity of ₱450,000, how much liabilities does
the enterprise have?
2. Jufel Tan owner’s equity at the end of the year is 70% of the total assets. If total assets is ₱500,000, how much is
the total liabilities?
3. As at the end of the year, Gwen Holland Brokerage has a total assets equal to ₱970,000 and total liabilities equal
to ₱500,000. What is the owner’s equity of Gwen Holland Brokerage as of the end of the year?
4. The firm’s owner’s equity at the end of the accounting period is ₱357,500 or 65% of the total assets, how much is
the total liabilities?
Now, let us learn what affects owner’s equity.
We have this EXPANDED ACCOUNTING EQUATION
ASSETS = LIABILITIES + (CAPITAL – DRAWINGS + INCOME – EXPENSES)
Owner’s Equity is affected by:
Item Effect
1. Owner’s contributions increase
2. Owner’s drawings decrease
3. Revenues/Gains increase
4. Expenses/Losses decrease
ELEMENTS OF THE FINANCIAL STATEMENTS
This is the expanded accounting equation:
ASSETS = LIABILITIES + (CAPITAL – DRAWINGS + INCOME – EXPENSES)
these are the:
Elements of Financial Statements
Financial statements portray the financial effects of transactions and other events by grouping them into
broad classes according to their economic characteristics. These broad classes are termed the elements of
financial statements.
The elements directly related to financial position (balance sheet) are:
Assets
Liabilities
Equity
The elements directly related to performance (income statement) are:
Income
Expenses
Definition of the Elements of the Financial Statements
Assets are present economic resource controlled by the entity as a result of past events.
Ways that future economic benefits may flow to an entity:
1. used singly or in combination with other assets in the production of goods or services to be sold by the
entity
2. exchanged for other assets
3. used to settle a liability
4. distributed to the owners of the entity
Liabilities are present obligations of the entity to transfer an economic resource as a result of past events.
1. Ways to settle a liability:
2. Payment of cash
3. Transfer of noncash assets
4. Provision of services
5. Replacement of the obligation with another obligation
6. Conversion of the obligation into equity
Equity is the residual interest in the assets of the entity after deducting all its liabilities.
Derivation of Accounting Equation: Assets – Liabilities = Owner’s Equity
Income increases economic benefits during the accounting period in the form of inflows or enhancements of assets
or decreases of liabilities that result in increases in equity, other than those relating to contributions
from equity participants.
(income encompasses revenues and gains) referring to the investments of the
owner
Revenues are inflows of or other enhancements to assets and/or settlements of its liabilities from ongoing
operations. Ex. Service Income
Professional Fees
Sales (sale of inventories)
Gains are increases to equity (net assets) from peripheral or incidental transactions.
- represent all other periodic increases to equity other than those reported as revenues or
investments by owners. Ex. Gain on sale of equipment
Expenses are decreases in economic benefits during the accounting period in the form of outflows or depletions of
assets or incurrences of liabilities that result in decreases in equity, other than those relating to distributions to
equity participants. Ex. Salaries Expense
Utilities Expense referring to withdrawals of the
Rent Expense owner/partners or dividends (for
corporations)
Losses are decreases to equity (net assets) from peripheral or incidental transactions.
- represent all other periodic decreases to equity other than those reported as expenses or as
distributions to owners. Ex. Loss on sale of equipment
Application of the Accounting Equation
Problems:
1. Rosanna Bucarin starts with a Repair Shop business in Tacurong City. At the beginning of the period, assets
amount to ₱350,000, liabilities, ₱100,000.
a. How much is the owners’ equity at the beginning of the period?
b. For each item below, determine its effects on the accounting values.
1. During the period, the business received cash of ₱50,000 for services rendered.
2. During the period, the business paid expenses amounting to ₱20,000.
3. During the period, the business bought repair equipment on account, ₱25,000.
4. At the end of the year, the owner withdrew cash of ₱10,000 from the business for her personal expenses.
5. During the period, the business rendered services on account, ₱20,000.
6. During the period, the business collected the accounts of the customer (refer to #5).
7. During the period, the business acquired land at a cost of ₱200,000, paying ₱50,000 cash and the balance to
be paid the following year.
Solution:
Question a:
A = L + OE
₱350,000 = ₱100,000 + ₱250,000
Or:
A - L = OE
₱350,000 - ₱100,000 = ₱250,000
Question b:
A = L + OE Effects on the accounting equation
a. ₱350,000 = ₱100,000 + ₱250,000 increase in assets = increase in liabilities and
owner’s equity
b.1 50,000 50,000 increase in assets = increase in owner’s equity
Bal. ₱400,000 = ₱100,000 + ₱300,000
b.2 ( 20,000) (20,000) decrease in assets = decrease in owner’s equity
Bal. ₱380,000 = ₱100,000 + ₱280,000
b.3 25,000 25,000 _______________ increase in assets = increase in liabilities
Bal. ₱405,000 = ₱125,000 + ₱280,000
b.4 (10,000) ( 10,000) decrease in assets = decrease in owner’s equity
Bal. ₱395,000 = ₱125,000 + ₱270,000
b.5 20,000 20,000 increase in assets = increase in owner’s equity
Bal. ₱415,000 = ₱125,000 + ₱290,000
b.6 ₱ 20,000
(20,000) increase in one asset = decrease in another
_________________________________________ asset
Bal. ₱415,000 = ₱125,000 + ₱290,000
b.7 200,000 150,000 increase in one asset = decrease in another
( 50,000) __ asset and increase in
Bal. ₱565,000 = ₱275,000 + ₱290,000 liabilities
=========================================
Assets = ₱565,000
========
Liabilities ((₱275,000) + Owner’s Equity (₱290,000) = ₱565,000
========
The illustration above, in general, shows that for every transaction, there are at least two effects on the accounting
equation and the accounting equation remains balanced.
There are nine (9) types of effects on the accounting equation. They are:
1. Increase in Assets = Increase in Liabilities
2. Increase in Assets = Increase in Owner’s Equity
3. Increase in One Asset = Decrease in Another Asset
4. Decrease in Assets = Decrease in Liabilities
5. Decrease in Assets = Decrease in Owner’s Equity
6. Increase in Liabilities = Decrease in Owner’s Equity
7. Increase in Owner’s Equity = Decrease in Liabilities
8. Increase in One Liability = Decrease in Another Liability
9. Increase in Owner’s Equity = Decrease in Another Owner’s Equity
References: Fundamentals of Accounting by Ballada
Financial Accounting and Reporting by Millan
https://www.youtube.com/watch?v=o9-Sh_6EmkA
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