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Chapter 3

Chapter 3

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Accounting 111 Chapter 3
Accounting 111 Chapter 3

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Published by: Noel Jr Siosan on Jul 09, 2013
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CHAPTER 3 THE ACCOUNTING EQUATION, THEORY OF DEBITS AND CREDITS AND FINANCIAL STATEMENTS

PREPARED BY: DR. LORNA T. GRANDE

Learning Objectives
The student should be able to: 1. Discuss the theory of debits and credits 2. Prepare an accounting equation for business transactions

3. Compute total assets, liabilities, and owner’s equity 4. Give the effects of transactions on the accounting equation

Learning Objectives
The student should be able to: 5. Enumerate the basic financial statements 6. Differentiate various kinds of financial statements
7. Discuss the importance of financial statements

THE ACCOUNTING EQUATION
ASSETS = EQUITIES

CREDITORS LIABILITIES

OWNER OWNER’S EQUITY

THE ACCOUNTING EQUATION ASSETS = LIABILITIES + OWNER’S EQUITY .

Original and additional investment b. Increase in assets accompanied by increase in owner’s equity such as: a. Borrowed money in a form of loan b.Transactions and their effects on the accounting equation 1. Increase in assets accompanied by increase in liabilities a. Receipt of income 2. Purchased items on credit .

Withdrawal of the owner b. Expenses paid or incurred .Transactions and their effects on the accounting equation 3. Decrease in asset due to decrease in liabilities a. Payment of liabilities 4. Decrease in asset because of decrease in owner’s equity due to a.

Increase in one liability account with a corresponding decrease in another liability account a. Purchases for cash b. Settlement of accounts payable with notes . Collection of accounts receivable 6. Increase in one asset with a corresponding decrease in another asset account.Transactions and their effects on the accounting equation 5. a.

Decrease in liability accompanied by an increase in owner’s equity a. Increase in liability accompanied by a decrease in owner’s equity a. Assumption of liability on mortgage property invested by the owner 8.Transactions and their effects on the accounting equation 7. Payment of liability of the enterprise by the owner .

Transfer of drawing account to capital account . Increase in some forms of owner’s equity account accompanied by a decrease in other forms of owner’s equity a.Transactions and their effects on the accounting equation 9.

Effects of transactions on accounting equation Assets Liabilities Owners equity Cash Equipt Supplies Accts Pay Capital .

000 150.000 25.000 Service income 175.000 2) 50.000 .000 150.000 2. Capital 100.000 4) 125.000 Equipt Supplies Accts Pay C.000 25.000 25.000 2.000 -3.000 3) -25.000 167.000 5) 25.000 2.000 125.000 25.000 2.000 drawing -5.000 142.000 25.000 25.000 electricity 172.000 150.000 2.000 2.000 2.000 25.Effects of transactions on accounting equation Assets = Liabilities Owners equity Cash 1) 100.000 150.000 Additional 150.000 Original 50.000 6) -3.000 147.000 2.000 2.000 2.000 7)-5.

liabilities.THE THEORY OF DEBIT AND CREDIT An Account – is The simplest form of the account is the Tan accounting account. . device used in summarizing the Title of the Account changes in the assets. Left side Right side revenue and or or expenses due to Debit side Credit side the occurrence of business transactions.

THE THEORY OF DEBITS and CREDITS ASSETS DEBIT = LIABILITIES + = CREDIT VALUE PARTED WITH (CREDIT) OWNER’S EQUITY VALUE RECEIVED = (DEBIT) .

THE RULES OF DEBITS and CREDITS & the normal balances of the accounts ACCOUNT ASSETS LIABILITIES OWNER’S EQUITY REVENUE EXPENSES NORMAL BALANCE DEBIT CREDIT CREDIT CREDIT DEBIT DEBIT CREDIT INCREASE DECREASE DECREASE INCREASE DECREASE INCREASE DECREASE INCREASE INCREASE DECREASE .

THE RULES OF DEBITS AND CREDITS USING THE T-ACCOUNTS Assets debit increase liabilities debit decrease credit decrease credit increase .

THE RULES OF DEBITS AND CREDITS USING THE T-ACCOUNTS Drawing debit increase Owner’s Equity debit decrease credit decrease credit increase .

THE RULES OF DEBITS AND CREDITS USING THE T-ACCOUNTS Expenses debit increase Income debit decrease credit decrease credit increase .

000 Lea Heart. Lea invested P200.Illustrative Problem 1.000 to a consultancy business Cash 1)200.000 . Capital 1) 200.

000 for rent of office space for 1 month Rent expense 2) 6.000 2) 6.000 . Paid P6.Illustrative Problem 2.000 Cash 1)200.

Illustrative Problem 3.000 Accounts Payable 3) 31.500 on credit Office Equipt 3) 30. P1.500 Office Supplies Expense 3) 1.500 .000 and office supplies for the month. Purchased office equipment 30.

000 Service Income 4) 50. Received P50.000 2) 6.Illustrative Problem 4.000 .000 4) 50.000 from clients for services rendered Cash 1)200.

000 Accounts Payable 5) 21.000 to X Co.000 2) 6.000 5) 21. Paid P21.000 4) 50.000 3) 31.500 .Illustrative Problem 5. Cash 1)200.

000 4) 50.Illustrative Problem 5.000 representing her salary for one month Cash 1)200.000 2) 6.000 5) 21. Paid the clerk P8.000 Salary expense 6) 8.000 6) 8.000 .

000 Office equipment 6.000 6) 8.000 30.000 215.000 250.000 3) 30.000 4) 50.Illustrative Problem The balances of the accounts: Cash 1)200.000 .000 2) 5) 21.000 35.

500 10.500 31.000 3) 31.500 .000 21.Illustrative Problem The balances of the accounts: Accounts Payable 5) 21.

00 200.000 Service Income 4) 50.000 Office supplies expense 3) 1.The balances of the accounts: Rent expense 2) 6.000 Lea Heart.000 50. Capital 1) 200.500 1.000 Salary expense 6) 8.500 .000 8.000 6.

000 ======== Lea Heart.000 ======= .000 Accounts payable P 10.Summary ASSETS = LIABILITIES + OWNER’S EQUITY Cash P215. Capital 200.000 Rent Expense (6.500 Total liabilities and Owner’ Equity P245.000 Office equipment 30.500) Total 234.500 P 10.000 Service Income 50.000) Salaries Expense (8.000) Office Supplies Expense (1.500 Total P245.

INCOME STATEMENT OR STATEMENT OF COMPREHENSIVE INCOME 3.FINANCIAL STATEMENTS 1. STATEMENT OF FINANCIAL POSITION or Balance Sheet (old term) 2. STATEMENT OF CHANGES IN EQUITY 4. CASH FLOWS STATEMENT 5. NOTES. COMPRISING A SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND OTHER EXPLANATORY NOTES .

It is also called Statement of Assets. It contains assets. . Liabilities and Equity.FINANCIAL STATEMENTS STATEMENT OF FINANCIAL POSITION A formal statement showing the financial position of an enterprise as of a particular date. It is also used to evaluate the business firm as to its liquidity and solvency. liabilities and owner’s equity.

SEE SAMPLE ON PAGE 60 . Solvency – refers to availability of cash over the longer term to meet maturing obligations. Financial structure – indicates how much is the equity of the creditors and how much is the equity of the owners.FINANCIAL STATEMENTS STATEMENT OF FINANCIAL POSITION Liquidity – refers to the ability of the company to meet currently maturing obligations.

It presents the income.FINANCIAL STATEMENTS INCOME STATEMENT A formal statement showing the performance of an entity for a period of time. expenses. gains. losses and profit or loss during the period. SEE SAMPLE ON PAGE 54-57 . Th e income statement provides information regarding the profitability of the enterprice.

the beginning equity of the owner is increased by additional investment and net income or profit for the period and is decreased by withdrawal and loss. For a sole proprietorship. SEE SAMPLE ON PAGE 57-58 .FINANCIAL STATEMENTS STATEMENT of CHANGES IN EQUITY It summarizes the changes in equity for a given period of time.

SEE SAMPLE ON PAGE 63-64 .FINANCIAL STATEMENTS STATEMENT of CASH FLOWS Shows the sources and uses of cash of an entity for a given period of time. This statement shows the net increase or decrease in cash during the period and the cash balance at the end of the period.

. and uses or outflows of cash and cash equivalents from the normal operating activities of the enterprise. Operating activities These are the sources or inflows. Uses include payments of purchases and expenses. The sources include collections from customers and from rentals.FINANCIAL STATEMENTS STATEMENT of CASH FLOWS a.

FINANCIAL STATEMENTS STATEMENT of CASH FLOWS b. . Investing activities These are the cash flows derived from the acquisition and disposal of long-term assets and other investments not included in cash equivalents. These cash receipts and disbursements arise from activities involving non-operating assets.

. These are the cash flows that result from transactions between the enterprise and the owners (equity financing) and between the enterprise and its creditors (debt financing). Financing activities These are the cash flows derived from the equity capital and borrowings of the enterprise.FINANCIAL STATEMENTS STATEMENT of CASH FLOWS c.

FINANCIAL STATEMENTS STATEMENT of CASH FLOWS Methods of presenting the cash flow from operating activities: 1. . Direct method – gross cash receipts and gross cash payments are itemized.

increase or decrease in current trade non-cash assets and liabilities. Indirect method – the profit or loss for the period is adjusted for the effects of non-cash transactions. . and other income and expenses associated with investing and financing activities.FINANCIAL STATEMENTS STATEMENT of CASH FLOWS Methods of presenting the cash flow from operating activities: 2.

FINANCIAL STATEMENTS NOTES TO FINANCIAL STATEMENTS Notes to financial statement s or footnotes are used to report information that could not fit in into the body of the statements but are necessary to enhance the understandability of these statements. .

FINANCIAL STATEMENTS NOTES TO FINANCIAL STATEMENTS a. Supporting information or computation of line items presented and aggregated in the financial statements. Statements of significant accounting policies used c. . Statements of compliance with PFRS b.

Other disclosures such as contingent liabilities. unrecognized contractual commitments and nonfinancial disclosures. See pages 65-67 .FINANCIAL STATEMENTS NOTES TO FINANCIAL STATEMENTS d.

RELEVANCE - 2. RELIABILITY . FAITHFUL REPRESENTATION 3.FINANCIAL STATEMENTS QUALITATIVE CHARACTERISTICS OF FINANCIAL INFORMATION 1.

or to confirm and correct prior expectations. . RELEVANCE Is the capacity of information to make a difference in a decision by helping users form predictions about the outcome of past.FINANCIAL STATEMENTS QUALITATIVE CHARACTERISTICS OF FINANCIAL INFORMATION 1. present and future events.

FINANCIAL STATEMENTS QUALITATIVE CHARACTERISTICS OF FINANCIAL INFORMATION 2. . FAITHFUL REPRESENTATION It means that the actual effects of the transactions shall be properly accounted for and reported in the financial statements.

. and faithfully represents what it purports to represent. RELIABILITY Refers to the quality of information that assures the users that the information is free from bias and error.FINANCIAL STATEMENTS QUALITATIVE CHARACTERISTICS OF FINANCIAL INFORMATION 3.

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