ACCTG 1 Fundamentals of Accounting

The Accounting Equation and the Double-entry System

ELEMENTS OF FINANCIAL STATEMENTS
The elements of financial statements are define as follows:

THE ACCOUNT
The basic summary device of accounting is the account. A separate account is maintained for
each element that appears in the balance sheet (assets, liabilities and equity) and in the income
statement (income and expenses). Thus an account may be defined as a detailed record of the
increases, decreases and balance of each element that appears in an entity’s financial statements.
The simplest form of the account is known as the “T” account because of its similarity to the letter “T”.
The account has three parts as follows:

THE ACCOUNTING EQUATION

Financial statements tell us how a business is performing. They are the final products of the
accounting process. The most basic tool of accounting is the accounting equation. This equation
presents the resources controlled by the enterprise, the present obligations of the enterprise and the
residual interest in the assets. It states that assets must always equal liabilities and owner’s equity.
The basic accounting model is.

Assets = Liabilities + Owner’s Equity

Note that the assets are on the left side of the equation opposite the liabilities and owner’s equity and also the
equation explains why liabilities and owner’s equity follow the same rules of debit and credit.
DEBITS AND CREDITS –THE DOUBLE–ENTRY SYSTEM
Accounting is based on a double–entry system which means that the dual effects of a business
transaction is recorded. A debit side entry must have a corresponding credit side entry.
An account is debited when an amount is entered on the left side of the account and credited
when an amount is entered on the right side. The abbreviations for debit and credit are Dr. (from the
Latin debere) and Cr. (from the Latin credere), respectively.
The account type determines how increases or decrease in it are recorded. Increases in assets
are recorded as debits while decreases in assets are recorded as credits. Conversely, increases in
liabilities and owner’s equity are recorded by credits and decreases are entered as debits.
The rules of debit and credit for income and expense accounts are based on the relationship of
these account to owner’s equity. Hence, increase in income are recorded as credits and decreases
as debits. Increases in expenses are recorded as debits and decreases as credits. These are the
rules of debit and credit.
NORMAL BALANCE OF AN ACCOUNT
The normal balance of any account refers to the side of the account—debit or credit—where
increases are recorded. Asset, owner’s withdrawal and expense accounts normally have debit
balances; liability, owner’s equity and income accounts normally have credit balances.

ACCOUNTING EVENTS AND TRANSACTIONS

An accounting event is an economic occurrence that causes changes in an enterprise’s
assets, liabilities, and/or equity. Events may be internal actions, such as the use of equipment for the
production of goods or services.

TYPES AND EFFECTS OF TRANSACTIONS

It will be beneficial in the long-term to be able to understand a classification approach that
emphasizes the effects of accounting events rather than the recording procedures involved.
1. Source of Assets (SA). An asset account increases and a corresponding claims (liabilities or
owner’s equity) account increases. Examples: (1) Purchase of supplies on account; (2) Sold
goods on cash on delivery basis.
2. Exchange of Assets (EA). One asset account increases and another asset account
decreases. Example: Acquired equipment for cash.
3. Use of Assets (UA). An asset account decreases and a corresponding claims (liabilities or
equity) account decreases. Example; (1) Settled accounts payable; (2) Paid salaries of
employees.
4. Exchange of Claims (EC). One claims (liabilities or owner’s equity) account increases and
another claims (liabilities or owner’s equity) account decreases. Example: Received utilities bill
but did not pay.
Every accountable event has dual but self-balancing effect on the accounting equation. Recognizing
these events will not in any manner affect the equality of the basic accounting model. The four types
of transaction above may be further expanded into nine types of effects as follows:
1. Increase in Assets = Increase in Liabilities (SA)
2. Increase in Assets = Increase in Owner’s Equity (SA)
3. Increase in one Asset = Decrease in another Asset (EA)
4. Decrease in Assets = Decrease in Liabilities (UA)
5. Decrease in Assets = Decrease in Owner’s Equity (UA)
6. Increase in Liabilities = Decrease in Owner’s Equity (EC)
7. Increase in Owner’s Equity = Decrease in Liabilities (EC)
8. Increase in one Liability = Decrease in another Liability (EC)
9. Increase in one Owner’s Equity = Decrease in another Owner’s Equity (EC)
ACCOUNTING FOR BUSINESS TRANSACTIONS
Accountants observe many events that they identify and measure in financial terms. A
business transaction is the occurrence of an event or a condition that affects financial position and
can be reliably recorded.

Financial Transaction Worksheet

Every financial transaction can be analyzed or expressed in terms of its effects on the
accounting equation. The financial transactions will be analyzed by means of financial transaction
worksheet which is a form used to analyze increases and decreases in the assets, liabilities or
owner’s equity of a business entity.

Illustration. Jimminn Park decided to establish a sole proprietorship business and named it as
Kookie Graphics Design. Jimminn Park discovered his talent in graphic designing through Youtube
Academy while on a lockdown in their province. He possesses the talent to visually communicate to a
target audience with the right combination of words, images and ideas that is why he pursued this
new career.
Kookie Graphics Design can do the layout and production design of newspapers, magazines,
corporate reports, journals and other publications. The entity can create promotional displays;
marketing brochures for services and products; packaging design for products; and distinctive logos
for businesses. He also enters into agreements with clients for the progressive development and
maintenance of their web sites. His initial revenue stream comes form web designing.
The owner, Jimminn Park, makes the business decisions. The assets of the company belong to
Jimminn Park and all obligations of the business are his responsibility. Any income that the entity
earns belongs solely to Jimminn Park.
When a specific asset, liability or owner’s equity item is created by a financial transaction, it is listed in
the financial transaction worksheet using the appropriate accounts. The worksheet that follows shows
the first transaction of the Kookie Graphics Design. The dates are enclosed in parentheses.

During March 2020, the first month of operations, various financial transactions took place. These
transactions are described and analyzed as follows:

Mar. 1 Jimminn Park started his new business by depositing P400,000 in a bank account in the
name of Kookie Graphics Design at BPI Poblacion Branch.

The financial transaction is analyzed as follows:

 An entry separate and distinct from Jimminn Park’s personal financial affairs is created.
 An economic resouce –cash of P400,000 is invested in the business entity. The source of this
asset is the contribution made by the owner, which represents owner’s equity. The owner’s
equity account is Jimminn Park, Capital.
  The dual nature of the transaction is that cash is invested and owner’s equity created. The
effects on the accounting equation are as follows: increase in asset-cash from zero to
P400,000 and increase in owner’s equity from zero to P400,000.
 At this point, the entity has no liabilities, and assets equal owner’s equity.

Mar. 5 Computer equipment costing P150,000 is acquired on cash basis. The effect of the
transaction on the basic equation is:

This transaction did not change the total assets but it did change the composition of the assets—It
decreased one asset—cash and increased an another asset –computer equipment by P150,000.
Note that the sums of the balances on both sides of the equation are equal. This equality must always
exist.

Mar. 9 Computer supplies in the amount of P25,000 are purchased on the account.
Assets don’t have to be purchased in cash. It can be purchased in credit. Acquiring the computer
supplies with a promise to pay the amount due later is called buying on account. This transaction
increases both the assets and the liabilities of the business. The asset affected is computer supplies
and the liability created is an accounts payable.

Mar. 11 Kookie Graphics Design collected P90, 000 in cash for designing interactive web sites
for two experts.
The entity earned service income by designing web sites for clients. Jimminn Park rendered his
professional services and collected revenues in cash. The effect on the accounting equation is an
increase in the asset—cash and increase in owner’s equity. Income increases owner’s equity. This
transaction caused the business to grow, as shown by the increase in total assets from P425,000 to
P515,000.
Mar. 16 Jimminn Park paid P15,000 to BH Bills Express, a one-stop bills payment service
company, for the semi-monthly utilities.
Expenses are recorded when they are incurred. Expenses can be paid in cash when they occur, or
they can be paid later. The payment for utilities is an expense for the month of March. It represented
an outflow of resources and a reduction of owner’s equity. Expenses have the opposite effect of
income; they cause the business to shrink as shown by the smaller amount of total assets of
P500,000.

Mar. 17 The entity has service agreements with several Netpreneurs to maintain and update
their web sites weekly. Jimminn Park billed these clients P40,000 for services already
rendered during the month.

The entity has performed services to clients so income should already be recognized. Jimminn Park
is entitled to receive payment for these but the clients did not pay immediately. Performing the
services creates an economic resource, the clients’ promise to pay the amount which is called
accounts receivable. This transaction resulted to an increase in an asset—accounts receivable and
an increase in owner’s equity P40,000.
Mar. 19 Jimminn Park made a partial payment of P17,000 for the Mar 9 purchase on account.
This transaction is a payment on account. The effect on the accounting equation is a decrease in the
asset—cash and decrease in the liability—accounts payable. The payment of cash on account has no
effect on the asset—computer supplies because the payment does not increase or decrease the
supplies available to the business.

Mar. 20 Checks totaling P25,000 were received from clients for billings dated Mar. 17.
Last Mar. 17, Jimminn Park billed clients for services already rendered. On Mar. 20, the entity was
able to collect P25,000 from them. The asset—cash increased by P25,000. The business should not
record service income on Mar. 20 since it has already recorded the income last Mar. 17. Total assets
are unchanged. The business merely reduced one asset—accounts receivable and increased
another—cash.

Mar. 21 Jimminn Park withdrew P20,000 from the business for his personal use.
Withdrawal of cash or other assets for personal use is the way by which the owner of the entity
receives advance distribution of the profits. On Mar. 1, Jimminn Park invested P400,000; both cash
and owner’s equity increased. The transaction was an investment by the owner and not an income-
generating activity. Jimminn Park simply transferred funds from his personal account to the business.
A cash withdrawal is exactly the opposite. The P20,000 cash withdrawal transaction resulted to a
reduction in both cash and owner’s equity.
Mar. 27 Magic Shop Publsihing submitted a bill to Jimminn Park for P10,000 worth of
newspaper advertisements for this month. Jimminn Park will pay this bill next month.

Magic Shop Publishing rendered services on account. Kookie Graphics Design has incurred an
expense in the amount of P10,000 by availing of Magic Shop Publishing’s services. There was no
payment during the month. This advertising expense resulted to a decrease in owner’s equity and an
increase in the liability—accounts payable.

Mar. 31 Jimminn Park paid his assistant designer salaries of P17,000 for the month.

This transaction resulted to a reduction in owner’s equity as well as a reduction in cash. By providing
his services to Jimminn Park for the month, the assistant designer has created for the business an
expense—salaries expense.

THE USE OF T-ACCOUNTS

Analyzing and recording transactions using the accounting equation is useful in conveying basic
understanding of how transactions affect the business. However, it is not an efficient approach once
the number of accounts involved increases. Double-entry system provides a formal system of
classification and recording business transactions.

Illustration. The rules of debit and credit will be applied to the Kookie Graphics Design illustration
for comparison. Three transactions will be added to the. Before being recorded, a transaction must be
analyzed to determine which accounts must be increased or decreased. After this has been
determined, the rules of debit and credit are applied to effect the approximate increases and
decreases to the accounts.

Mar. 1 Jimminn Park started his new business by depositing P400,000 in a bank account in the
name of Kookie Graphics Design at BPI Poblacion Branch.

This transaction increased both the asset—cash and owner’s equity. According to the rules of debit
and credit, an increase in asset is recorded as debit while an increase in owner’s equity is recorded
as credit; thus, the entry is to debit cash and to credit Jimminn Park, capital. The transaction dates
are placed on the left side of the amounts for reference.

Mar. 2 Computer equipment is acquired by issuing a P50,000 note payable to Anpanman

Office Systems. The note is due in six months.

The transaction increased by P50,000 the asset—computer equipment and the liability—notes
payable. Computer equipment must be debited and notes payable must be credited.

Mar. 3 Jimminn Park paid P15,000 to Crystal Snow Suites for rent on the office studio for the
months of March, April and May.
The entity paid advance rent for three months. A resource having future economic benefit—prepaid
rent, is acquired for a cash payment of P15,000. Increases in assets are recorded by debits and
decreases in assets are recorded by credits. The transaction resulted to a debit to prepaid rent and a
credit to cash for P15,000. The prepaid rent is consumed based on the passage of time so that after
one month, P5,000 of the prepaid rent will be transferred to the rent expense account.

Mar. 4 Received advance payment of P18,000 from Dynamite Hotel for web site
updating for the next three months.

The entity has an obligation to Dynamite Hotel for the next three months. This liability is called
unearned revenues. The asset—cash is increased by a debit of P18,000 and the liability—unearned
revenues is increased by a credit of P18,000. As it renders service, the entity discharges its obligation
at a rate of P6,000 per month for the next three months.

Mar. 5 Computer equipment costing P150,000 is acquired on cash basis.

This transaction increased the asset—computer equipment and decreased the asset—cash. Assets
are increased by debits and decreased by credits; thus, computer equipment is debited and cash is
credited for P150,000.
Mar. 9 Computer supplies in the amount of P25,000 are purchased on account.

The asset—computer supplies is increased by a debit of P25,000 while the liability account—
accounts payable is increased by a credit for the same amount.

Mar. 11 Kookie Graphics Design collected P90,000 in cash for designing web sites.

The transaction increased the asset—cash and increased the income account—design revenues.
Assets are increased by debits, income are increased by credits; hence, a debit of P90,000 to cash
and a credit of P90,000 to design revenues is made. Increases in income increase owner’s equity.

Mar. 16 Jimminn Park paid P15,000 to BH Bills Express for the semi-monthly utilities.

Expenses are increased by debit and assets are decreased by credits; therefore, utilities expense is
debited and cash credited for P15,000. Increases in expenses decrease owner’s equity.

Mar. 17 Jimminn Park billed clients P40,000 for services already rendered during the month.
Assets are increased by debits, income are increased by credits. Increases in income increase in
owner’s equity. A debit of P40,000 to accounts receivable and a credit of P40,000 to the income
account—design revenues is needed.

Mar. 19 Jimminn Park partially paid P17,000 for the Mar. 9 purchase of computer supplies.

Assets are decreased by credits while liabilities are decreased by debits. The transaction is
recorded by debiting accounts payable and crediting cash for P17,000 each.

Mar. 20 Received checks totaling P25,000 from clients for billings dated Mar. 17.

Collections on account reduced the asset—accounts receivable but increased the asset—cash.
Assets are increased by debits and decreased by credits; thus, a debit to cash for P25,000 and a
credit to accounts receivable for P25,000 is made.

Mar. 21 Jimminn Park withdrew P20,000 from the business for his personal use.
Withdrawals are reductions of owner’s equity but are not expenses of the business entity. A
withdrawal is a personal transaction of the owner that is exactly the opposite of an investment.
This transaction increased the withdrawals account but reduced cash. Debits record increases in the
withdrawals account and credits record decreases in asset accounts, thus, a debit to withdrawals and
a credit to cash for P20,000 each is necessary.
Mar. 27 Magic Shop Publishing billed Jimminn Park for P10,000 ads. Jimminn Park will pay next
month.

This transaction increased the expense—advertising expense and increased the liability—accounts
payable P10,000. Expenses are increased by debits while liabilities are increased by credits; hence,
an entry to debit advertising expense and to credit accounts payable for P10,000 is needed.

Mar. 31 Jimminn Park paid his assistant designer salaries of P15,000 for the month.
Expenses are increased by debits and assets are decreased by credits. Hence, salaries expense is
debited for P17,000 and cash credited for the same amount. Increases in salaries expense decrease
owner’s equity.

ACTIVITY 1 Elements of Financial Statements

Directions: Write the letter from column B that matches the column A items on the space provided
before the number.

Column A
_____ 1. Equity
_____ 2. Expenses
_____ 3. Liability
_____ 4. Asset
_____ 5. Income
Column B
a. Decreases in assets, or increases in liabilities, that result in decreases in equity, other than
those relating to distributions to holders of equity claims
b. Increases in assets, or decreases in liabilities, that result in increases in equity, other than
those relating to contributions from holders of equity claims
c. The residual interest in the assets of the entity after deducting all its liabilities
d. A present obligation of the entity to transfer an economic resource as a result of past
events
e. A present economic resource controlled by the entity as a result of past events
f. A duty or responsibility that an entity has no practical ability to avoid

ACTIVITY 2 Accounting Equation

Directions: For each transaction, indicate whether the assets (A), liabilities (L), or owner’s equity
(OE), increased (+), decreased (-), or did not change (0) by placing the appropriate sign
in the appropriate column and prove whether Assets = Liabilities + Owner’ Equity after
all the analysis.
During the month of May, Dela Cuesta Security Agency had the following transactions:

A L OE
Ex. Withdrew cash for personal use, P45,000 — —
a. Acquired equipment on credit, P90,000 ________ ________ ________
b. Purchased supplies in cash, P3,000 ________ ________ ________
c. Additional investment by owner, P120,000 ________ ________ ________
d. Received payment for services rendered, P18,000 ________ ________ ________
e. Received payment from customers already billed, ________ ________ ________
P9,000
Assets = Liabilities + Owner’s Equity
Examples: -45,000 -45,000

ACTIVITY 3 Rules of Debit and Credit

In the concept maps below, summarize the rules of debits and credits under given accounts.
ACTIVITY 4 Financial Transaction Worksheet
Jose Ibarra Gonzales, Jr. is the owner of Gonzales Repairs Specialist. On August 1, 2020, the
assets, liabilities and proprietor’s capital of the business were: Cash, P27,500; Accounts Receivable,
P4,400; Supplies, P5,500; Equipment, P66,000; Accounts Payable, P9,900; Gonzales, Capital,
P93,500. The transactions for the month of August were as follows:

a. Paid P4,500 of the outstanding accounts payable.

b. Received P2,500 on account from customers.
c. Purchased P3,100 worth of supplies on account (on credit).
d. Returned a defective piece of equipment that was purchased last month and received a cash
refund of P14,800.
e. Borrowed of P10,000 from a supplier, to repay the loan in 30 days.
f. Paid creditor P2, 000 on account.
 g. Purchased equipment for P15,000, giving P2,000 cash and promising to pay the balance in 60
days.
h. Bought supplies, paying P2,250 cash.
i. Received a P1,900 check from customer on account.

Required: Record the transactions using a financial transaction worksheet.

MASTERY TESTS
MULTIPLE – CHOICE TEST
1. The entity purchases P20,000 office supplies for entity use, on credit. Which of the following
will be affected?
1. Assets 2. Liabilities 3. Capital

a. 1 and 2 only b. 2 and 3 only c. 1 and 3 only d. 1, 2, and 3

2. Which of the following is incorrect if the sole proprietor of an entity borrows P50,000 in the
name of the entity and deposits it into the entity’s bank account?
a. The assets of the entity increase by P50,000.
b. The liabilities of the entity increase by P50,000.
c. The drawings of the entity increase by P50,000.
d. Assets and liabilities both increase by P50,000.
3. Which of the following transaction affects the total value of liabilities of firm?
a. Goods purchased from suppliers by cash
b. Interest received from bank
c. Office equipment bought on credit
d. Goods sold to customers on credit
4. Which of the following accounting equations are incorrect?
1. Assets = Liabilities + Owner’s Equity
2. Assets –Liabilities = Capital + Revenue – Expenses
3. Assets + Liabilities = Capital –Revenue + Expenses
4. Non-current assets + Current Assets = Non-current Liabilities –Current Liabilities + Capital

a. 1 and 2 only b. 3 and 4 only c. 1 and 3 only d. 2 and 3 only

5. Suppose a customer pays his debt of P20, 000 by issuing a check. The effect of the
transaction on the accounting equation would be.
a. Both assets and liabilities increase by P20,000
b. Both assets and liabilities decrease by P20,000
c. Only assets decrease by P20,000
d. Assets and liabilities remain unchanged
6. Which of the following is not an example of additional capital?
a. A sole proprietor purchases a car through the bank account of the entity.
b. A sole proprietor brings a second-hand computer from his home to the office.
c. A sole proprietor transfers P1,000 from his own bank account to the entity’s account.
d. A sole proprietor uses his own building as an office without receiving any rent.
7. Which of the following is correct under the double-entry system?
a. Asset amount must be equal to liability amount.
b. The change in asset must be compensated by a change in liability.
c. The change in debit-side entry must be compensated by a change in credit-side entry.
d. An increase in asset must be compensated by a decrease in asset.
8. Using the accounting equation, what is the value X if assets, current liabilities, non-current
liabilities and capital are X, P40,000, P60,000 and P350,000 respectively?
a. P250,000
b. P350,000
c. P370,000
d. P450,000
 9. Which of the following statements regarding the double-entry system is incorrect?
a. An increase in asset means a credit entry on assets account.
b. A decrease in liability means a debit entry in liabilities account.
c. An increase in drawings means a debit entry in capital account.
d. A decrease in non-current asset means a credit entry in assets account.
10. If J-HOPE Accessories has assets of P690,000 and owner’s equity of P450,000. What is the
value of its liabilities?
a. P450,000
b. P690,000
c. P204,000
d. P240,000

NAME: _____________________________________ COURSE & YEAR: ________________