Module 2: Major Accounts and The Accounting

Equation

This module will discuss the basic accounting equation and the major account titles that are used
in basic accounting. You will be learning the elements of accounting equation and the five major
account titles.

Content Course Competencies

The learners demonstrate an understanding of the five major accounts, namely; assets,
liabilities, capital, income and expenses. Also they demonstrate an understanding of the
accounting equation.

Performance Course Competencies

At the end of the module, you should be able to:
 Solve problems by applying the accounting equation.

Valuing Objectives
 At the end of the module, you should be able to manifest good sense of balance in
your personal and academic pressures.

Most Essential Unit learning outcomes

At the end of the module, you should be able to:
a. illustrate the accounting equation.
b. perform operations involving simple cases with the use of accounting equation.

UNIT 1: major accounts

Unit learning outcomes
 discuss the five major accounts
 cite examples of each type of account
 prepare a Chart of Accounts
Word Hunt: Find words that you think is related to accounting. There are at least 12 words. List down
the words bellow and identify if the word is asset, liabilities or Owner’s Equity.

U R M C R G S R S F S S P W U
E C E F Q N Q A W E A E I X T
S Q X N A L L B I X N L R V M
U K U O T A A T G O E B Z U H
P C L I R W I T H D R A W A L
P X G I P L R S I V F V Q Q B
L V E G I M U V B P C I V S I
I S H B Q S E P B W A E R T A
E C A S H A J N H X G C L E A
S I C U P P K H T H C E N S G
Z S B Y B F X Q R Q K R D S F
E U Y D M U Y L Q Z L F Y A M
G U N E V E R A I G X C N Y J
X P D Y J Z A I K O P S V O U
L J X I T N R O S X X X W L Q
 The following are major accounts used in accounting. Define the three major accounts in your own
understanding of the words.
ELEMENTS OF ACCOUNTING

In order to understand better the accounting equation as it relates to the financial position and
results of operations of a business enterprise, the relationship of the accounting elements should be
clearly defined. There are three elements of accounting namely: ASSETS, LIABILITIES, CAPITAL.

I. ASSETS
Assets are resources owned by the enterprise as a result of past events and from which
future economic benefits are expected to flow to the enterprise. In short, they are properties and
rights owned by the firm. There are two major classifications of assets: Current Assets and Non-
Current Assets.
A. CURRENT ASSETS - under Philippine Accounting Standards 1 (PAS 1), "Presentation of Financial
Statements" an entity shall classify assets as current when:
a. It expects to realize the asset, or intends to sell or consume it, in its normal operating cycle;
b. It holds the asset primarily for the purpose of trading;
c. It expects to realize the asset within twelve months after the reporting period; or
d. The asset is cash or cash equivalent, unless, the asset is restricted from being exchanged or used
to settle a liability for at least twelve months after the reporting date.
Current assets include cash and those assets which can be readily converted into cash or sold or
consumed within one year or the normal operating cycle whichever is longer. Normal operating cycle
refers to the time span during which cash is used to acquire goods and services, which in turn are sold to
customers, who in turn pay for their purchases with cash. Common examples include the following:
1. Cash - normally consists of coins and currencies on hand, money orders and some
checks from customers, and deposits in bank accounts.

2. Trading Securities - also known as Temporary Investments. These are short-term

investments of funds which are available for current operations and intended to be held for
generating short- term profits from fluctuations in value.

3. Receivables - represent amounts collectible from customers, clients and other

persons for goods, services or money given. These include:
a. Accounts Receivable - these are collectibles from customers arising from sale of goods
or services on open accounts without any formal written promise to pay.
b. Notes Receivable - these are collectibles which are supported by formal promises to
pay in the form of promissory notes.
c. Other Receivables such as Accrued Interest Receivable, Advances to Officers and
Employees, and Dividends Receivable.

 Allowance for Doubtful Accounts, sometimes termed as Allowance for Bad

Debts, is a contra-asset account or valuation account used to record
accumulated balance of customers' accounts that are doubtful of collectability.
 It is a contra-asset account because it is an offset against an asset (Accounts
Receivable) to produce a more useful and reliable measure of the company's
liquidity. It reduces Accounts Receivable if it remains uncollected at the end of
the accounting period. Because the Allowance for Doubtful Accounts is merely
an estimate and not a precise calculation, professional judgment plays a
considerable role in determining the size of this valuation account. It should be
emphasized that this is NOT an asset but rather a contra-asset account.

4. Inventories - are assets that are held for sale in the ordinary course of business, in the
process of production for such sale or in the form of materials or supplies to be consumed in
the production process or in rendering of services. In a merchandising firm, the title
Merchandise Inventory is used. For a manufacturing firm, inventory accounts include Raw
Materials Inventory, Work-in- Process Inventory, Finished Goods Inventory and Factory
Supplies.

5. Prepaid Expenses - are expenses paid and recorded as assets before they are used or
consumed. Examples of these expenses paid in advance include Prepaid Rent, Prepaid
Insurance, and Prepaid Advertising.
 Part of this sub-classification is office supplies and store supplies such as stationery, ball
pens, erasers, envelopes and other supplies not yet used. It can be in the form of Office
Supplies or Store Supplies depending on its purpose.

B. NON-CURRENT ASSETS - under PAS 1, all other assets that cannot be classified as current are
classified as non-current. This includes tangible, intangible, operating and financial assets of a long-
term nature. Included here are:
1) Fixed Assets - also known as Property, Plant and Equipment (term normally used for a
manufacturing firm). These are tangible assets which are held by an enterprise for used in
production or supply of goods and services, for rental to others, or for administrative
purposes, and are expected to be used for more than one accounting period. It may also be
defined as "tangible assets with an estimated useful life beyond one year, used in the conduct
of business, and are not intended for sale in the ordinary course of business". It includes among
others:

a. Land - a lot or real estate owned and used by a firm as building site, parking area and other
business operations. It should be noted that land for current sale as in case of subdivided
lots is a current asset. Also, land held for speculation or for future sale should be classified
as long-term investment.
b. Building - structure used to house the office, store or factory
c. Equipment - includes among others:
 Machinery - may be composed of stamping machines, ovens, conveyors, lathes,
etc.
 Furniture and fixture- tables, chairs, lighting fixtures, wall decors, etc.
 Office equipment- typewriters, calculator, computers, etc.
 Store equipment - cash registers, weighing scales, etc.
 Delivery equipment - trucks, pick-ups, vans, forklifts, etc.
  Accumulated Depreciation is a contra-asset account representing usage of asset
or expired cost of the asset up to the present. It is a contra- asset account
because it is deducted from the appropriate fixed asset account (except land
because its value Increases as time passes by, most often than not) to produce
the book value for the asset. Accountants often use the term book value or
carrying value to describe the net valuation of an asset in a company's
accounting records. Book value is of significance primarily for accounting
purposes. It represents costs that will be offset against the revenue of future
periods. It also gives users of financial statements an indication of the age of the
company's depreciable assets (older assets tend to have larger amounts of
accumulated depreciation associated with them than newer assets). It is
important to realize that the computation of book value is based upon an
asset's historical cost. Thus, book value is not intended to represent an asset's
current market value. Like Allowance for Doubtful Accounts, this is NOT an asset
but rather a contra-asset account.

2) Long-term Investments - are assets held by an enterprise for the accretion of wealth through
distribution such as interest, royalties, dividends, and rentals, for capital appreciation or for
other benefits to the investing enterprise such as those obtained through trading relationships.
It may also be defined as assets not directly identified with the operating activities of the
business. They are expected to contribute to the success of the business by making an
independent contribution to earnings or exercising a certain favorable effect upon the sales and
operation of the company. The company holds them for a period longer than one year. Included
under this sub-classification are the following:
o Investment In Stocks - investments in the capital stock of a corporation
o Investment In Bond - Investments in government or corporation bonds
o Investment Property - investment in real properties (land and/or building) being held by
the company for capital appreciation purposes or to earn additional income (i.e. rentals)
o Fund tor non-current purposes like Plant Expansion Fund, which is cash set aside for
future purchase of additional property

3) Intangible Assets - identifiable non-monetary assets without physical substance held for use in
the production or supply of goods or services, for rental to others, or for administrative
purposes. They are long-lived assets without physical characteristics and whose value lies in the
rights, privileges and competitive advantages that they give the owner. Items falling under this
category are:

A. Patent - an exclusive right granted by the government to an inventor enabling him to

control the manufacture, sale or other use of his invention for a specified period of
time
B. Copyright - an exclusive right granted by the government to an author, composer or
artist enabling him to publish, sell or otherwise benefit from his literary, musical or
artistic work.
C. Trademark - a symbol, sign or name used to mark a product to distinguish it from other
products.
D. Franchise- a right or privilege granted by the franchisor to a franchisee. In a public
franchise the State allows a private entity the use of public property in performing
services like use of public land for telephone or electric lines, use of streets or highways
 for a bus line. In a private franchise, the franchisee acquires the right to use the
trademark, patent and process of the franchisor as in the case of putting up a Jollibee
outlet.
E. Goodwill- value of all favorable attributes that relate to a business enterprise like good
name, capable staff and personnel, high credit standing, reputation for fair dealings,
reputation for superior products, favorable geographic location and list of regular
customers. It arises when expected earnings exceed normal earnings.

4) Other Non-current Assets - include other long-term items which cannot be appropriately
classified under the usual asset categories. Examples include:
 Advances to Officers and Employees not collectible within one year
 Restricted Cash Accounts such as Cash in Closed Banks
 Long-term Installment Receivables
 Non-productive Property or property no longer used in operations like plant facilities which
have been idle for an extended period or those abandoned but not physically retired. These
are simply known as 'IDLE ASSETS"
 Damaged Inventory not yet declared as loss of the enterprise

II. LIABILITIES
Liabilities are present obligations of an enterprise arising from past transactions or events, the
settlement of which is expected to result in an outflow from the enterprise of resources
embodying economic benefits. Like assets, liabilities have two major classifications:
Current Liabilities and Non-current Liabilities.

A. CURRENT LIABILITIES - under PAS 1, an entity shall classify liability as current when:
a. It expects to settle the liability in its normal operating cycle;
b. It holds the liability primarily for the purpose of trading
c. The liability is due to be settled within twelve months after the reporting period; or
d. It does not have an unconditional right to defer settlement of the liability for at least
twelve months after the reporting period.

Current liabilities include obligations which are expected to be settled in the normal course of the
enterprise's operating cycle, and obligations which are due to be settled within one year from the
balance sheet date.

Liabilities, such as trade payables and accruals for employees and other operating costs, are classified as
current liabilities since they are to be paid within one year or the normal operating cycle whichever is
longer. Trade payable may be defined as indebtedness representing amounts due to trade creditors as a
result of the purchase of merchandise and/or services in the ordinary course of business. Other
liabilities, non-trade payables in particular, that are due for settlement within twelve months after the
last day of the current accounting period, are also classified as current.
All other obligations are to be classified as non-current. Examples include:
1. Accounts Payable - if not qualified, this is trade accounts payable. This refers to indebtedness
that arise from purchase of goods, materials, supplies or services in an open charge account,
that is, It Is not evidenced by any written promise to pay.
 2. Notes Payable - when a promissory note is issued as evidence of the indebtedness that arise
from purchase of goods, materials, supplies or services or in place of an open charge account for
such purchases.

3. Communications Payable - may include obligations to companies for postage, telephone and
telegraph and similar services received by the business.
4. Utilities Payable - obligations to utility companies like electric companies (Benguet Electric
Cooperative), water companies (Baguio Water District).

5. Taxes and Licenses Payable - payables to the government in the form of business and transfer
taxes, income taxes, business permits, etc.

6. Withholding Tax Payable, SSS Payable, Phil. Health Payable, PAGIBIG Payable - payables to
government agencies like Bureau of Internal Revenue, Social Security System, Phil. Health
Insurance Corporation and Home Development Mutual Fund (HDMF), respectively, representing
payroll-related mandatory contributions of employer and employees.

7. Unearned Revenues - represent obligations for goods or services that a company must provide
or deliver in a future accounting period in return for an advance payment from a customer like
in the case of Unearned Interest Income, Unearned Rent Income, and Unearned Subscriptions
Revenue

8. Accrued Expenses - also known as Accrued Liabilities, these are expenses that have been
incurred but not yet paid like in the case of Accrued Salaries Payable and Accrued Interest
Payable.

B. NON-CURRENT LIABILITIES - under PAS 1all other liabilities not classifiable as current should be
classified as non-current liabilities. Examples include:
1. Long-term Notes Payable - an obligation evidenced by a promissory note that is to be paid
beyond one year.

2. Bonds Payable - a liability supported by a formal unconditional promise made under seal to
pay a specified sum of money at a determinable future date, and to make periodic interest
payments at a stated rate until the principal is paid.

3. Payable - a long-term obligation to a bank or other financial institutions secured by real

properties of the business.

III. CAPITAL

Capital is the residual interest in the assets of the enterprise after deducting all its liabilities. It is the
owner's contribution to the business. The term used in reporting a firm's equity depends on the kind of
business organization it is. If it is a sole proprietorship, the term "'OWNER'S EQUITY" would be more
appropriate. On the other hand, a partnership's capital can be referred to as "PARTNERS' EQUITY'' and
for a corporation, "STOCKHOLDERS’ EQUITY'' or SHAREHOWERS' EQUITY''. The owners' equity comes
from two sources:
1. Net Investment = Investments – Drawings
2. Net Income=Income – Expenses
In a sole proprietorship (which is the focus of succeeding discussions), the following items are
considered:

A. (NAME OF OWNER), CAPITAL - the total of the initial and additional contributions made by the
owner, which is increased by profits and decreased by losses and owner's withdrawals.

B. (NAME OF OWNER), DRAWING or (NAME OF OWNER), WITHDRAWAL or (NAME OF OWNER),

PERSONAL - represents cash or other assets taken by the owner for personal use. This has an
effect of reducing the owner's capital.

C. INCOME - are increases in economic benefits during the accounting period in the form of inflows or
enhancements or assets or decreases of liabilities that result in increases in equity, other than those
relating to contributions from equity participants. In other words, it refers to increases in owner's equity
resulting from selling goods, rendering services or performing other business activities. Common
examples include:
1) Service Revenue / Professional Fees /Income from Fees - revenue earned from selling services.
2) Rent Income - revenue earned from renting out commercial spaces (like apartments,
condominiums, market stalls, office spaces) to third parties
3) Interest Income - revenue earned for lending money
4) Commission Income - revenue earned by real estate brokers, insurance agencies, travel
agencies, etc.
5) Sales - principal revenue of both merchandising and manufacturing concerns from selling goods
to customers.
 Sales Returns and Allowances is a contra-revenue account which represents merchandise
returns from customers and/or deductions from the original sales price. The returns may be
due to the delivery of defective goods or the wrong merchandise was sent.
o Sales Returns refers to the merchandise returned at selling price by the customers
due to defects, inferior quality or not in accord with the customer's specifications.
o Sales Allowances refers to cases when the customer would be willing to keep the
merchandise, if the seller is willing to grant a deduction from the selling price.
 Sales Discount is a contra-revenue account that refers to the reduction in the amount to be
paid by a customer as a result of early payment of an invoice.

Both Sales Returns and Allowances and Sales Discounts are deducted from Gross Sales to
arrive at the Net Sales. This would be elaborated in the discussion of accounting for
merchandising business

D. EXPENSES - are decreases in economic benefits during the accounting period in the form of outflows
or depletions of assets or incidences of liabilities that result in decreases in equity other than those
relating to distributions to equity participants. These are decreases in owner's equity resulting from the
costs of goods and services used up in the course of earning revenues. Common examples include:
1. Advertising Expense - refers to cost of publications on newspapers, radio, television, calling
cards, billboards and other costs of promoting the business.

2. Communications Expense - refers to cost of all means of communications used during the
period like telephone, telegraph services and postage.
3. Delivery Expense - also known as Freight Out or Transportation Out. It represents the cost of
gasoline, oil and other related expenses in transporting goods to customers.

4. Depreciation Expense - refers to the portion of the total cost of fixed assets allocated to current
operations.
5. Insurance Expense - refers to insurance premiums paid or payable to an insurance company. In
an insurance contract, one party, the insurance company, undertakes to guarantee the business
against loss by a specified event or peril.
6. Interest Expense - refers to the cost of borrowing funds used by the business. Also known as
Finance Cost.

7. Rent Expense - refers to charges on the right to occupy shop or office space or enjoy the use of
other properties or assets belonging to another party.

8. Repairs and Maintenance Expense - refers to the cost of repairing and servicing certain assets
like buildings and office equipment.

9. Representation Expense - refers to the cost of entertaining customers and prospective clients
and others.

10. Salary Expense - refers to the compensation or remuneration in whatever form given to
employees for the services they render to the firm.

11. Supplies Expense - refers to the cost of ballpens, erasers, stationery and other supplies
used or consumed by the enterprise.

12. Taxes and Licenses - refer to business taxes, licenses, and other fees due to the government.

13. Utilities Expense - refers to the cost of electricity and water consumed during the current
accounting period.

14. Purchases - refers to the merchandise acquired or bought during the period, which is intended
to be sold in the ordinary course of business
 Purchase Returns and Allowances is a contra-expense account, which refers to the
reduction from the amount the company should pay for merchandise bought as a result
of defect, Inferior quality or wrong specifications. Its nature is similar to that of Sales
Returns and Allowances. The difference lies only in the perspective.
 Purchase Discount is a contra-expense account that refers to the discount taken by the
company for early payment.
Both Purchase Returns and Allowances and Purchase Discounts have an effect of
reducing Purchases. This would also be explained further in the discussion of accounting
for merchandising business.

15. Freight In or Transportation in - refers to the cost of transporting items bought for resale from
its point of origin to the point of destination. Actually, this is a delivery expense but shouldered
by the buyer.
 16. Cost of Merchandise Sold - represents the value of items sold to customers, which is computed
by adding the beginning inventory, purchases and freight in to come up with Merchandise
Available for Sale and deducting ending inventory.

Drill 1: Determine the nature of each of the following accounts by writing “A” for Assets, “L” for
Liabilities and “OE” for Owner’s Equity on the space provided.
1. Prepaid Insurance _6. Accounts Receivable
2. Loans Payable _7. Office Equipment
3. Drawings _8. Unearned Revenue
4. Office Supplies _9. Cash
5. Accounts Payable _10. Capital

Drill 2:
A contra account is displayed alongside an associated account, and it has a balance that is opposite to
the account it is associated with. A contra asset account is an asset account with a normal credit
balance, and it will decrease an asset account. The following are examples of contra accounts.
Determine which asset account does it decrease.

Contra-asset accounts (Cr) Asset Account (Dr)

1. Allowance for Bad Debt
2. Accumulated Depreciation
3. Sales Discount
4. Discount on notes receivable
5. Obsolete Inventory Reserves

Drill 3: Match the different account titles on the left to their major classifications on the right. Write the
CAPITAL LETTER of your answers on the blank provided.
 . 1. Cash A. Current Assets

. 2. Mortgage B. Non-current Assets

. 3. Notes payable C. Current liabilities

. 4. Notes receivable D. Non-current liabilities

. 5. Machine E. Owner’s equity

. 6. Taxes payable F. Not applicable
. 7. Fees

. 8. Prepaid expenses

. 9. Accrued expense

. 10. Loans

WRITTEN WORKS 3

1ST GRADING 1ST SEMESTER

Using the lessons discussed in this module, answer the questions on a separate file
found at the back of this module under Appendix. Read instructions first before you
answer. You are all encouraged to answer the questions with all your understanding
because the lessons learned in this module is very relevant to the succeeding lessons.
Always refer to the rubrics in answering this activity to obtain better scores. God
bless!

UNIT 2: THE ACCOUNTING EQUATION

Form other equations based on the original accounting equation:

A = L + OE
Equation 1

Equation 2
 From the accounting equation above. How does each business transaction affect the accounting
equation? Write your answer on the space provided.
_____________________________________________________________________________________
_____________________________________________________________________________________
__________________________________________________________

You may have some of the following below. Your task is to provide at least 2 examples for each that
you possess.
Examples
ASSET 1.
2.
LIABILITIES 1.
2.
OWNER’S EQUITY 1.
2.

The following table illustrate the effect of transactions on the assets, liabilities, and owner’s
equity as a result of different transactions affecting the accounting equation. The abbreviations in the
examples are:
INC= Increase
DEC= Decrease
NC= No Change

Transactions Assets Liabilities Capital Analysis

1. the owner INC NC INC An entity separates and distinct from the
invests cash owner is created. The cash investment of the
owner increases and the assets of the
business and the capital of the owner.
2. Owner invest INC NC INC The equipment increases the assets of the
equipment business. Since this is an investment of the
owner, capital of the owner increases
correspondingly.
3. Renders INC NC INC The business earned an income by rendering
services for services and collecting revenues in cash. The
cash effect in the accounting equation is an
increase in cash for the cash collected and
an increase in capital as revenue increases
capital.
4. Renders INC NC INC Assets increase by the amount of revenue
services expected to be collected from the customer
on credit to whom the services were rendered. Capital
or also increases since rendering of services
account. represent revenue.
5. Collects INC/D NC NC Assets increase as there is cash inflow in the
account in EC amount of the collection. However, assets
transaction correspondingly decrease with the amount of
#4 the collection as the account (Accounts
Receivable) will decrease. This is because the
amount the customer owes has already
been collected.
6. Purchase INC INC NC Supplies increase the assets of the business
supplies and the liabilities correspondingly increase
on credit as the supplies were bought on account
or on credit.

7. Returns DEC DEC NC Assets decrease with the number of supplies

defective returned. Liabilities correspondingly decrease
supplies as the returned supplies decrease the
amount owed.
8. Pays the DEC DEC NC The transaction is a payment of account.
supplies Since there is cash outflow representing the
bought payment of an existing liability, assets
on decrease in the amount of cash paid and
account liabilities decrease in the amount of the
liability on supplies paid.
9. Borrows cash INC INC NC Cash increases the assets of the business as
issuing a there is an inflow of cash because the
note business borrowed money. Notes payable
increases the liabilities of the business as it
presents an obligation on the part of the
business to pay at a future date.
10. Purchases INC/D NC NC Land increases the assets of the business
land using cash EC but correspondingly another asset
decreases in the account of cash because
the business used cash for purchase.

11. Pays utilities DEC NC DEC The owner’s equity decreases in the form of
expense for the expense while assets decrease because the
month business used cash to pay for the expense.

12. Pays the DEC DEC NC Assets decrease in the account cash because
note in full of payment, while liabilities also decrease as
an evidence of payment of an obligation.

Just like any equation, the accounting equation means the right and the left sides are equal. Thus, the
assets on the left should be equal the liabilities and capital on the right.

Let’s try to determine the missing amount in each of the accounting equations below.
Complete the table by writing the correct amount:
Assets Liabilities Owner’s Equity
1. 70, 000 15, 000
2. 30, 000 70, 000
3. 80, 000 25, 000
4. 90, 000 12, 000
5. 45, 000 21, 000

Double entry accounting shows that for every debit entry there is a corresponding credit entry.

To enrich your understanding do the following example activity.

Note: transaction 1 is an illustration on how to go about with this activity. Please follow the
format in doing Activity 1. Ensure that the balance is maintained between the assets and liabilities and
capital on the other side.
1. Transaction: On June 1, 2020, Frances Angel’s fashion boutique was able to sell three dresses
for a total sale of P7, 500 plus three pairs of shoes amounting to P3, 000.
Date Transaction Assets = Liabilities + Owner’s Equity

2020 June 1 Sale of dress 7,500 7,500

Sale of shoes 3,000 3,000
Activity 1: Determine the following values:

1. The amount of the liabilities of a business having P50, 200 of assets, and in which the owner
has a P24, 400 equity.
2. The owner’s equity of a business with total assets of P60, 000, and liabilities of P42, 000.
3. The value of the assets of a business having P60, 000 in liabilities, and in which the owner has
a P22, 000 in equity.
4. The owner’s equity of a business having P46, 000 of assets, and of which the 20, 700 was
contributed by creditors.
5. The owner’s equity of a business with total assets of P70, 000, and liabilities of P37, 000.

TAKE NOTE!

PERFORMANCE TASK 1

1ST Grading 1st Semester 2021-2022

Using the lessons discussed in this module, satisfy the requirements of the our activity found

at the back of this module under APPENDIX. Read the instructions first before you answer.

You are all encouraged to answer the questions with all your understanding because the

lessons learned in this module is very relevant to the succeeding lessons. Always refer to the

rubrics provided in answering in order to obtain better scores. God bless!