i

Disclaimer

This learning material is used in compliance with the flexible teaching-learning approached

espoused by CHED in response to the pandemic that has globally affected educational

institutions. Authors and publishers of the contents are well-acknowledged. As such, the

college and its faculty do not claim ownership of all sourced information. This learning

material will be exclusively used for instructional purposes and not for commercialization.

CatSU College of Business and Accountancy

i
 PREFACE

This module provides a reinforcement of basic accounting, within the context of business

and business decisions. Structured according to prepared course syllabus, students are

expected to obtain knowledge of the principles and concepts of accounting as well as their

application that will enable them to appreciate the production of accounting data.

Emphasis is placed on understanding the reasons underlying basic accounting concepts and

providing students with an adequate background on the recording of transactions, their

classifications and reporting function of accounting in a service firm through the preparation

of Statement of Financial Position, Income Statement, Statement of Changes in Equity, and

Cash Flow Statement. Exposure through the use of numerous problems and practice sets

(both those found in the module and those to be given by the instructor as the term

progresses) in recording and reporting transactions is a requirement in this course.

In no way is this module deemed to be absolutely adequate and complete for the learning of

basic accounting. Reading of other materials and practice through problems and exercises is

greatly encouraged.

ii
 LEARNING OUTCOMES

After this completing this course, the student is expected to:

 Define accounting and discuss the importance of accounting as a language of

business.
 Understand the framework of accounting, its functions, principles, and assumptions;

and to name the financial statements and their elements and understand their

relationships
 Identify and differentiate business transactions, explain the accounting cycle, and

understand and prepare journal entries

 Transfer data from journals to ledgers and prepare basic financial statements; analyze

the results of business transactions

 Prepare adjusting entries, closing, entries; prepare the post-closing trial balance;

prepare and post reversing entries

iii
 TABLE OF CONTENTS
Cover Page
Disclaimer i
Preface ii
Learning Outcomes iii
Table of Contents iv

Chapter 1 – Introduction to Accounting 1

Discussion
Definition, purpose, nature, functions, scope, and objectives of accounting
The Accounting Profession
Users of accounting information
History of accounting
Forms of business organization
Kinds of business activities
Relationship between business and accounting
Summary

Chapter 2 – The Accounting Framework 16

Discussion
Basic accounting assumptions
Functions of accounting
The basic financial statements
Users of financial information
Elements of financial statements
Summary

Chapter 3 – The Accounting Process 26

Discussion
Definition of business transactions and source documents
The accounting equation
The accounting cycle
Typical account titles used
Rules of debit and credit and their applications
Journalizing
Summary

References v
Suggested Readings and References v

iv
 1 - INTRODUCTION TO ACCOUNTING

OBJECTIVES
1. Identify and explain the various definitions in accounting.
2. Explain the history, development and nature of accounting.
3. Differentiate the different forms of business organization.
4. Explain the relationship of business and accounting.

CONTENT
1. Definition, purpose, nature, functions, scope, and objectives of accounting
2. Users of accounting information
3. History of accounting
4. Forms of business organization
5. Types of businesses and kinds of business activities
6. Relationship between business and accounting

DEFINITION OF TERMS
Entity refers to any firm or organization (for-profit or non-profit). However, in this module, the
term will mostly be used to refer to any business enterprise.

DEFINITION OF ACCOUNTING

American Accounting Association

Accounting is the process of identifying, measuring, and communicating economic
information to permit informed judgment and decision by users of the information.

American Institute of Certified Public Accountants

Accounting is the art of recording, classifying and summarizing in a significant manner and in
terms of money, transactions and events which are in part at least of a financial character
and interpreting the results thereof.

Financial Reporting Standards Council

Accounting is a service activity. Its function is to provide quantitative information, primarily
financial in nature, about economic entities that is intended to be useful in making decisions.

Basic Purpose Accountable event – an economic

To provide quantitative financial information about a event which has an effect on
business that is useful to statement users particularly assets, liabilities and equity
owners and creditors, in making economic decisions.

Functions of Accounting
1. Identifying accountable events – means the recognition or non-recognition of
economic activities

2. Measuring accountable events – is the process of determining the monetary amounts

at which elements of the financial statements are to be recognized.

3. Communicating accountable events – is the process of preparing and distributing

accounting reports to potential users of accounting information

1
 WHY STUDY ACCOUNTING?
“For most people accounting is not remotely
important. Anyone in any sort of white-collar job
[] is likely to run into budgets and be held
accountable for things (even if they are not that
much within their control). To a degree therefore
some competence in reading figures and how to
present them matters.” [ CITATION Sim19 \l 1033 ]

Even for non-accountants, accounting knowledge will be a very important asset. More so
since everyone can become an entrepreneur. Knowledge in accounting will surely be of
great help to keep the business in good health and even help it succeed and grow.

“Financial statements contain important information about your company’s operating results
and financial position. The relationship between certain items of financial data can be used
to identify areas where your firm excels and, more importantly, where there are opportunities
for improvement. Using, understanding, and interpreting these statements will help you
make much better business decisions.” [ CITATION Leo13 \l 1033 ]

Even for other employees and managers, accounting gives a better understanding of how
their organization works. They end up with better control and confidence over their budgets
and careers.

It makes the point that managers can’t afford not to understand basic accounting.

“Financial management is a crucial aspect of any thriving business. Profit maximization is a

real concern for any organization – and it depends on solid financial decisions. To make
good decisions, management needs good information. And that information comes from the
accounting system.

According to an online article by Tax and Accounting Center, Inc., accounting is a

must-learn for owners of Small & Medium Enterprises in the Philippines so that
they will not be at the mercy of retainer paid accountants or bookkeepers. But even
if your skill is not enough to independently produce complete financial statements
for compliance, minimum skill and knowledge will go a long way, from having good
company recording and control procedures to avoiding exploitation and fraud and
many more.

Branches of Accounting
1. Public Accounting
a. Auditing – involves examination of financial statements of clients for the
purpose of expressing an opinion as to the fairness with which the financial
statements are prepared
b. Tax services – involves the preparation of tax returns and the determination
of tax consequences of certain proposed business endeavors
c. Management advisory services – involves the development and
interpretation of accounting information intended specifically to aid
management in running the business

2. Private Accounting

2
 a. General accounting1 – includes bookkeeping and preparation of financial
reports
b. Cost accounting – involves determining and controlling costs
c. Budgeting – involves preparation of financial plan as well as preparation of
report summarizing deviations from plan after the plan has been implemented
d. Internal auditing – involves examination of financial records of the company
to detect fraud and other malpractices and to ensure adherence to
established accounting procedures
e. Government accounting – involves analyzing, classifying, summarizing, and
communicating all transactions involving receipt and disposition of
government funds and property and interpreting the results thereof
f. Accounting education – the CPA serves as a faculty member in accounting
in various colleges and universities
g. International accounting – this is concerned with the transactions of
multinational companies in their dealings in the international trade

Users of Financial Information

Internal users refer to managers who use accounting information in making decisions
related to the company's operations.

In small businesses, management may include the owners. In huge organizations, however,
management is usually made up of hired professionals who are entrusted with the
responsibility of operating the business or a part of the business. They act as agents of the
owners.

The managers regularly face economic decisions – How much supplies will we purchase?
Do we have enough cash? How much did we make last year? Did we meet our targets? All
those, and many other questions and business decisions, require analysis of accounting
information.

External users, on the other hand, are not involved in the operations of the company but
hold some financial interest. The external users may be classified further into users
with direct financial interest (primary users) –investors, creditors; and users
with indirect financial interest (secondary users) – government, employees, customers and
the others.

A. Primary Users
1. Existing and potential investors – they need to determine whether to hold,
buy, or sell their investments

2. Lenders and Creditors – these are potential and existing creditors. They
need information on the capability of the business to pay loans and interests
when they fall due

B. Other Users
1. Employees – these comprise the labor force of the business firm. They want
to know whether the business has the ability to provide and sustain
remuneration, other benefits and growth. The firm’s stability and profitability
can be determined through analysis of the financial reports.

1
Only general accounting is tackled in this course. The rest of the branches are included in specialized subjects
and higher accounting courses.

3
 They may also be interested in its financial position and performance to
assess company expansion possibilities and career development
opportunities.

2. Customers – Customers who have businesses of their own are sometimes

dependent on the company for the smooth operation of their businesses.

When there is a long-term involvement or contract between the company and

its customers, the customers become interested in the company’s ability to
continue its existence and maintain stability of operations.

For example, a distributor (reseller), the customer in this case, is dependent

upon the manufacturing company from which it purchases the items it resells.

Other customers are only concerned if the company offers useful products at
fair prices, or whether the company will survive long enough to honor its
product warranties?

3. Government and its agencies – they require information to regulate the

activities of the entity, determine taxation policies, and as a basis for national
income and similar statistics.

They want to know whether the business is paying taxes according to current
tax laws. The language in which tax-related financial statements are prepared
is called IRC or Internal Revenue Code.  Tax preparation will be outside the
scope of this course.

4. Public – the financial statements may assist the public by providing

information about the trends and recent developments in the prosperity of the
entity and the range of its activities.

Anyone outside the company such as researchers, students, analysts and

others are interested in the financial statements of a company for some valid
reason.

Is the company providing useful products and gainful employment for citizens
without causing serious environmental problems?

HISTORY OF ACCOUNTING
Early Times
Accounting records are made by making markings on whatever surface that was most
convenient – stones, clay tablets, papyrus. The Romans for example kept elaborate records
and their systems were standardized for military payrolls and the accountability of provincial
governors. However, they did not develop any system of commercial bookkeeping since
numbers were expressed in terms of letters in the alphabet.

14th to 15th Century

The Italians pursued trade and commerce vigorously and developed extensive record-
keeping systems. They learned numerals and the basics of arithmetic from the Arabs. This
paved the way to the development of the double-entry bookkeeping system. Because of their
efforts in finding ways to come up with functional record-keeping systems, they were
regarded as the fathers of modern accounting. Some note-worthy works of the Italians are:

4
  The Genoese system (From Genoa, northwest Italy) assumed the concept of
business entity because it was the first to imply that unlike items could be compared
in terms of a common monetary unit. It also implied distinctions between Capital and
income that it included both expenses and equity accounts. The oldest double-entry
books were the Massari ledgers of the Commune of Genoa from 1340.
 The Florentine System (Florence, Italy) kept records in great detail almost in
narrative form. It listed debits above credits rather than on separate pages. Separate
columns for transactions were needed to record which monetary value was used. It
was also in Florence where development of big companies such as partnerships took
place.
 The Venetian System (Venice, Italy) is the key influence on double-entry
bookkeeping. The earliest Venetian records show an accounting system that was
highly developed, including the first true journal used in Renaissance bookkeeping.

The title of father of the double-entry bookkeeping

system, however, was given to an Italian monk
named Fra Luca Pacioli. He wrote the first
published work on the topic called “SUMMA DE
ARITHMETICA GEOMETRIA PROPORTIONIS ET
PROPORTIONALISTA in 1494. He did not
necessarily invent the system but he formalized the
practice and ideas which have been evolving in the
Portrait of Pacioli; Source: Wikipedia.com
years before and presented the world with the essentials
of bookkeeping as it is known today. Other men in other
countries also began to explore
about the subject.

16th – 18th century

During this period, the center of commerce shifted sequentially from Italy to Spain, to
Portugal, and then to Northern Europe. With the commercial shift was an accompanying shift
in accounting development.
 1673 – France adopted the first official accounting code, which required, among
other things, that balance sheets should be drawn up every two years. It was also
during this period that the practice of treating accounts as independent living entities
started along with the standardization of debits on the left, credits on the right.
 1700 – The French revolution led to the development of the Savory and the
Napoleon communist code. The serious study of accounting and development of
accounting theory also began in this period and has continued to the present day.

Industrial Revolution
The social and economic changes in Great
Britain, Europe, and the United States that began
in the second half of the 18th Century and
involved widespread adoption of industrial
methods of production. The specialization of
tasks, the concentration of capital, and the
centralization of work forces were important
aspects of these changes, which first affected
Great Britain. The industrial revolution had
catapulted England into an unrivaled prosperity.
Great Britain was the financial center of the
civilized world.

5
With industrial breakthroughs and shifts in business forms from proprietorship to partnership
and stock companies, came also new trends in accounting to answer the needs of the
industry. Accounting for depreciation has started as well as allocation of overhead and
inventory accounting. Increased government regulation of business made new demands on
firms, which also generated new accounting systems. Most notable is the increased taxation
of business and individuals which brought with it new tax accounting systems and
procedures.

In rapidly globalizing world, it only makes sense that same economic transactions are
accounted for in the same manner across various jurisdictions. This is reason why the
Philippines has adopted the International Financial Reporting Standards or IFRS. Thus,
Philippine Financial Reporting Standards directly
correspond to IFRS.
However, accounting systems still differ among Accounting variations among countries
countries due to the following: Factors causing the differences:
1. Differences in economic condition (e.g.
 Economic condition
degree of industrialization, rate of inflation,
level of economic growth)  Educational system
2. Educational systems  Political system
3. Political systems  Legal system
4. Legal systems  Socio-cultural characteristics
5. Socio-cultural characteristics

GENERALLY ACCEPTED ACCOUNTING STANDARDS (GAAPs)

GAAPs represent rules, procedures, practice, and standards followed in the preparation and
presentation of FS. These are like “Laws” that must be followed in financial reporting.

In the Philippines, the Financial Reporting Standards Council is the accounting body tasked
with the establishing of generally accepted accounting principles. Approved statements of
the body are called Philippine Financial Reporting Standards.

PURPOSE OF ACCOUNTING STANDARDS

Financial statements, when prepared in accordance with GAAPs, permit comprehensive
analysis and evaluation and therefore become more credible and reliable to statements
users. In other words, the purpose of accounting standards is to identify practices for
preparation and presentation of FS to promote a common understanding between preparers
and FS users.

International Accounting Standards Committee

The IASC, an independent private sector body, with the objective of achieving uniformity in
the accounting principles which are used by business and other organizations for financial
reporting around the world, was formed in 1973 through an agreement made by professional
accountancy bodies from Australia, Canada, France, and many other nations. The IASC is
headquartered in London, United Kingdom. In 2001, the IASC was reorganized into IASB.

Objectives of the IASC

1. To formulate and publish accounting standards to be observed in the presentation of financial
statements and to promote their worldwide acceptance and observation.
2. To work generally for the improvement and harmonization of regulations, accounting standards and
procedures relating to the presentations of financial statements.

*Approved statements of the IASB are known as INTERNATIONAL FINANCIAL

REPORTING STANDARDS (IFRS).

6
LEGAL FORMS OF BUSINESS ORGANIZATIONS
A. Proprietorship – owned by a single person who has complete control over
business decisions
Advantages:
Ease of entry and exit Tax savings
Full ownership and control Few government regulations
Disadvantages:
Unlimited liability
Limitations in raising capital
Lack of continuity
B. Partnership – a legal arrangement in which two or more persons agree to
contribute capital or services to the business and divide the profits or losses that
may be derived therefrom.
Advantages:
Ease of formation Management base
Additional sources of Tax implication
capital
Disadvantages:
Unlimited liability Difficulty of transferring ownership
Lack of continuity Limitations in raising capital
C. Corporation – an artificial being created by operation of law and is a legal entity
separate and distinct from its owners
Advantages:
Limited liability
Unlimited life
Ease in transferring ownership
Ability to raise capital
Disadvantages:
Time and cost of formation
Regulation
Taxes

A proprietorship is an unincorporated business owned by one individual. Going into

business as a sole proprietor is easy — a person begins business operations.
Proprietorships have three important advantages:
(1) They are easily and inexpensively formed
(2) they are subject to few government regulations, and
(3) they are subject to lower income taxes than are corporations.

7
However, proprietorships also have three important limitations:
(1) Proprietors have unlimited personal liability for the business’s debts, so they can
lose more than the amount of money they invested in the company. You might invest
P100,000 to start a business but be sued for P1 million if, during company time, one
of your employees runs over someone with a car.
(2) The life of the business is limited to the life of the individual who created it; and to
bring in new equity, investors require a change in the structure of the business.
(3) Because of the first two points, proprietorships have difficulty obtaining large
sums of capital; hence, proprietorships are used primarily for small businesses.

However, businesses are frequently started as proprietorships and then converted to

corporations when their growth results in the disadvantages outweighing their advantages.

A partnership is a legal arrangement between two or more people who decide to do

business together. Partnerships are similar to proprietorships in that they can be established
relatively easily and inexpensively. Moreover, the firm’s income is allocated on a pro rata
basis to the partners and is taxed on an individual basis. This allows the firm to avoid the
corporate income tax.

However, all of the partners are generally subject to unlimited personal liability, which means
that if a partnership goes bankrupt and any partner is unable to meet his or her pro rata
share of the firm’s liabilities, the remaining partners will be responsible for making good on
the unsatisfied claims. Thus, the actions of a Texas partner can bring ruin to a millionaire
New York partner who had nothing to do with the actions that led to the downfall of the
company. Unlimited liability makes it difficult for partnerships to raise large amounts of
capital.

In limited partnerships, however, creditors cannot go after the personal assets of the

limited partners.

8
A corporation is a legal entity created by a state, and it is separate and distinct from its
owners and managers. It is this separation that limits stockholders’ losses to the amount
they invested in the firm—the corporation can lose all of its money, but its owners can lose
only the funds that they invested in the company. Corporations also have unlimited lives, and
it is easier to transfer shares of stock in a corporation than one’s interest in an
unincorporated business. These factors make it much easier for corporations to raise the
capital necessary to operate large businesses. Thus, companies such as Hewlett-Packard
and Microsoft generally begin as proprietorships or partnerships, but at some point they find
it advantageous to become a corporation.

A major drawback to corporations is taxes. Most corporations’ earnings are subject to double
taxation—the corporation’s earnings are taxed; and then when its after-tax earnings are paid
out as dividends, those earnings are taxed again as personal income to the stockholders.

Although general rules and accounting procedures are fundamentally the same, accounting
for transactions particular to the partnership and corporation types of businesses are
covered by higher accounting subjects. Needless to say, this module will mostly use only the
proprietorship form for illustration and explanation of basic accounting concepts.

Three (3) Types of Business

A business entity is an organization that uses economic resources to provide goods or
services to customers in exchange for money or other goods and services.

Business organizations come in different types and in different forms of ownership.

1. Service Business
A service type of business provides intangible products (products with no physical
form). Service type firms offer professional skills, expertise, advice, and other similar
products.

Examples of service businesses are: salons, repair shops, schools, banks,

accounting firms, and law firms.

2. Merchandising Business
This type of business buys products at wholesale price and sells the same at retail
price. They are known as "buy and sell" businesses. They make profit by selling the
products at prices higher than their purchase costs.

A merchandising business sells a product without changing its form. Examples are:
grocery stores, convenience stores, distributors, and other resellers.

3. Manufacturing Business
Unlike a merchandising business, a manufacturing business buys products with the
intention of using them as materials in making a new product. Thus, there is a
transformation of the products purchased.

A manufacturing business combines raw materials, labor, and overhead costs in its

production process. The manufactured goods will then be sold to customers.

Hybrid Business
Hybrid businesses are companies that may be classified in more than one type of business.
A restaurant, for example, combines ingredients in making a fine meal (manufacturing), sells
a cold bottle of wine (merchandising), and fills customer orders (service).

9
TYPES OF BUSINESS ACTIVITIES

10
OPERATING ACTIVITIES
As the name connotes, operating activities has to do with the various business practices
done by a company on a daily basis. This involves things ranging from paying for running
costs to paying employees’ salaries. Delivery cost and product cost are also basic activities
to be classified under the operating activities of a company.

It also has to do with all expenditures made to keep the company running. The sales and
income accrued from operations also fall under the operation section of the paper work.

FINANCING ACTIVITIES
Financing activities are transactions that have to do with individual customer financing and/or
financing the company. Transactions such as loans, credit transactions, debt financing,
secondary offerings and initial public offerings fall under this category. Dividends, stock
repurchases as well as interest also belong here. In fact, any business activity that has to do
with fundraising or financing will be found here.

INVESTING ACTIVITIES
Investing transactions are business activities that have to do with the long-term use of cash.
These kinds of activities are not under the usual daily operations of the company and are
used to refer to activities that have to do with investments. These are business activities
capitalized over the space of at least a year. It also involves the purchase of long-term
assets. If it has to do with investing into something, then it is referred to as “the use of cash”
under this category. If it has to do with dividends from investment or the sale of real estate,
then it is referred to as a source of cash. Generally, purchase of land, property or equipment
of value fall under this category.

Any loans made to customers or other entities would also be considered an investing
transaction.2 Dividends and interest earned on investments would also qualify under the
investing category for Statement of Cash Flows. 

SUMMARY
A. Operating Activities – principal revenue-producing activities of an enterprise
and include:
a. Delivering or producing goods for sale
b. Providing services

B. Financing Activities
a. Obtaining resources from and returning resources to owners
b. Obtaining resources through borrowings (short-term or long-term)
c. Repayments of amounts borrowed

C. Investing Activities
a. Acquisition and disposition of property, plant, and equipment (PPE) and other
long-term assets
b. Acquisition and disposition of debt and equity instruments of other enterprises
that are not considered cash equivalents or held for dealing or trading
purposes

For mastery of the types of business activities, you may remember financing activities as
transactions between the business and its owners and creditors (external financing). Thus,

2
Notice that when loans are extended by the company, transaction is an investing activity. However, when the
enterprise is the one availing the loan, the transaction is a financing activity.

11
repaying liabilities to suppliers although referring to repayment of debt will not be considered
financing.

Investing activities, on the other hand, have something to do with long-term assets. One
thing to remember is that an asset ordinarily considered long-term will not be so if it is held
for trading, since that would mean the asset is transformed into cash frequently within the
operating cycle. Generally, however, business transactions dealing with furniture, fixtures,
equipment, investments, buildings, etc. will be considered investing activities.

Operating activities may simply be given a residual definition; that is, transactions not
classifiable under the first two will fall under operating activities.

RELATIONSHIP BETWEEN BUSINESS AND ACCOUNTING

Accounting is the way a business keeps track of its operations. Accountants analyze the
business finances so the owner can make better decisions. This information is organized
into reports that show the financial health of a business. Accounting also
helps business owners meet their compliance obligations. [ CITATION Xer \l 13321 ]

Going back to the purpose of accounting, it helps business stakeholders make better
decisions through the recording and processing of economic information. Through
accounting, managers and owners monitor the business enterprise’s health and respond to
maintain or improve condition and performance.

12
SUMMARY

Accounting is regarded as the language of business. It is a means through which business

entities communicate information to different users.

The basic purpose of accounting is to provide information needed by users in making

economic decisions.

Business activities may be financing, investing, or operating.

The three major types of businesses are: service business, merchandising business, and

manufacturing business. Service businesses offer intangible products to customers using

their skills and expertise. Merchandising businesses buy goods and sell the same at higher

prices. Manufacturing businesses purchase goods and use them to make new products that

are to be sold.

The basic forms of organization or business ownership include: sole proprietorship,

partnership, and corporations.

It is essential to learn about the types of businesses and forms of organizations in pursuing

business studies. In accounting, it is important to be familiar with them because of the

differences in accounting practices.

13
Review Questions

1. What are the three functions of accounting?

Identifying, Measuring, and Communicating accounting information

2. What are the typical forms of business organizations?

Sole proprietorship, partnership and corporation

3. What are the characteristics of a sole proprietorship?

 Owner and business are not separated
 Business is not a separate entity
 Owner has unlimited liability for business obligations
 Appropriate for small operations

4. What are the characteristics of a partnership?

 More than one partners own the business together
 Business is not a separate entity
 General partners have unlimited liability for business obligations
 Limited partners have limited liability for business obligations
 Income from partnership is transferred to partners
 Partners pay individual income tax on the income from partnership

5. What are the characteristics of a corporation?

 Business is a separate entity
 Owners of a corporation are stockholders
 Stockholders have limited liability up to the amount invested in stock
 Raising a large capital is easier for a corporation
 Income from a corporation is taxed twice
 A corporation pays corporate income tax on its income
 Stockholders pay individual income on dividend income

6. Give some advantages of a corporation.

 Stockholders have limited liability up to the amount invested in stock
 Raising a large capital is easier for a corporation

7. Give a disadvantage of a corporation.

Income from a corporation is taxed twice

8. What are the types of business activities?

Operating activities, investing activities and financing activities

14
SELF-ASSESSMENT

1. What is the basic purpose of accounting? How is this purpose attained?

2. Identify the form of business organization according to the characteristic presented. If

it applies to more than one form of organization, supply all that applies.

Characteristic Legal Form of Business Nature of Characteristic

Organization (advantage or
disadvantage)
1. Ease of transferring Advantage
ownership

2. Lack of continuity Disadvantage

3. Capital base Advantage

4. Management base Advantage

5. Limited life Disadvantage

6. Regulation Disadvantage

3. In your own words, how will you relate accounting to business?

4. Identify the type of business activity by analyzing the following business transactions:

Type of
No
Business Transaction Business
.
Activity

1 The owner invested P200,000 cash in the business.

2 Paid the loan due to BANCO DE ORO, P50,000

3 Rendered service to a customer on account, P3,000

4 Paid the FICELCO bill, P4,350

5 Bought a delivery truck on account, P450,000

6 The owner withdrew cash from the business for personal use, P5,000

15
7 Paid the rent for the month, P10,000
Sold an old computer for P500. The computer has a book value of
8 P2,000 at the time of sale.

9 An account customer paid his account in full, P2,560

The account with a certain supplier was paid by issuing a check for the
10 full amount, P12,000

16
 2 - THE ACCOUNTING FRAMEWORK

CONTENT
1. Basic accounting assumptions
2. Functions of accounting
3. The basic financial statements
4. Elements of financial statements

ACCOUNTING CONCEPTS AND PRINCIPLES

Objective of FS – to provide information about the financial position, performance, and cash
flows of an entity that is useful to a wide range of users in making economic decisions.

Accounting Assumptions are basic notions or fundamental premises on which the

accounting process is based.
1. Going Concern Assumption means that the entity is viewed as continuing in
operation indefinitely in the absence of evidence to the contrary statements.
2. Accrual Assumption means that income is recognized when earned regardless of
when received and expense is recognized when incurred regardless of when paid.
3. Accounting Entity Assumption states that the enterprise is separate from the owners,
managers, and employees who constitute the firm. Transactions of the firm must not
be merged with transactions of the owners.
4. Time Period Assumption requires that the indefinite life of an enterprise is subdivided
into time periods of accounting periods which are usually of equal length for the
purpose of preparing FS.
5. Monetary Unit Assumption has two aspects:
a. Quantifiability – means that elements of the FS should be stated in terms of a
unit of measure which is the peso in the Philippines
b. Stability of Peso – means that the purchasing power of peso is stable or
constant and that its instability is insignificant and therefore may be ignored.
The accounting function is to account for pesos only and not for changes in its
purchasing power.

Identifying Function of Accounting

This is the recognition or non-recognition of accountable events. There are four recognition
principles:
1. Asset recognition
2. Liability recognition
3. Recognition of income
4. Recognition of expense

RECOGNITION PRINCIPLES – Recognition as defined by the Conceptual Framework is the

process of capturing for inclusion in the statement of financial position or the statement(s) of
financial performance an item that meets the definition of an asset, a liability, equity, income
or expenses.

Basically, whether to recognize an element answers the questions, “Should we record it?
Should we make a journal entry? Should it be included in the financial statements?”

Recognition is appropriate if it results in both relevant information about assets, liabilities,

equity, income and expenses and a faithful representation of those items, because the aim is
to provide information that is useful to investors, lenders and other creditors.

 Asset - A present economic resource controlled by the entity as a result of past

events. An economic resource is a right that has the potential to produce economic
benefits.

17
  A present obligation of the entity to transfer an economic resource as a result of past
events. An obligation is a duty or responsibility that the entity has no practical ability
to avoid.
 Income - Increases in assets, or decreases in liabilities, that result in increases in
equity, other than those relating to contributions from holders of equity claims.
 Expenses - Decreases in assets, or increases in liabilities, that result in decreases in
equity, other than those relating to distributions to holders of equity claims.

These terms will be explained further later.

Measuring Function of Accounting

1. Historical Cost – original acquisition cost
2. Current Cost – replacement cost or current purchase price
3. Realizable Value – current selling price
4. Present Value – discounted value of future net cash inflows that the asset is
expected to generate in the normal course of business

Communicating Function of Accounting

Financial statements
1. Statement of financial position
2. Income statement
3. Statement of comprehensive income
4. Statement of changes in equity
5. Statement of cash flows
6. Notes to financial statements

*The statements enumerated above are those required to be presented under Philippine
Financial Reporting Standards. Other reports may still be made by companies for other
purposes.
*Numbers 3 & 6 are tackled in higher accounting subjects. The rest are basic financial
statements introduced in basic accounting courses. SOCI is a more inclusive statement that
covers items not reported in the Income Statement, and the Notes to financial statements
clarify accounting procedures used by a company, and divulge information that has
occurred during and immediately after the close of the accounting period.

18
STATEMENT OF FINANCIAL POSITION
This is a formal statement showing the financial position of an entity as of a particular date.
The balance sheet shows the three elements of financial position, namely:

1. Assets Operating Cycle

These are properties or things of value, tangible
or intangible, controlled by the entity as a result of This is the time from the acquisition of asset to the time
past transactions and events and from which this asset is realized into cash or cash equivalents in the
ordinary course of business.
future economic benefits are expected to flow to
the entity. An entity which conducts business on cash basis has a
shorter operating cycle than that of a business which
2. Liabilities extends credit to customers.
These are present obligations of an entity arising
from past transactions or events, the settlement
of which is expected to result in an outflow of Cash

asset from the entity.

3. Owner’s Equity Cash sale Inventory

This is the residual interest of the owner or
owners in the assets of the business entity. Also Operating Cycle of a cash-basis business
known as net assets. The other term for owner’s
equity is capital.
Cash

ASSETS
Characteristics:
Collection Inventory
1. Acquired from a past event
2. Value of the assets can be measured reliably
3. Will give future economic benefits to the owner
4. Owner of the assets has complete control over Axxount Credit

them and has the legal capacity to restrict

Receivable Sale

others from using these assets Operating Cycle of a business extending credit

*Note that even if an entity is expecting to receive

any payment or asset (say, someone has promised to give or donate property) if such
cannot be reliably measured, no recognition will be made, although the information may be
disclosed in Notes to Financial Statements.

Classification:
1. Current Assets – include unrestricted cash or cash equivalents and other noncash
items which are expected to be realized, sold, or consumed within the normal
operating cycle.
2. Noncurrent Assets – those assets which cannot be classified as current

Examples of Current Assets

1. Cash – literally money, coins and currency that are legal tender or standard medium
of exchange
2. Cash equivalents – highly liquid investments readily available for cash, normally
within 3mos.
3. Marketable securities - short term investments that can be realized into cash within a
year
4. Accounts receivable – collectibles from customers arising from credit sales in the
ordinary course of business. These are open accounts not covered by promissory
notes, otherwise, they are called Notes receivable.
5. Merchandise inventory – goods or products acquired to be sold to customers at a
profit

19
 6. Prepaid expenses – represent unused portion of an expense that has already been
paid for
Normally, prepaid expenses are determined at the end of the reporting period.
Examples of prepaid expenses:
Prepaid supplies – unused office supplies like pens, coupon bonds, ink, etc.
Unexpired insurance – portion of insurance premium that has not been used
yet
Prepaid rent – portion of rent that has not yet expired
7. Interest receivable – represents interest earned on promissory notes issued by
customers

Examples of Noncurrent Assets

1. Property, plant and equipment – tangible Property, plant, and equipment
assets held for use in production or supply
of goods and services, for rental to others, (PPE), except Land, are shown in the
or for administrative purposes and are Balance Sheet net of accumulated
expected to be used during more than one depreciation.
period (PAS 16)
2. Long-term investments – intended to be held for more than a year
3. Intangible assets – identifiable nonmonetary asset without physical substance
4. Other noncurrent assets

Examples of PPE
1. Land – the lot the business owns
2. Building – the structure owned and used by the business in its operation
3. Equipment
a. Office equipment like computers, typewriters, fax machines, copiers
b. Delivery equipment like trucks, van, tricycle
c. Transportation equipment like cars, motorcycle used by owner in transacting
business
d. Store equipment like cash register, money counters, detectors
e. Shop equipment like computers and printers in a computer shop; welding and
press machine in a machine shop; or cellphones in a loading station.
4. Furniture and fixtures – appliances, cabinets, show cases, sala sets, audio and video
units
5. Tools – like screwdrivers, pliers, etc.

LIABILITIES
Characteristics:
a. Present obligation of the business
b. Arises from a past transaction or event
c. Settlement of the liability requires the transfer of cash and noncash assets or to
provide services at some future date

Classifications of Liabilities
1. Current liabilities – expected to be settled within 12 months after the reporting period
or within the normal operating cycle
2. Noncurrent liabilities – those not classified as current

Examples of Current Liabilities:

1. Accounts payable – obligation or debt to suppliers for purchases of goods or services
on credit in the ordinary course of business not covered by a promissory note
2. Notes payable – obligation in the ordinary course of business covered by a note

20
 3. SSS premium payable – premium deducted by employer from employees’ salaries to
be remitted to the Social Security System
4. Withholding taxes payable – taxes withheld for employees to be remitted to the BIR
5. Philhealth contributions payable – medical contributions deducted from employees’
salaries to be remitted to PHILHEALTH
6. Accrued expenses – expenses incurred but not yet paid, like rent payable, salaries
payable, utilities payable (bills for water, electricity, telephone, etc.)

Examples of Noncurrent Liabilities:

1. Mortgage payable – loans with real property given as collateral
2. Bank loan payable – those payable beyond 1 year from the balance sheet date
3. Notes payable -those payable beyond 1 year from the balance sheet date

OWNER’S EQUITY
Account titles:
1. (Name of owner), capital – used to record investments of the owner
2. (Name of owner), withdrawals – used to record withdrawals of owner from the
business assets

Forms for the STATEMENT OF FINANCIAL POSITION

1. Report form – the three sections: Assets, Liabilities, and Equity are presented following a
downward sequence
2. Account Form – assets are presented on the left side while Liabilities and Equity on the right
side.

21
An accountant is having a hard time sleeping and goes to see his doctor. “Doctor, I just
can’t get to sleep at night.” “Have you tried counting sheep?” “That’s the problem – I make a
mistake and then spend three hours trying to find it.”

22
Sample Statement of Financial Position

Report Form

ARIATE LAW OFFICE

STATEMENT OF FINANCIAL POSITION
January 1, 2020

ASSETS
Current
Assets

Cash PHP 30,000

Accounts
Receivable 45,000

Prepaid Advertising 5,000

Prepaid Insurance 10,000

Office Supplies 500

Total Current Assets PHP 90,500

Noncurrent Assets

Property, plant and equipment 20,000

Less: Accumulated depreciation 5,000

Total Noncurrent Assets 15,000

TOTAL ASSETS PHP 105,5003

LIABILITIES AND OWNER'S EQUITY

Current Liabilities

Accounts Payable PHP 30,000

Accrued Expenses 8,000

3
Notice the two lines under the bottom value for every section of a financial report. This is called the double
rule. Double underlining in accounting is typically used to indicate a grand total. Double underlining only
appears in the figure at the bottom of a column of a financial statement or the like, and indicates the
completion of that specific accounting procedure.

23
 Unearned Fees 20,000

Loan Payable 30,000

Total Current Liabilities PHP 88,000

Owner's Equity
1
Ariate, Capital 7,500

TOTAL LIABILITIES AND OWNER'S EQUITY PHP 105,500

24
INCOME STATEMENT
Forms for the INCOME STATEMENT
1. Functional presentation - also known as Cost of This statement shows the result of
Sales method, expenses are classified according
operation.
to their function as part of Cost of Sales, selling
activities, administrative activities, and others
activities. If income > expenses = net income
2. Natural Presentation – also known as Nature of If income < expenses = net loss
expense method, expenses are aggregated
according to their nature.

Examples of Income accounts:

1. Service fees or service income – used to record income earned for services rendered
to customers in the ordinary course of business
2. Professional fees – used to record services rendered by a doctor, CPA, lawyer,
architect, engineer, and other professionals in the ordinary course of business
3. Commission income – income earned by agents and brokers
4. Rent revenues or rent income – income earned in renting out assets to other entities
5. Interest income – income earned on money lent. Usually, interest is earned on Notes
Receivable
6. Tuition fees – income account used by academic institutions
7. Gain on sale of PPE – income earned on the sale or disposal of PPE when selling
price is more than its book value
8. Sales or Sales Income or Sales revenue – income account for a merchandising
business representing sale of goods in the ordinary course of business

TYPES OF ACCOUNTS
1. Real accounts – balance sheet accounts, and as differentiated from nominal
accounts, are forwarded to the next accounting period
2. Nominal accounts – income statement accounts and are temporary in nature. At the
end of the accounting period, these accounts are closed to Capital.

Examples of Expense and Loss Accounts:

A. For service business
1. Salaries and wages – remuneration for services of employees
2. Taxes and licenses – used for permits, licenses
3. Doubtful Accounts expense – used for bad accounts receivable. The other term is
bad debts expense, or uncollectible accounts expense
4. Communication expense –connected with the use of telephones, cellphones,
faxes, internet, and other modes of communication
5. Utility expenses – expenses for water and electricity usage
6. Supplies expense – for office supplies, shop supplies, store supplies, etc.
7. Rent expense – rent of space
8. Insurance expense
9. Depreciation expense – for value lost on PPE due to usage, obsolescence, wear
and tear, etc.
10. Interest expense
11. Loss on sale of PPE – difference between selling price and book value, where SP
< BV

B. For merchandising business

1. Cost of sales – cost of merchandise sold
2. Purchases – cost of merchandise bought
3. Purchase returns and allowances – cost of merchandise returned to suppliers.
This is a deduction from purchases.

25
 4. Freight in – cost of transporting merchandise bought
5. Freight out – cost of transporting merchandise sold
6. Sales commissions expense – given to salesmen for sales made

Sample Income Statement

Ariate Law Firm
Income Statement
For the Month of December 2019

Revenue
Fees Earned PHP 60,000

Expenses
Salary Expense PHP 15,000
Rent Expense 7,000
Advertising
1,000
Expense
Utilities Expense 3,000
Depreciation Expense 5,000
Supplies Expense 2,000
Interest Expense 5,000
Miscellaneous Expense 2,000
PHP 40,000

NET INCOME PHP 20,000

STATEMENT OF CASH FLOWS

This is a basic statement summarizing the changes in the cash account – cash receipts and
cash disbursements – of the business during a given period of time. It consists of the
following:

1. Cash flows from operating activities – derived primarily from principal revenue
producing activities of the entity.
Examples:
a. cash received from sale of services or merchandise (inflow)
b. cash from collection of receivables (inflow)
c. cash payments to suppliers for goods and services (outflow)
d. cash payments for selling, administrative and other expenses (outflow)

2. Cash flows from investing activities – derived from the acquisition and disposal of
noncurrent assets
a. Cash received from sale of noncurrent assets (inflow)
b. Cash payment for acquisition of noncurrent assets (outflow)

3. Cash flows from financing activities – derived from equity and borrowings of the entity
Cash inflows
a. Cash received from short-term or long-term borrowings
b. Cash received from owner
Cash outflows
c. Payments for short-term or long-term borrowings

26
 d. Cash withdrawals by owner
Sample Statement of Cash Flows
De Los Santos Salon
Statement of Cash Flows
For the Period Ended December 31, 2019

Cash flows from operating activities

Cash received for services rendered PHP 112,074

Collection of accounts receivable 30,824

Payment of salaries (11,500)

Payment for utilities (2,500)

Payment for miscellaneous expenses (28,000)

Payment for supplies (3,500)

Payment for communication expenses (3,500)

Cash provided by operation PHP 93,898

Cash flows from investing activities

Payment for equipment (50,000)

Cash used in investing activities (50,000)

Cash flows from financing activities

Payment of interest (25,950)

Cash used in financing activities (25,950)

Net increase in cash PHP 17,948

STATEMENT OF CHANGES IN EQUITY

This summarizes the changes in a company’s equity for a period of time. This shows the
beginning balance of the equity and the changes that occurred in a given period of time.
These changes often refer to additional investments, withdrawals, and the operation’s
income or loss. The resulting ending balance is presented in the Statement of Financial
Position.

De Los Santos Salon

27
 Statement of Changes in Equity
For the Period Ended December 31, 2019

₱20,000.0
Ariate, Capital, January 1, 2019 0
Investment in December 2019 ₱10,000.00

Net income for 2019 20,000.00

TOTA
₱30,000.00
L

Less: Withdrawals 27,500.00

Decrease in Owner's Equity 2,500.00

₱17,500.0
Ariate, Capital, December 31, 2019 0

28
SELF-ASSESSMENT:

1. What are the basic financial statements? Discuss each briefly.

2. What are the basic accounting elements? Classify each according to financial
statement.

3. Explain the relationship of the different financial statements.

4. Classify the following accounts in column A and column B:

Financial Statement
ITEMS Accounting Element
Classification
Statement of
1 Cash Current asset
Financial Position
2 Rent income

3 Notes receivable

4 Land

5 Withdrawal

6 Mortgage payable

7 Merchandise inventory

8 Prepaid insurance

9 Depreciation expense – building

10 Bad debts

11 Utilities expense

12 Professional revenue

13 Uncollectible accounts

14 Supplies on hand

15 Plant, property, and equipment

29
 3 - THE ACCOUNTING PROCESS

CONTENT:
1. Definition of business transactions and source documents
2. The accounting equation
3. The accounting cycle
4. Typical account titles used
5. Rules of debit and credit and their applications
6. Journalizing

BUSINESS TRANSACTIONS
This is an accountable event or economic event which has an effect on assets, liabilities and
equity of the business entity.

This means that there are transactions or events which do not affect the elements of
financial statements, and are therefore not recorded. It can be recalled from the recognition
principles that elements must at least be measurable and have probable impact on business
resources, obligations, and performance.

Each business transaction is identified, analyzed, measured, summarized and

communicated to the data users, all in accordance with the generally accepted accounting
principles. Business transactions may be
1. Internal – only the business is involved in the business transaction
2. External – the parties involved are the business and a third party

Internal
Party involved Example of transactions
The business only The building was destroyed by fire
The business only Yearly Depreciation expense for the
company’s equipment was charged

External
Third party involved Example of transactions
Another business entity The business bought one ream of bond
paper from PASSERSBUY for P150
The owner The owner, Juan dela Cruz, invested
additional cash of P25,000 into the
business
The creditor The business borrowed cash from
LANDBANK to finance business expansion,
P200,000
The Government The business paid for business permits and
licenses, P2,500
The employees The business paid for salaries worth
P12,000
The customers The business rendered service to a
customer and received cash of P3,500
*Note that parties that would be considered internal under a different discipline like the
owner and the employees are considered external parties since the business is treated as a
separate being from its stakeholders under the accounting entity assumption.

30
SOURCE DOCUMENTS
To meet the quality of objectivity, each transaction must be supported by a document. The
document must be properly compiled and controlled for easy reference. Where a good
system of record keeping exists, financial information becomes more reliable for it can easily
be traced back to the source documents.

 Original documents are considered better source documents than duplicated or

copies
 Source documents coming from independent outside parties are considered neutral
and more objective evidence of transactions than those documents coming from
within the business entity
 Documents coming from within the business entity are to be recorded only when
approved for recording by authorized officer or officers of the business

Examples of Source Documents

1. Official receipt (OR)
This supports cash payments if the OR is
issued by other entities or it support cash
receipts when the OR is issued by the
business.

2. Charge Sales Invoice (CSI)

This supports purchases on account
when issued by other entities. When the
CSI is issued by the business, it supports
sales on account.

3. IOUs
This supports advances made by
employees.

4. Promissory notes (PN)

This supports receivables from customers, if the PN is issued by the customer. This
supports liability to a creditor, when the PN is issued by the business.

5. Statement of Account (SOA)

This supports liability to a creditor for purchases
of goods or services on account, or to a service
provider like FICELCO and VIWAD.

6. Cash Sales Invoice (CI)

This supports cash purchases when issued by
other entities. When the CI is issued by the
business, it supports cash sales.

7. Delivery Receipt (DR)

This supports delivery of goods to customers.

8. Bank passbook, bank statements, validated

deposit slips and withdrawals
They support information about cash in bank.

9. Payroll sheet
Prepared to support payment of salaries of
employees.

31
 10. Registration papers
These support ownership of PPE like transport vehicles, land, building. They also
support payment of permits and licenses.

The Accounting Process:

1. Identification – those events that is financial in nature that should be recognized and
recorded.
2. Recording – transactions may be recorded manually, with the use of mechanical
devices, or with the use of computers.
3. Classifying – is the grouping of similar items together in order to make the recording
of many different events and transactions more efficient.
4. Summarizing – is the stating of groups of data in concise form
5. Interpretation – provides explanation and develops relationships that give meaning to
the information.

THE ACCOUNTING EQUATION

The relationship between the three basic accounting elements of the balance sheet –
Assets, Liabilities, and Owner’s Equity – can be expressed in the form of a simple equation
known as the Accounting Equation. All accounting information is recorded within the
framework of the Accounting Equation. This equation is

Assets = Liabilities + Owner’s Equity

P500,000 = P200,000 + P300,000 *assumed figures

Assets – are the resources owned by the business that will provide future benefits
Liabilities – are the rights of creditors that represent the debt of the business
Owner’s equity – are the rights of the owners in the business. This is the amount by which
the business assets exceed
business liabilities. The statement of changes in equity shows another way of computing capital:
Capital = beginning capital + additional investment + net income (–net loss) –
withdrawal
Derived formula
Net income (loss) = total revenues – total expenses and losses
Liabilities = assets – capital If,
Capital = assets – liabilities Total revenues > total expense = net income
Net assets = assets – liabilities Total expenses > total revenues = net loss
Net assets = capital

Who to pay How much to pay When to pay

Creditor Amount borrowed + interest Determinable future time
Owner Remaining assets after On termination of business
payment to the creditor* operation
*remaining assets may be equal, more, or less than the capital invested. If remaining assets
are less than capital invested, investors have incurred a loss. Needless to say, if there are
no more assets remaining but there is still an outstanding balance for liabilities the owners
have incurred a loss equal to the amount of liabilities remaining.

The accounting equation must always balance. The peso amount on the left side of the
equation should always equal to the peso amount on the right side. If the assets decrease,
liabilities and/or equity must also decrease. An increase in an asset may also correspond to
a decrease in another asset, or an increase in a liability may also have a corresponding
decrease in another liability.

Business transactions – economic events or condition that directly changes an entity’s

financial condition or directly affects its results of operations. An accounting transaction

32
takes place when a business exchanges a thing or things of value for another. In short, the
business

Debit/s Credit/s
Value/s received = Value/s given up

Transactions are always looked upon from the business point of view, which is separate and
distinct from the owner’s point of view. This refers to the principle of Entity Concept. All
business transactions can be stated in terms of changes in the three elements of the
accounting equation.

DOUBLE-ENTRY ACCOUNTING – is a record keeping system in which each business

transaction affects at least two accounts.
Account – is the record used to classify and store information about increases and
decreases in an item.
The T-Account – is so called because of its shape. It is used to show the increase or
decrease in an account caused by a transaction. It is a more efficient and convenient tool
used by accountants to analyze the parts of a transaction.

Account title
Top
Left side Right side Debit Credit

Rules of debit and credit – debits and credits are used to record the In other words,
increases and decreases in each account affected by a business
transaction. The rules of debit and credit vary according to whether DEBIT:
an account is classified as an asset, liability, or an owner’s equity Increase in asset
account. Decrease in liability
Decrease in capital
Rules for asset accounts: o Withdrawals
1. An asset account is increased on the debit side o Expenses and losses

2. An asset account is decreased on the credit side

3. The normal balance for an asset is a debit balance. CREDIT:
Decrease in asset
Rules for Liability and Owner’s equity Increase in liability
1. The liability and capital accounts are increased on the credit Increase in capital
side. o Investment
o Income and gains
2. The liability and capital accounts are decreased on the debit
side.
3. The normal balance for the liability and capital accounts is a credit balance.

RECORDING BUSINESS TRANSACTIONS

Accounting Cycle – is the complete series of steps used to account for a business’ financial
transactions during a fiscal period. These are the steps:
1. Analysis of business transactions
2. Journalizing
3. Posting to the ledger accounts
4. Preparing the trial balance
5. Preparing adjusting entries
6. Completing the worksheet
7. Preparing the financial statements
8. Journalizing and posting closing entries
9. Preparing the post-closing trial balance

33
34
BUSINESS TRANSACTION FLOW

source journal ledger financial

trial balance
documents entries accounts statements
Source Documents – papers prepared as evidence to support business transactions. The
type of document depends on the nature of the transaction.
The Journal – book of original entry. It is the book where all transactions are initially
recorded in a chronological order of the day to day transactions. The process of recording
transactions in a journal is called journalizing.
The Ledger – is a book of final entry. It is a book or file with the business entire collection of
account records also referred to as general ledger.
The Trial Balance – is a listing of all the accounts in the general ledger and the sum of the
debit and credit amounts of their balances.

TRIAL BALANCE4 – is a listing of all the asset, liability, capital, revenue, and
expense account balances at one point in time. All debits are summed, as are all
credits, to ensure that total debits equal total credits. Testing for the equality of total
debits and credits is one way of finding out whether you have made any errors in
recording transaction amounts.

Purpose of the trial balance:

1. It indicates if the ledger is in balance by showing whether the total accounts
with debit balances equals the total accounts with credit balances.
2. It aids in locating errors.
3. It assists in the preparation of financial statements.

A trial balance in which debits equals credits is not necessarily error-free. A

trial balance may contain errors but still look correct if:
1. No entry was made for a given transaction.
2. An entry was posted twice.
3. An amount was journalized or posted to the wrong account.
4. An incorrect amount was recorded for a given transaction.

Transposition Error – occurs when digits are incorrectly arranged. Example: P864 is
written or posted as P684 or P468.

Slide Error – occurs when the decimal point is put in the wrong place. Example: P684
is written as P68.40 or P6.84.

Correcting Entry – an entry made to correct an error in a journal entry discovered

after posting.

CHART OF ACCOUNTS – is a list of all accounts and their account (code) numbers used
for journalizing business transactions.

Order of the accounts – the accounts are normally listed in the order in which they appear
in the financial statements. The balance sheet accounts first, in the order of assets, liabilities

4
Trial balance is not required by the standards, but only facilitates the preparation of the financial
statements.

35
and owner’s equity. The income statement accounts are then listed in the order of revenues
and expenses.

Numbering of accounts – an account number identifies the account. Account numbers may
have two, three, four, or more digits. The number of digits used varies with the needs of the
business. The first digit 1 will represent Assets; 2 will represent Liabilities; 3 will represent
Owner’s Equity; 4 will represent Revenues; and 5 will represent Expenses. The second digit
indicates the location of the account within its class.

Example for CHART OF ACCOUNTS:

Giselle Dela Cruz, a lawyer, decided to open a law firm named Dela Cruz Law Firm. The
partial chart of accounts listed below is used:

Balance Sheet accounts Income Statement accounts

1 – Assets 4 – Revenues
11 – Cash 41 – Fees Earned
12 – Accounts Receivable
13 – Furniture and Equipment
5 – Expenses
51 – Salary Expense
2 – Liabilities
21 – Accounts Payable 52 – Utilities Expense
22 – Loan Payable 53 – Communication Expense
54 – Miscellaneous Expense
3 – Owner’s Equity
31 – Dela Cruz, Capital
32 – Dela Cruz, Drawing

What do you call a trial balance that doesn’t balance? A late night.

36
ILLUSTRATIVE PROBLEM
The following are transactions of Wahclass Boarding House for the month of May 2020, its
first month of operation:

DATE Type of
BUSINESS TRANSACTION Parties involved
2020 activity
May
Miss Wah invested the following: The business and the owner Financing
Cash, P150,000; Lot, P265,000
1 and her house, P450,000 in her
new business venture, a boarding
house
Cost of construction of 10 rooms, The business and the Investing
15 additional kitchen and toilets paid contractor
in cash, P108,000
Purchased tables and chairs from The business and the trade Investing
22 CATANDUANES BAZAAR, creditor (CATANDUANES
P12,500. Terms: on account. BAZAAR)
Business permit paid, P1,500 The business and the Operating
23
government
Thirty students applied as bed The business and the Not yet an
spacer. Two students will be customers (the students) accountable
accepted per room. Rent is event
25
P1,500 per student per month
inclusive of electricity and water
costs
Twenty students were accepted to The business and the Not yet an
start on June 1. Bed spacers are customers (the students) accountable
28 required to pay rent in advance event
equivalent to one month every 1st
day of the month.
June
The twenty bed spacers paid their The business and the Operating
1
June rent today customers (the students)
Paid CATANDUANES BAZAAR The business and the trade Operating
1 the account in full creditor (CATANDUANES
BAZAAR)
The bill for electricity was paid The business and FICELCO Operating
25
today, P4,200
The bill for water usage was paid The business and VIWAD Operating
26
today, P1,800

37
Analysis of Business Transactions
2020
May 1 Miss Wah invested the following: Cash, P150,000; Lot, P265,000 and her house,
P450,000 in her business venture, a boarding house

Analysis guide:

QUESTIONS ANSWERS
Who are the parties involved in the The business and the owners
transaction?
Is this a business transaction? Yes, it is an external business transaction.
Did it affect the accounting elements? If so, Yes. Two elements were affected:
which elements were affected? CAPITAL is affected because of the
investment by the owners.
ASSETS were affected because the
investment was made in the form of cash,
house, and lot which are all assets.
What are the effects to the accounting Total assets were increased because of the
elements? receipt of cash, house, and lot.
Capital was also increased because an
investment is always an increase in capital.
What are the value received and value Increase in asset = value received or Debit
parted with? Increase in capital = value parted with or
Credit
How much is the value received and value Value received (DEBIT):
parted with? Cash P150,000
Lot 265,000
House 450,000
Total P865,000

Value parted with (Credit):

Total investment P865,000
What are the accounts to be used to record Assets
the transaction? For cash, use CASH
For lot, use LAND
For house, use BUILDING

Investment
Use Wah, CAPITAL
How should you record the transaction in Enter the value received on the left side of
the T-account? the account, and enter the value parted with
on the right.

Cash Land
2020   2020  
May 1 May 1
150,000   265,000  

Wah, Capital Building

2020 2020  
May 1
May 1 865,000
450,000  

38
 Cost of construction of 10 rooms, additional The business and Investing
15
kitchen and toilets paid in cash, P108,000 the contractor

Cash Building
2020   2020
May 1 150,000  May 15 108,000 May 1 450,000
  15 108,000

Purchased tables and chairs from The business and Investing

22 CATANDUANES BAZAAR, P12,500. Terms: on the trade creditor
account.

Furniture and Fixtures Accounts Payable

2020   2020
May 22 12,500 May 22 12,500
 

Business permit paid, P1,500 The business and the Operating

23
government

Cash Taxes and Licenses

2020   2020
May 1 150,000  May 15 108,000 May 23 1,500
  23 1,500

Thirty students applied as bed The business and the Not yet an
spacer. Two students will be customers (the students) accountable
25 accepted per room. Rent is P1,500 event
per student per month inclusive of
electricity and water costs

Analysis:
This is not an accountable event. No accounting element has been affected yet. No value
has been received by the business from the business, nor has any value been parted with.

Twenty students were accepted to The business and the Not yet an
start on June 1. Bed spacers are customers (the students) accountable
28 required to pay rent in advance event
equivalent to one month every 1st
day of the month.

Analysis:
This is not an accountable event. No accounting element has been affected yet. No value
has been received by the business from the business, nor has any value been parted with.

June
The twenty bed spacers paid their The business and the Operating
1
June rent today customers (the students)

39
 Cash Rent income
2020 2020 2020
May 1 150,000 May15 108,000 June 1 30,000
June 1 30,000   23 1,500

Paid CATANDUANES BAZAAR The business and the trade Operating

1 the account in full creditor (CATANDUANES
BAZAAR)

Cash Accounts Payable

2020 2020 2020 2020
May 1 150,000 May15 108,000 June 1 12,500 May 22 12,500
June 1 30,000   23 1,500
June 1 12,500

The bill for electricity was paid The business and FICELCO Operating
25
today, P4,200

Cash Utilities
2020 2020 2020
May 1 150,000 May15 108,000 June 25 4,200
June 1 30,000   23 1,500
June 1 12,500
25 4,200

The bill for water usage was paid The business and VIWAD Operating
26
today, P1,800

Cash Utilities
2020 2020 2020
May 1 150,000 May15 108,000 June 25 4,200
June 1 30,000   23 1,500 28 1,800
June 1 12,500
25 4,200
28 1,800

In summary, the general ledger (a group of accounts or T-accounts) will show the following
at the end of June 2020:

WAH BOARDING HOUSE

General Ledger
June 30, 2020

ASSETS: LIABILITIES: CAPITAL:

40
 Cash Accounts Payable Wah, Capital

2020   2020 2020 2020

May 15
May 1 150,000 June 1 12,500 May 22 12,500 May 1 865,000
108,000

June 1 30,000 23 1,500

0
  Jun1 12,500

  25 4,200

  28 1,800

128,000
180,000

52,000  

Land Rent income

2020   2020

May 1 265,000 June 1 30,000

 

Furniture and Fixtures Utilities

2020   2020  

May 22 12,500   June 25 4,200  

Building Taxes and Licenses

2020   2020  

May 1 450,000   May 23 1,500  

15 108,000  
558,000

To facilitate the preparation of financial statements, a “Trial Balance” (this is a working

paper, not a financial statement) is prepared to prove the equality of debits and credits.

WAH BOARDING HOUSE

Trial Balance
June 30, 2020

Cash ₱52,000
Land 265,000

41
 Furniture and fixtures 12,500
Building 558,000
Wah, capital ₱865,000
30,0
Rent income 00

Utilities 6,000

Taxes and licenses 1,500  

₱895,000 ₱895,000
SUMMARY

A business transaction is an accountable event or economic event which has an effect on

assets, liabilities and equity of the business entity. This may be internal or external.

Source documents are important to prove the legitimacy and verifiability of accounting

transactions.

The relationship between elements of the financial statements are best illustrated through

the accounting equation.

Debits and credits are used to record the increases and decreases in each account affected

by a business transaction. The rules of debit and credit vary according to whether an

account is classified as an asset, liability, or an owner’s equity account.

Transactions are first analyzed if they are recordable. If they are, these transactions will be

journalized, corresponding amounts posted in the ledgers, and a trial balance will be

prepared to aid in the preparation of the financial statements.

42
SELF-ASSESSMENT

A. Identify the term being described.

1. The term used to refer to the division of the life of a business and within
which financial statements are prepared.
2. An economic event which has an effect on the assets, liabilities or owner’s
equity of a business entity.
3. A Device used to record effects on transactions to the accounting
elements.
4. The book of final entry.
5. The entries prepared at the end of the accounting period to bring nominal
accounts to zero balances.
6. A list of accounts that the business entity uses in recording business
transactions.
7. The act of recording business transaction in the journal.
8. A working paper used to check the equality of debit and credit balances.
9. A series of procedures used to record, classify and summarize business
transactions.
10. The book of original entry.

B. Fill in the correct answer to each question:

1. Total liabilities, P450,000; total owner’s equity, P600,000, how much is total assets?
_______________

2. Total liabilities, P3000,000; total assets, P800,000, how much is total capital?
_______________

3. Total capital, P400,000; total assets, P1,200,000, how much is total liabilities?
_______________

4. Total assets, P200,000; total capital P600,000, how much will be total liabilities if total
current liabilities is P400,000? _______________

5. Total current liabilities is P300,000; Net total asset is P1,300,000, how much is the
amount of total capital? _______________

6. Using information in (5), if there were no withdrawals during the year and beginning
capital was P1,000,000, how much was the net income? _______________

7. Beginning capital is P200,000; withdrawals, P500,000; Ending capital. P400,000.

How much is net income? _______________

8. Total assets P5,000,000; beginning capital, P4,300,000; capital invested during the
year, P1,000,000; withdrawals, P5000,000; net loss P800,000. How much is total
liabilities? _______________

43
REFERENCES

(n.d.). Retrieved from Accounting Verse Web site: https://www.accountingverse.com

Brigham, E. F., & Houston, J. F. (2012). Fundamentals of Financial Management. South-Western

Cengage Learning.

Custodio, L. B. (2012). Basic Accounting 1 Part 1: A Modular Approach.

Gettler, L. (2013, May 29). Retrieved from www.aim.com.au.

Knowing Basic Business Accounting for Non-Accountants Philippines. (2020). Retrieved from
taxacctgcenter.ph.

Thomson, S. (2019, July 8). Why is accounting important to non-accountants?

Xero Limited. (n.d.). Retrieved from Xero.com: https://www.xero.com/us/resources/accounting-

glossary/s/what-is-business-accounting/

SUGGESTED FURTHER READINGS

1. Ballada, W. & Ballada, S. (2015) Basic Accounting, Sampaloc, Manila: Domdane

Publishers & Made Easy Books

2. Millan, Z. (2017) Financial Accounting & Reporting Part 1A. Baguio City: Bandolin

Enterprise

3. Millan, Z. (2017) Financial Accounting & Reporting Part 1B. Baguio City: Bandolin

Enterprise

4. Millan, Z. (2017) Financial Accounting & Reporting Part 2. Baguio City: Bandolin

Enterprise

5. Valencia, E. & Roxas G. (2014) Basic Accounting: Concepts, Principles, Procedures and

Applications. Baguio City: Valencia Educational Supply