THE

ACCOUNTING
EQUATION
And the Double Entry System

Introduction
This presentation attemps to provide information and study techniques
relating to accounting equation. The authors assume that the users have
at least the basic knowledge about the topic ( i.e. definitions of
accounting, accounts, assets, liabilities, equity, income and expense)
Prerequisites:
definitions of
Assets
Liabilities
Equity
Income
Expense

ASSETS = LIABILITES +
EQUITY
The equation is best understood by using the terms resources
and claims. The assets are the resources while the liabilities and
equity are the claims to those resources. Lets say you have 5
pieces of crackers. These are your resources. After a while your
friend asks you for a piece and you promised to give him in some
future time (e.g. at break), that one piece is considered as his
claim (the cracker belongs to him even he currently doesnt have
its possession, since you promised to give him one) and in effect,
decreases your claim (now thats called equity). You see, the
balance is still observed: In the 5 crackers (A), 1 belongs to your
friend (L) and the remaining 4 (OE) belongs to you.

For every increase or

decrease in resources,
there should be an
accompanying increase or
decrease in claims. The
increase and decrease in
resources yields no effect in

Dual Effect of Transactions

Lets take another example. Assume you have a bakery and consider the
following economic events:
1. Your friend Alpha buys P100 worth of bread and pays cash.
For every increase/decrease in resources, there should be an
accompanying increase/decrease in the claims. You sold bread. You
therefore have revenue. You also received cash for the good you provided.
In effect there is an increase in cash (Asset) and increase in Sales Revenue
(Equity). The asset you received is your claim.
The type of transaction is called source of assets. (SA)

ASSETS

LIABILITIES

OWNERS EQUITY

2. Your friend Beta buys P100 worth of bread with a promise to pay at some
future date (purchased on account/ on credit).
For every increase/decrease in resources, there should be an
accompanying increase/decrease in the claims. You sold bread, so you have
revenue. Although you didnt receive cash, he had promised to pay in the
future and therefore, have claims in his resources (ie cash). In the business
point of view, you expect collection in the future and falls the definition of
accounts receivable. In effect you have increase in Accounts Receivable
(Asset) and increase is Sales Revenue (Equity).
This transaction is also called source of asset.

ASSETS

LIABILITIES

OWNERS EQUITY

3. You received cash from Beta for the payment of the bread he bought
before.
You received cash from Beta and therefore increased assets. Also his
debt is extinguished and Accounts Receivable should be decreased, in
effect also decreasing assets. The increase and decrease in resources yields
no effect in the claims, and vice versa.
This transaction is called Exchange of Assets. (EA)

ASSETS

LIABILITIES

OWNERS EQUITY

You are transferring the

resources from the
Accounts receivable to Cash. In
analogy to the picture, youre
transferring the resources
(water) From the A/R (bottle) to
Cash (Glass). This analogy can
be applied to all exchange of
assets and claims transactions.

4. You received a bill from Meralco for P500 and paid it immediately.
The bill received from Meralco is considered as an expense because you
already used it in the current month to produce profits. There is an
increase in expense and therefore decrease in Equity (expense is a
decrease in equity). Also, you paid the bill and in effect decreases your
resources (cash). For every increase/decrease in resources, there should be
an accompanying increase/decrease in the claims.
This transaction is called use of asset. (UA)

ASSETS

LIABILITIES

OWNERS EQUITY

5. You received a bill from Maynilad for P500

The bill received from Maynilad is considered as an expense because
you already used it in the current month to produce profits. You did not pay
the bills. It is assumed that you decided to pay it at some future date and
thereby resulting and obligation (accounts payable). The increase and
decrease in resources yields no effect in the claims, and vice versa. There is
a increase of Liability (Accounts Payable), a creditors claim and decrease
in Equity (Utility Expense), an owners claim. Its like the transfer of the
claims in the crackers in previous example, increasing in your friends and
decreasing yours.
This kind of transaction is called exchange of claims. (EC)

ASSETS

LIABILITIES

OWNERS EQUITY

Techniques in Analyzing
Transactions
Translate the transaction to tagalog. Its effective.
Look for cue words (e.g. on account/credit transaction signifies a
transaction with accounts/notes payable (SA). If silent, its cash.
Rendered/ sold means revenue (SA). Terms Bought/Purchased/ Acquired
signifies source of asset transactions. Transactions like Paid
salaries,Paid Accounts, Paid as part of payment of.. are UAs. Bills
received are ECs. Bills paid are UAs.)
Decrease in Assets may increase another asset, or decrease either
liability or equity.
Increase in Assets may decrease another asset, or increase either liability
or equity.

Techniques in checking the Equality

of the Equation in every transaction
In every transaction, add all the assets and subtract all the
claims. The answer should be zero.
Look for the Source of Asset and Use of Asset transactions in
the problem. Then add all the amounts in SA transactions and
subract amounts from UA transactions. The answer should be
the final balance of the assets and the end of the last
transaction (see next slide).

Example
ASSETS

LIABILITY

100

EQUITY

SA/U
A

AMOUNT

100

SA

100

SA

10

(50) + 50
10

10
15

(15)

50 (20)

30

SA*

30

(50)

(50)

UA

(50)

UA

(20)

(20)

(20)

70
5
65
70
urce of asset and exchange of assets transaction. The effect is net increase, source of asset of 30 by finan
70
70
70

Why is that?
It is because SA increases both the resources and claims part of the
equation. Likewise, UA decreases the both sides. EA and EC cancels each
other and do not affect the opposite side. Therefore, the total amounts
should increase in SA transactions and decrease in UA ones.