FA MODULE 3: ANALYZING BUSINESS TRANSACTIONS

LECTURE 1: Business Transaction

 A business transaction is any event or happening

measured in terms of money that has an effect on the
financial condition or results of operations of a business
entity.
 Each business transaction results in a balanced effect to
at least two accounts.
 For example, the purchase of computer for cash is a
business transaction. This transaction increases the asset
computer and decreases the asset cash. It has a balanced
effect and, in accounting, this transaction is recorded as
debit to asset computer because it is increased, and a
credit to asset cash because cash is decreased. On the
other hand, if the computer is bought on account, instead
of a decrease in asset cash, an increase in a liability,
accounts payable is recognized. The increase in liability is
recorded as a credit to accounts payable.

As business transactions happen, the effect (increase or

decrease) of the transaction on the accounting elements are evaluated.
Analysing

 the first step in the accounting process,

 The process of evaluating the effects of business transactions on
the accounting elements.
 It is very important because if the analysis of transactions is
incorrect, wrong journal entries will be recorded in the general
journal, and this error will be carried over to the financial
statements.
 It is therefore imperative that the correct transaction analysis be
made in order to arrive at accurate financial reports. Remember
that users of financial information utilize these financial reports
in making decisions about the business.

According to the accounting principle of separate business entity,

 The business entity is separate and distinct from its owners. The
business entity and its owners are two separate personalities,
distinct and different from each other.
 Transactions must be analyzed from the point of view of the
business entity and not from the point of view of the owners.
 Many accounting students get confused when they analyze
business transactions because they make a wrong assumption
that the business entity and the owners are one and the same.
 For example, when an owner invests cash in the business, from
the point of view of the business entity, the asset cash of the
business is increased and the capital of the owner in the
business is also increased. On the other hand, from the point of
view of the owner, the asset cash of the owner is decreased and

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FA MODULE 3: ANALYZING BUSINESS TRANSACTIONS
his asset investment in the business is increased. For this
transaction, the first set of analysis must be used, since it is the
one based on the business entity's point of view. To avoid an
erroneous analysis always bear in mind that transactions must
be evaluated from the point of view of the business entity and
that the owners and the business entity are separate and
distinct from each other.

LECTURE 2: Types of Business Transactions

1. Investment by the owner

 Cash investment (Cash is received from the owner as
investment in the business.)
 Non-cash investment (Non-cash assets such as equipment,
furniture, tools, etc. are invested by the owner.)
2. Performance of service or sale of product
 For cash (Cash is received from customer for services
rendered or products sold.)
 On account (Cash is not received from customers when
services are rendered or when products are sold; customer
will pay at a later date.)
 With down payment and balance on account (Cash down
payment is received from the customer and the remainder
is to be paid at a later date.)
3. Purchase of asset
 For cash (Cash is paid to fully pay for asset bought.)
 On account (No cash is paid at time of purchase of asset;
payment is to be made at a later date.)
 With down payment and balance on account (Cash down
payment is made and the remainder is to be paid at a later
date.)
4. Collection of customer account (accounts receivable)
 For cash (Cash is received from customer to fully settle
account.)
 With promissory note (Customer’s promissory note is
issued to settle account)
5. Payment of supplier accounts (accounts payable)
 For cash (Cash is paid to supplier/creditor to fully settle
accounts payable.)
 With promissory note (Promissory note is issued to settle
accounts payable.)
6. Payment of expense (Cash is paid to pay expenses.)
7. Withdrawal of assets, usually cash, for owner’s personal use.

LECTURE 3: Forms of Business Organizations

1. Sole proprietorship or single proprietorship

 Single or sole proprietorship is a business owned by one person.
 The owner is solely responsible for all debts and obligations of
the business.
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FA MODULE 3: ANALYZING BUSINESS TRANSACTIONS
 All profits are earned and losses are borne by the owner.
Because the owner is personally liable for losses, there is
unlimited liability for the owner.
 When business assets are not enough to pay for business debts,
creditors can go after the personal assets of the owner.
ADVANTAGES:
 It is easy and cheap to register. Only Department of Trade
and Industry (DTI) and Bureau of Internal Revenue and
business permits and licenses are required to start
operation.
 Few regulatory requirements are required.
 There is fast decision-making because only one person
decides.
 Owner has complete control of the business.
 Only a small start-up capital is needed for small and
medium-sized businesses.
 All net income goes to the owner.

DISADVANTAGES:

 There is unlimited liability. Creditors can go after the

personal assets of the owner when the business cannot
pay its debts.
 There is a delay in decision-making if the owner is not
available, and no one is authorized by the owner to decide
in his absence.
 There is a lack of continuity. In case of business failure,
the business has to close down.
 Banks may not be ready to provide financing to sole
proprietorship, unless the owner has sufficient assets and
a good credit standing.
2. Partnership
 The Civil Code of the Philippines defines partnership as any
contract of partners involving two or more persons who bind
themselves to contribute money, property, or industry to a
common fund, with the intention of dividing the profits among
themselves.
 The partnership agreement is the contract that contains
provisions about capital contribution, responsibilities of the
partners, sharing of profits and losses, dissolution of the
partnership, and such other matters relevant to the business.
 To avoid any potential cause for future misunderstanding, the
partnership agreement must be very specific, clear, and precise.
It is recommended that a lawyer be hired to draft the partnership
agreement.

ADVANTAGES:

 It is reasonably easy and inexpensive to form a partnership.

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FA MODULE 3: ANALYZING BUSINESS TRANSACTIONS
 It is not financially burdensome to start because initial
capital is shared in accordance with the partnership
agreement.
 Partners can contribute their different skills and expertise for
the benefit of the partnership.

DISADVANTAGES:

 There is unlimited liability for some partners, based on

partnership agreement.
 It can be difficult to find a suitable partner.
 Possible future conflict among partners may lead to
dissolution of the partnership, if partners cannot resolve their
differences.
 Faulty decisions or mistakes detrimental to the interest of the
business made by some partners bind all other partners.
3. Corporation
 According to Batas Pambansa Blg 68 otherwise known as the
Corporation Code of the Philippines, a corporation is an
artificial being created by operation of law, having the right of
succession of powers, attributes, and properties expressly
authorized by law or incident to its existence.
 Unlike the sole proprietorship and partnership, the corporation
has a legal personality of its own and the shareholders have no
obligation to pay for the debts of the corporation.

ADVANTAGES:

 There is limited liability for the owners.

 Transferability of ownership is easy, especially if the shares
are publicly traded. There is continuity of operation, even if
the owners are incapacitated.
It is a separate legal entity.
It is easier to raise capital as banks may provide financing
at better terms.

DISADVANTAGES


There are many regulatory reporting requirements by the
Securities and Exchange Commission, the Bureau of
Internal Revenue, and other government agencies.
 It is more expensive and complicated to set up a
corporation compared to sole proprietorship and
partnership.
 Filing requirements and voluminous corporate records are
required to document business operations.
 At times, some stockholders may not agree with the
decisions of the Board of Directors, and hostilities among
the owners may result.
4. Cooperative

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 Republic Act 9520, otherwise known as the Philippine
Cooperative Act of 2008, states: "A cooperative is an
autonomous and duly registered association of persons, with a
common bond of interests, who have voluntarily joined together
to achieve their social, economic, and cultural aspirations by
making equitable contributions to the capital required,
patronizing their products and services and accepting a fair
share of the risks and benefits of the undertaking in accordance
with universally accepted cooperative principles.”

ADVANTAGES:

 Many members, who equally contribute capital, own and

control the cooperative.
 Each member is entitled to cast one vote, in case an issue is
to be decided affecting the operation of the cooperative.
 The members are not liable to pay for the debts of the
cooperative.
 There is profit distribution for patronage or loyalty to the
products or services offered by the cooperative.

DISADVANTAGES:

 Since the members decide on issues, delays may result in

the decision-making process.
 Dedication of the members and patronage of the products
and services offered by the cooperative are necessary for the
cooperative to be successful.
 At times, conflict may arise among members that can
damage the cooperative, especially if opposing groups who
want to control the cooperative are formed.
 Internal control must be implemented, particularly about
money matters.
 Since there is one vote per member, it discourages members
who want to contribute more capital to the cooperative.
 The lack of skills and training of members who are holding
responsible positions can destroy the operation of the
cooperative. For example, the bookkeeper or accountant
must be knowledgeable about accounting to maintain
accurate accounting records of the transactions of the
cooperative.

LECTURE 4: Types of Business According to Activities

1. Service business.
This business provides services, instead of tangible
products, to its customers. A service business may be as simple
as a beauty parlor, spa, nail salon, housekeeping services, dental
clinic, doctor’s clinic, car repair shop, etc., or it can be a more
complex operation, such as banks, schools or universities,
insurance companies, auditing firms, law firms, or transportation
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FA MODULE 3: ANALYZING BUSINESS TRANSACTIONS
services, which include airlines, shipping lines, bus companies,
and taxi fleets.
Examples Of a service business are Cebu Pacific,
Philippine Airlines, Going Straight, Regal Films, ABS-CBN, GMA,
University of the East, Banco de Oro, RCBC, Manulife, Globe,
SMART, PLDT, etc.
2. Merchandising business.
The merchandising business buys ready-made tangible
goods to be sold at a higher price to its customers. Effectively,
merchandisers are in the buy and sell business. Merchandisers
can be wholesalers/distributors or retailers.
Wholesalers/distributors are businesses that buy products in
bulk or large volumes to be sold to smaller wholesalers,
distributors, or retailers.
Examples of wholesalers/distributors are businesses
that sell in large volumes to supermarkets, fast food chains,
convenience stores, restaurants, hospitals, etc. The customers of
wholesalers/distributors are businesses who are selling to other
businesses. Retailers are businesses that buy ready-made
products to be sold to ultimate consumers. Examples Of retailers
are SM Supermarket, Puregold, SM Department Store,
Landmark, Seven Eleven, Ministop, Starbucks, Jollibee,
McDonalds, Kentucky Fried Chicken, stalls in malls, wet
markets, etc. The products sold by merchandisers are called
merchandise inventory.
3. Manufacturing business.
The manufacturing business converts raw or direct
materials to finished products.
The three cost elements in a manufacturing process are
direct material, direct labor, and factory overhead. Direct labor
and factory overhead are applied to raw materials through a
manufacturing process to convert the raw materials to a finished
product. The finished products are sold to the customers of the
manufacturing business
Examples of manufacturing business are Toyota, San
Miguel, Asia Brewery, CDO, Purefoods, Magnolia, Unilever,
Proctor and Gamble, Coca Cola, Century Tuna, Gardenia,
Republic Flour Mills, etc.

LECTURE 5: Review of Expanded Accounting Equation

In the process of analyzing transactions, the rules of debit and

credit dictate the action to take, based on the effect of the transaction
on the accounting elements. Let us review the expanded accounting
equation,

A = L + [C + (R - E) - D].

Do you remember what these letters stand for? These represent the six
accounting elements:

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FA MODULE 3: ANALYZING BUSINESS TRANSACTIONS
A - Assets, anything that the business owns

L - Liabilities, anything that the business owes

C - Capital, the claim of the owner/s in the assets of the business

R - Revenues, the amount charged by the business to its

customers for services performed or products sold (effectively increases
owner’s equity)

E - Expenses, the amount spent by the business to earn the

revenues (effectively decreases owner’s equity)

D - Drawing (for sole proprietorship and partnership) or

Dividends (for corporation), owner’s withdrawal of assets, usually cash
for personal use (effectively decreases owner's equity).

Remember that capital, revenues, expenses, and drawing/dividends are

components of owner’s equity.

LECTURE 6: Rules of Debit and Credit

In accounting, debit simply means the left side of the account

and credit simply means the right side of the account. There should be
no other meaning to be associated with debit and credit. Many
accounting students relate debit and credit to some other meanings,
such as debit card, credit card, credit rating, credit bank account
balance, debit bank account balance, etc. It is when students associate
debit and credit with these meanings that they get confused when
analyzing business transactions. Moreover, some students associate
debit and credit with the mathematical processes of addition and
subtraction. Again, debit and credit should not be associated with any
mathematical process, because the mathematical action to take
depends on the effect of the transaction on the accounting elements. To
avoid being confused, do not give any other meaning to debit other than
the left side of the account, and to credit other than the right side of the
account.

The rules of debit and credit identify the action to take (debit or
credit) to specific accounts based on the effect (increase or decrease) of
the transaction to the accounting elements. The rules of debit and
credit are directly related to the expanded accounting equation. Both of
them are based on the accounting elements. The expanded accounting
equation is expressed as A = L + [C + (R E) D]. In algebra, the expanded
accounting equation can also be expressed as A + E + D = L + C + R.

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FA MODULE 3: ANALYZING BUSINESS TRANSACTIONS

The accounting elements on the left side of this derived equation,

assets, expenses, and drawing, dividends follow the same debit and
credit rule and the accounting elements on the right side of this derived
equation, liabilities capital and revenues follow the same debit and
credit rule. The debit and credit rule for the assets, expenses and
drawing/dividends is the opposite of the debit and credit rule for
liabilities, capital and revenues.

You will notice that although there are six accounting elements,
there are basically only TWO sets of rules for debits and credits: one set
for assets, expenses, and drawing/dividends (left side of the derived
equation) and another set, which is the opposite of the first rule, for
liabilities, capital, and revenues (right side of the derived equation).

LECTURE 7: Normal Balance of Accounts

The normal balance of accounts is the increased side of the

account. Going back to the rules of debit and credit, what is the
increased side of assets, expenses and drawing/dividends? Isn't debit
the increased side of assets, expenses and drawing? What is the
increased side of liabilities, capital and revenues? Credit is the
increased side of liabilities, capital, and revenues.

Therefore, debit balance is the normal balance of assets, expenses, and

drawing/dividends and credit balance is the normal balance of
liabilities, capital, and revenues. It is important to know the normal
balance of accounts because this knowledge will be helpful in analyzing
transactions, recording general journal entries, posting to the general
ledger, and preparing accounting reports.

LECTURE 8: The Double-Entry Accounting System

According to the double-entry accounting system (also called the

dual accounting system),

A business transaction affects at least two accounts, and the

debit and credit amounts recorded for the affected accounts must be
balanced.

For example, if the business paid Php 5,000 for rent, the two
accounts affected are asset Cash and expense Rent Expense. Cash is

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decreased by Php 5,000 and Rent Expense is increased by Php 5,000.
Therefore, following the rules of debit and credit, to record this
particular transaction, debit Rent Expense for Php 5,000 and credit
Cash for Php 5,000.

A transaction can affect more than two accounts. If the

business bought a computer for Php 35,000 and paid a down payment
of Php 10,000 and balance on account, there are three accounts
affected. The asset Computer increased by Php 35,000; asset Cash
decreased by Php 10,000, and liability Accounts Payable increased by
Php 25,000. To record this transaction, the business needs to debit
Computer for Php 35,000, credit Cash for Php 10,000, and credit
Accounts Payable for Php 25,000. Note that the debit amount (Php
35,000) is equal to the sum of the credit amounts (Php10,000 + Php
25,000).

LECTURE 9: The Chart of Accounts

A list of account titles with their corresponding accounting codes

that the business will use in recording and posting in the books of
accounts and in reporting in the financial statements.

The purpose of the chart of accounts is to make sure that the

same account title and account codes are used for the same transaction
in order to have uniformity in recording the same transactions. Since
there are many internal and external users of financial information
shown in the financial statements of the business, it is therefore
important to use standardized account titles so that there is
consistency in the recording of specific transactions and reporting the
same in the financial statements. In recording transactions, the account
titles as shown exactly in the chart of accounts must be used.

Account codes are assigned based on the accounting elements.

The prefix or the first digit in the account code identifies the accounting
element of the account and the next 2 or 3 digits (small businesses
usually have fewer accounts than larger businesses, so small
businesses usually have 3-digit account codes and large businesses
have 4-digit account codes) is the sequence or order number of the
account in the accounting element. Businesses assign the sequence
number in the order that the accounts are presented in the financial
statements.

LECTURE 10: Tools for Analyzing Transactions: The T-Account

The T-account is an accounting device that facilitates the

analysis of transactions.

It is called the T-account because it is in the form of the letter T.

A T-account has three parts, namely, the(1) account title or

account name, the(2) debit side on the left side, and the(3) credit side
on the right side.
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FA MODULE 3: ANALYZING BUSINESS TRANSACTIONS
One T-account is created for every account title.

A transaction affecting the particular account title is posted

either in the debit side or the credit side of the T-account. In posting
transactions to the T-account, it is advisable to indicate the date on the
left side of each posted amount. It is easier to trace errors later if the
postings are cross-referenced by date.

After all transactions are posted to the T-account, the amounts on

each side of the T-account are totaled.

 Footing
- is the process of computing the total of each side of the T-
account by adding all the amounts on each side.
- Since there are two sides to a T-account, a T-account can
have two footings, the debit footing and the credit footing.
- However, footing is computed only if there are more than
one amount posted on the side of the account. If there is
only one amount posted, there is no need to compute the
footing. It is possible that a T account can have several
amounts posted on one side, and one or no amount posted
on the other side. In this case, compute the footing only on
the side that has more than one amount posted.

For instance, if the account Revenues has several amounts

posted on the credit side and no amount posted on the debit
side, then the credit footing must be computed and no debit
footing is computed. In this example, the account Revenues has
only one footing, the credit footing.

The account Cash is always an active account, meaning there

are many transactions that affect the Cash account. Cash
usually has many amounts posted on both the debit and credit
sides. The debit footing and credit footing must be computed
for accounts with more than one amount posted on both sides
of the account. As earlier mentioned, there is no need to
compute the footing if an account has only one amount posted
on the side and the footing for that side is equal to that one
amount posted.

 Balancing
- is the process of computing the balance or net amount of
an account by getting the difference between the debit
footing and the credit footing.
- There is no need to compute the balance if an account has
only one footing, the footing is already the balance of the
account.
- The balance of an account is computed by deducting the
smaller footing from the larger footing and the resulting
balance is placed on the side with the larger footing.

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