PILAR COLLEGE OF ZAMBOANGA CITY, INC.

R.T. Lim Boulevard, Zamboanga City

Basic Education Department
PAASCU Accredited Level III
A.Y. 2019-2020

BOOKKEEPING 10 / ACCOUNTING 10

NATURE OF ACCOUNTING AND ITS RELATED ACCOUNTS

1. Basic Phase in Accounting / Accounting Cycle

2. The Chart of Accounts and its descriptions
3. The Asset Accounts
4. The Liability Accounts
5. The Owner’s Equity
6. Revenue Accounts
7. Expense Accounts
8. Accounting Transactions
9. The Accounting Equation
10. The Rules on Debit and Credit

Subject Matter: Accounting Cycle

Learning Objectives:
1. Define the meaning of “Accounting Cycle”
2. Enumerate the steps in the accounting cycle
3. Determine the four (4) basic steps in the analysis of transactions (Step 1);
4. Demonstrate cooperation, openness and open-mindedness during class discussion and
activity

Reference: Basic Accounting Made Easy by Win Ballada, page 5-2

blog.accountingcoach.com/accounting-cycle/

CONTENTS:
What is the accounting cycle?
The accounting cycle is often described as a process that includes the following steps: identifying,
collecting and analyzing documents and transactions, recording the transactions in journals, posting
the journalized amounts to accounts in the general and subsidiary ledgers, preparing an unadjusted
trial balance, perhaps preparing a worksheet, determining and recording adjusting entries, preparing
an adjusted trial balance, preparing the financial statements, recording and posting closing entries,
preparing a post-closing trial balance, and perhaps recording reversing entries.

Cycle and steps seem to be a carryover from the days of manual bookkeeping and accounting when
transactions were first written into journals. In a separate step the amounts in the journal were posted
to accounts. At the end of each month, the remaining steps had to take place in order to get the
monthly, manually-prepared financial statements.

Today, most companies use accounting software that processes many of these steps simultaneously.
The speed and accuracy of the software reduces the accountant’s need for a worksheet containing
the unadjusted trial balance, adjusting entries, and the adjusted trial balance. The accountant can
enter the adjusting entries into the software and can obtain the complete financial statements by
simply selecting the reports from a menu. After reviewing the financial statements, the accountant can
make additional adjustments and almost immediately obtain the revised reports. The software will
also prepare, record, and post the closing entries.
ACCOUNTING CYCLE is a series of sequential steps or procedures performed to accomplish the
accounting process.

STEPS IN THE ACCOUNTING CYCLE

10. Reversing Journal Entries are Journalized and posted

This cycle is repeated each accounting period. The first three steps in the accounting cycle are
accomplished during the period. The fourth to the ninth steps generally occur at the end of the period.
The last step is optional and occurs at the beginning of the next period.

STEP 1 ANALYSIS OF TRANSACTIONS

AIM: To gather information about transactions or events generally through the source documents.
To categorize the types of transactions that can occur in a business, they are recognized as two
types: internal and external.
An internal transaction is a transaction that takes place in the company, usually among the
employees of the company. An example would be a payroll when an employee of a company gets
paid by the accountant of the company.
For a sole proprietorship, an internal transaction can be done by one person only, the owner of the
company. An example would be the owner withdrawing money from the business (for any reason)
An external transaction is a transaction that occurs between a business and an external entity.
Examples are:

 The company sells a product to a customer

 The owner of the company sends an employee to teach a class to a night school somewhere
and then the company gets paid by that other school
 The company borrows money from a bank
In our introduction to accounting, we saw that an accounting transaction is one that involves money
exchange. This means that events such as hiring an employee, meeting with a customer, or
negotiating the value of a job are not transactions, even if money is mentioned. As long as there is no
money exchange, it does not count as a transaction in the accounting sense.
Reference: www.functionx.com/excel/accounting/transactions.htm
The analysis of transactions should follow these four basic steps:

1. Identify the transaction from source documents.

2. Indicate the accounts – either assets, liabilities, equity, income or expenses – affected by the
transaction.
3. Ascertain whether cash account is increased or decreased by the transaction.
4. Using the rules of debit and credit, determine whether to debit or credit the account to record
its increase or decrease.

SOURCE DOCUMENTS

Transactions and events are the starting points in the accounting cycle. By relying on source
documents, transactions and events can be analyzed as to how they will affect performance and
financial position. Source documents identify and describe transactions and events entering the
accounting process. These original written evidences contain information about the nature and the
amounts of the transactions. These are the bases for the journal entries; some of the more common
source documents are sales invoices, cash register tapes. Official receipts, bank deposit slips, bank
statements, checks, purchase orders, time cards and statement of accounts.

Reference: BASIC ACCOUNTING Made Easy by Win Ballada pages 5-2 to 5-4

Source documents to support transactions

Any business transaction is recorded on a source document, i.e. purchase order, sales order, invoice, credit note

Types of sources documents

Features of invoice
Invoices are numbered to keep track of sent invoices
Invoice usually includes the following information:
 Name, address of seller and purchaser
 Date of sale
 Description of sale (goods or services)
 Quantity and unit price of what has been sold
 Details discount if it is provided
 Total amount of invoice plus sales tax if applicable
 Other (date of payment, terms of sale)

Subject Matter: Chart of Accounts

Learning Objectives:
1. Define the meaning of “Chart of Accounts”
2. Enumerate the simple chart of accounts and the accounts under balance sheet and income
statement;
3. Demonstrate cooperation, openness and open-mindedness during class discussion.

Reference: wiki.answers.com/Q/What_is_an_accounting_transaction
Basic Accounting Concepts, Principles, Procedures and Applications
By Edwin G. Valencia pages 73-74

CONTENT:
The Chart of accounts
The increases and decreases in accounting element as affected by a business transaction are
recorded in a device called account name, account title or account. Each accounting element is
composed of several accounts which describe the related economic transactions and events. To
maintain uniform account name, the business must have a listing of all the accounts it uses to record
economic transactions. This listing of all accounts is called “Chart of Accounts”.

A list of ledger account names and numbers arranged in the order in which they customarily
appear in the financial statements. The chart serves as a useful source for locating a given account
within the ledger. The numbering system for the chart of accounts must leave room for new accounts.
A range of numbers is assigned to each financial statement category. For example, asset accounts
may be assigned the numbers 1-100 and liabilities assigned 101-200. For large businesses, a wider
range of numbers would be required for each grouping. In fact, some companies employ a three-digit
numbering system for each account. In such a case, the first digit identifies the financial statement
category and the remaining digits apply to the position of that account within that category. For
example, 1 may be the first digit for Assets, and Cash, being the first asset account, would be
identified as 101.

The chart of accounts is usually arranged in the financial statement order – that us, asset
accounts first, followed by liability accounts, owner’s equity, revenues and expenses accounts. An
example of chart of accounts could be listed as follows:
 MICOMP SERVICE
Chart of Accounts
Account Account
Number Number
Assets (110-190) Liabilities (210-290)
110 Cash 210 Accounts Payable
120 Accounts Receivable 220 Notes Payable
130 Notes Receivable 230 Interest Payable
140 Prepaid Supplies 240 Loan Payable
150 Land 250 Withholding Tax Payable
160 Building
170 Office Equipment Owner’s Equity (310-390)
310 Cruz, Capital
320 Cruz, Drawing

Expenses (510-590) Revenues (410-490)

510 Salary Expense 410 Service Income
520 Rent Expense 420 Interest Income
530 Utilities Expense 430 Rent Income
540 Bad Debts Expense
550 Advertising Expense
560 Insurance Expense
570 Taxes and Licenses
580 Supplies Expense

Note: The account number is assigned to each account. It is used to facilitate recording, arranging and cross-referencing
the accounts. Assets start with 1; liabilities start with 2; owner’s equity starts with 3; revenues start with 4; and expenses
start with 5.

Description of Account Titles

Accounting uses several account titles to describe economic transactions and events. These
accounts are classified as either real (permanent) accounts or nominal (temporary) accounts.
Real accounts are those accounts that comprise the elements of the balance sheet – the
assets, liabilities and owner’s equity. These accounts are called real accounts because they are not
closed or not put to zero balance at the end of the accounting period.

Simple Chart of Accounts

Group headings - Sales, Cost of Goods Sold, Direct Expenses, Administration Expenses, Selling Expenses,
Distribution Expenses, Establishment Expenses, Financial Expenses.

Within each of these headings will be the individual nominal ledger accounts that make up the chart of
accounts. Establishment expenses may consist of rent, rates, and repairs.

Balance Sheet Accounts

Asset Accounts
Cash, Bank Accounts, Accounts Receivable (Debtors), Prepaid Expenses, Inventory (Stock on Hand), Land,
Buildings, Vehicles & Equipment, Investments & Stocks, Accumulated Depreciation and Other Assets

Liability Accounts
Accounts Payable (Creditors), Credit Cards, Tax Payable, Employment Expenses Payable, Bank Loans

Stockholders' Equity Accounts

Common Stock (Share Capital), Retained Earnings (Revenue Reserves), Drawings

Profit & Loss accounts

Revenue Accounts
Sales Revenue, Sales Returns & Allowances, Sales Discounts, Interest Income

Cost of Goods Sold Accounts

Purchases and sales Expense All sales Expense Purchase Returns & Allowances

Expense Accounts
Advertising Expense, Bank Fees, Depreciation Expense, Payroll Expense, Payroll Tax Expense, Rent
Expense, Income Tax Expense, Office Expense, Utilities Expense

Types of accounts
1. Asset accounts: represent the different types of economic resources owned by a business, common
examples of Asset accounts are cash, cash in bank, building, inventory, prepaid rent, goodwill, accounts
receivable
2. Liability accounts: represent the different types of economic obligations by a business, such as accounts
payable, bank loan, bonds payable, accrued interest.
3. Equity accounts: represent the residual equity of a business (after deducting from Assets all the liabilities)
including Retained Earnings and Appropriations.
4. Revenue accounts or income: represent the company's gross earnings and common examples include
Sales, Service revenue and Interest Income.
5. Expense accounts: represent the company's expenditures to enable itself to operate. Common examples
are electricity and water, rentals, depreciation, doubtful accounts, interest, insurance.
6. Contra-accounts: from the term ciccia, meaning to deduct, the value of which are opposite the 5 above
mentioned types of accounts. For instance, a contra-asset account is Accumulated depreciation. This label
represents deductions to a relatively permanent asset like Building.

Subject Matter: The Asset Accounts and its description

Learning Objectives:
1. Define the meaning of “Assets”
2. Determine and define the main categories of Assets;
3. Enumerate the criteria for assets to be considered as current;
4. Explain the phrase “operating cycle of a business”;
5. Enumerate the commonly used asset accounts; and
6. Demonstrate cooperation, accuracy, openness and open-mindedness during class
discussion and activity.

Reference: Basic Accounting Concepts, Principles, Procedures and Applications

By Edwin G. Valencia pages 74-76

CONTENT:

The Asset Accounts

Assets are resources or things of value owned by an enterprise. Generally, they are recorded
in the books of accounts with a normal debit balance. The asset accounts are classified into tow (2)
main categories, the current assets and the noncurrent assets.
Current Assets – an asset should be classified as a current asset when any of the following criteria
are met:
1. It is expected to be realized, or held for sale or consumption in the normal course of the
enterprise’s operating cycle; or
2. It is held primarily for trading purposes or for the short-term and expected to be realized within
twelve months of the balance sheet date; or
3. It is cash or cash equivalent which is not restricted for current use.
It can be inferred that if an asset does not meet any of the criteria above, it shall be classified
as noncurrent asset.
The operating cycle of an enterprise is the time between the acquisition of materials entering
into a process and its realization in cash or an instrument that is readily convertible into cash.
 THE OPERATING CYCLE OF A BUSINESS

Servicing Business Merchandising Business

CASH CASH

Phase 1: Buy Phase 3: Collect

Phase 1: Phase 2: merchandise from customers
Render Collect
service to from Phase 2: Sell
customers customers to customers
on account

Some of the current assets that are commonly used are:

 Cash – any item on hand with monetary value that a bank will accept for deposit and all amounts
currently on deposit with the bank in the name of the business. This includes coin and currency,
personal checks, money orders; traveler’s check made payable to the business and bank drafts. Also
included are any funds that are currently on deposit at a bank and readily available as checking and
savings account.

 Cash Equivalents – investments that are readily convertible to cash and with short maturity of three
months or less from the date of acquisition. They are available upon demand (unrestricted).
Examples are three-month maturity treasury bills, money market funds, commercial papers, and the
like.

 Temporary Investments – short-term investments with a term of more than three months but within
one year. Examples are current trading securities, current available for sale securities, etc.

 Accounts Receivable – the amounts collectible on open accounts of the customers. These represent
debtor’s oral promise to pay certain amount to the business and the right of the business to collect
certain amount in peso. Examples are receivables from sales of goods or services.

 Notes Receivable – a promissory note received by the business from its debtors and/or customers. A
promissory note is a written promise to pay a certain amount on specified or determinable date.

 Allowance for Doubtful Accounts – this is an amount estimated uncollectible on receivable in

compliance with the principle of conservatism. It is credited to serve as a contra account for the
related receivable. Other terms used to describe this account are “allowance for uncollectible
accounts” and “allowance for bad debts”.

 Accrued Interest Receivable – the interest earned on note receivable but not yet received in cash.

 Inventories – assets held for sale in the normal operation of the business, in the process of
production for sale, or in the form of materials or supplies to be consumed in the production process or
in the rendering of services. Examples are merchandise inventory and raw materials inventory.

 Prepaid Supplies – various supplies which have been bought for use in the office but are still unused.
Examples are unused coupon bonds, ink, ballpen, and janitorial supplies.

Noncurrent Assets – these are assets that do not meet the criteria of a current asset. Generally, they
include tangible, intangible, operating and financial assets of a long-term nature.

 Long-term Investments – investments intended to be held for more than one year. Examples are
investments in bonds, investments in stocks, investments to affiliates, etc.

 Land – the site owned by the business on which the business building is constructed. This plant asset
is not subject to depreciation. All other plant assets are subject to depreciation.
 Building – the structure owned by the business that is used in the operation of the business.

 Furniture and Fixtures – long-lived items used by the business including store furnishings, such as
showcases, counters, scales, containers, display racks, as well as furniture used for office purposes,
such as desks, chairs and cabinets.

 Equipment – consists of what generally might be called the machinery used in the business such as
computers, delivery equipment of any sort, or machinery used in conveying, packing, sorting or
altering the commodities handled.

 Accumulated Depreciation – the aggregate periodic costs of using a depreciable plant asset. In
accordance with the systematic cost allocation principle, the acquisition cost of depreciable plant asset
should be allocated as expense over the useful lives of the related plant assets. Examples are
accumulated depreciation – building, accumulated depreciation – equipment, etc.

 Intangible Assets – long-lived assets that do not have the physical substance and not held for sale
but are useful in the operation of a business. In most cases, intangible assets provide their owners
with privileges, rights or competitive advantages over other firms. Examples are goodwill, trademark,
tradename, copyright, patent and franchise.

Subject Matter: The Liability and Owner’s Equity Accounts and its description

Learning Objectives:
1. Define the meaning of “Liabilities” and “Owner’s Equity”;
2. Determine and define the main categories of Liabilities;
3. Enumerate the criteria for liabilities to be considered as current or noncurrent;
4. Enumerate the commonly used liability and owner’s equity accounts; and
5. Demonstrate cooperation, accuracy, openness and open-mindedness during class
discussion and activity.

Reference: Basic Accounting Concepts, Principles, Procedures and Applications

By Edwin G. Valencia pages 76-78

CONTENT:
The Liability Accounts
Liabilities are obligations owed by an enterprise. In other words, they represent claims against
the assets of the business. Liability accounts have a normal credit balance. The liability accounts are
classified into two main categories, (1) the current liabilities and the (2) non-current liabilities.

Current Liability – a liability that meets the following criteria:

1. It is expected to be settled in the normal course of the enterprise’s operating cycle; or
2. It is due to be settled within twelve months of the balance sheet date.

All other liabilities should be classified as non-current liabilities.

Examples of current liabilities are:

 Bank Overdrafts (also known as Cash Overdrafts) – refer to the credit balance in the cash
account resulting from the issuance of checks (payments of liabilities through checks) with a sum
larger than the balance of actual cash deposit in the bank.
 Accounts Payable is an obligation or debt to creditors for money borrowed or merchandise and
other assets bought on credit.
 Notes Payable is a promissory note issued by the business to its creditors for money borrowed or
merchandise and other assets bought on credit.
 Accrued Interest Payable is the interest incurred in the current period but not yet paid.
 Current Portion of Loans Payable is the amount of money borrowed from a bank or financial
institution.
 SSS Premium Payable represents the amount of employee and employer contribution to SSS
which are not yet remitted to SSS. Employees and employers are required to be member of
Social Security System. As members, they are required to pay membership dues to SSS as
employee’s share and as employer’s share.
 Withholding Tax Payable is the amount of income tax withheld from the salary of employee in
behalf of BIR that the employer has to remit to BIR on the specified due date.

Noncurrent Liabilities – liabilities that do not meet the criteria of a current liability. Generally, they
comprise the portion payable beyond one year of a long-term liability.
 Noncurrent Portion of Long-Term Debt – includes note payable, loans payable, mortgage
payable, etc.
 Bonds Payable – a long-term debt, requiring interest and principal payments according to
contractual terms. This debt security is used when the corporation wants to increase additional
funds but does not want to increase the number of owners.
An enterprise should continue to classify its long-term interest bearing liabilities as non-current,
even when they are due to be settled within twelve months of the balance sheet date, if the
following conditions are met;

1. The original term was for a period of more than twelve months;
2. The enterprise intends to refinance the obligation on a long-term basis; and
3. The intention is supported by an agreement to refinance, or to reschedule payments, which
is to be completed before the financial statements are approved.

The Owner’s Equity Accounts

Owner’s Equity – the residual amount after deducting liabilities from assets. It comprises the capital
contribution and withdrawals by the owner. It is increased by capital contribution of the owner and net
income of the business and decreased by owner’s withdrawals and net losses of the business.

Owner’s equity is described as owner’s capital (sole proprietorship), partner’s capital

(partnership) and stockholder’s equity (corporation). These accounts have normal credit balances.

 Drawing is a temporary account used to record initially the amount taken by the owner from the
business. This is closed to the capital account of the owner at the end of the accounting period.
This is a balance sheet temporary account.

Subject Matter: The Revenue and Expense Accounts and its description

Learning Objectives:
1. Define the term “Revenue” and “Expense”;
2. Define and explain briefly the nominal accounts;
3. Determine the normal balances of the revenue and expense accounts;
4. Enumerate the commonly used revenue and expense accounts; and
5. Demonstrate cooperation, openness and willingness to learn during class discussion and
activity.
Reference: Basic Accounting Concepts, Principles, Procedures and Applications
By Edwin G. Valencia pages 79-80

CONTENT:
NOMINAL ACCOUNTS are those accounts that comprise the elements of the income statement – the
revenue and expense accounts. These accounts are called temporary accounts because they are closed
or put to zero balance at the end of the accounting period.
THE REVENUE ACCOUNTS
Revenue represents the earnings of the business from sales of goods or service rendered.
Revenue accounts have a normal credit balance. Some common revenue accounts are:
 Sales – a temporary proprietorship account used to summarize sale of goods of a trade or a
merchandise business. This includes cash sales and sales on account.
 Service Income – the earnings derived from service rendered by a servicing business to its
customers. This includes cash and on account services.
 Professional Fees – the earnings derived from services rendered by a professional or
professional servicing firm to its clients which could be in cash or in collectibles.
 Interest Income – the earnings representing the time value of money derived from the promissory
notes received by the business, whether in cash or collectible in the future.
 Rent Income – the income earned from allowing others for the use of the property or facility of the
business.
 Gain on sale of Other Assets – the income derived from the sales of assets used in the business
operation. There in gain on sale if the proceeds exceed the book value or cost of the disposed
asset. Examples are gain on sale of equipment, gain on sale of investments, gain on sale of land,
etc.

THE EXPENSE ACCOUNTS

Expenses are costs incurred in conducting the business activities. Expense accounts have
normal debit balances. Some common expense accounts are:
 Cost of Sales – the value of merchandise sold.
 Supplies Expense – the amount of supplies consumed or used by the business during the
period. Examples are used office papers, inks, ballpen, etc.
 Salaries and Wages Expense – the amount paid to services rendered by the employees in the
operation of the business.
 Doubtful Account Expense – the estimated amount of losses from collectible accounts arising
from credit sales of the current period. This is also called bad debts expense or uncollectible
account expense.
 Depreciation Expense – represents the current periodic cost for using depreciable plant assets.
In accordance with the systematic cost allocation principle, the acquisition cost of depreciable
plant asset should be allocated as expense over the useful lives of the related plant assets.
 Insurance Expense – the amount of insurance policy incurred during the current period. Examples
are premiums on building insurance, life insurance, plant insurance, etc.
 Taxes and Licenses Expense – the cost of local as well as national taxes that are incurred and
required to be paid in connection with the conduct of business. Examples are: cost of acquire mayor’s
permit, registration cost of the business, percentage tax on sales, etc.

Subject Matter: The Accounting Equation

Learning Objectives:
1. Define the term “Accounting Transaction”;
2. Identify and define the accounting equation;
 3. Determine and define the term working capital;
4. Enumerate and explain the two (2) sides of the accounting equation; and
5. Demonstrate cooperation, openness and willingness to learn during class discussion and
activity.

Reference: Basic Accounting Concepts, Principles, Procedures and Applications

By Edwin G. Valencia pages 95-98

CONTENT:

INTRODUCTION TO TRANSACTION ANALYSIS:

THE BASIC ACCOUNTING EQUATION

What is an accounting transaction?

An accounting transaction is the exchange of request/response messages to perform accounting.
Accounting can be performed in the form of accounting transactions that report on resource usage by
a session. Accounting transaction can occur during a session if accounting or charging indications are
needed [pol based acct] or only at the start and the end of the session.

Business Transactions occur on a daily basis as a result of doing business. Items are purchased or
sold, credit is extended or borrowed, income is made or expenses are assumed. These business
transactions result in changes to the three elements of the basic accounting equation.
1. A transaction that increases total assets must also increase total liabilities or owner's equity.
2. A transaction that decreases total assets must also decrease total liabilities or owner's equity.
3. Some transactions may increase one account and decrease another on the same side of the
equation i.e. one asset increases and another decreases.

Accounting is built upon the fundamental accounting equation:

Assets = Liabilities + Owner's Equity

This equation must remain in balance and for that reason our modern accounting system is called a
dual-entry system. This means that every transaction that is recorded in accounting records must
have at least two entries; if it only has one entry the equation would necessarily be unbalanced.

The equation’s three parts are explained as follows:

1. Assets = what the business has or owns (equipment, supplies, cash, accounts receivable)
2. Liabilities = what the business owes outsiders (bank loan, accounts payable)
3. Owner’s Equity = what the owner owns (investment and business profit)

THE ACCOUNTING EQUATION

From the equation we can see that what the business owns (assets) equals what it owes both
creditors (liabilities) and the owners (equity).

1. The business owes creditors for loans made and other obligations to pay for goods or services.
2. The business owes the owner for any money or other assets that the owner invests in the
business
3. The business also owes the owner the profit that is realized from business operations.

The accounting equation can be expressed in 3 ways:

Assets = Liabilities + Owners' Equity

Liabilities = Assets - Owners' Equity
Owners' Equity = Assets – Liabilities

If you know any two of the amounts you can calculate the third.
The accounting equation plays a vital role in analyzing and recording economic transactions
and events of a business enterprise.
 The formula implies that a business, being a separate economic entry from its owner, generally
acquires economic resources (assets) which are contributed by its creditor(s) (liabilities) and
owner(s).

The position of liabilities in the equation being near to the assets implies that the third party
creditors shall obtain first priority over the assets of the enterprise. The third party creditors are
protected by law to have priority over the assets of the business in case of liquidation. Accordingly,
this idea resulted to a modified accounting equation expressed as follows:

ASSETS - LIABILITIES = CAPITAL

This modified basic equation implies that the owner’s equity would only be residual value of
assets after the creditors have secured their claims over the assets of the enterprise. Thus,

If the business has assets in the amount of P 100,000

And a liability of 30,000
The owner’s equity is P 70,000
=======

From this modified basic accounting equation, the equation for working capital has been
derived. The term working capital refers to the difference of business current assets and current
liabilities, which ensures that the business has sufficient resources to continue its operations
smoothly and avoid costly interruptions. Generally, this involves a number of activities related to the
firm’s receipt and disbursement of cash. Thus,

If the business has current assets in the amount of P 70,000

And the current liabilities of 35,000
The business working capital would be P 35,000
=======

In this case the working capital ratio is 2:1, computed as follows:

Current assets P 70,000

Divide by current liabilities P 35,000
Working capital ratio 2
=======

The ration implies that in every P1 current liability the business has an available P2 to pay.
Thus, the excess of P1 can be used as current back-up resources to continue the current operation
smoothly.

The Two Sides of the Accounting Equation

The accounting equation is divided into two sides (the left and the right sides) which are
accounted for to always maintain a balanced amount. In other words, if a balance sheet is
constructed immediately after each transaction, it should always be found that the total assets must
be equal to the totals of the aggregate liabilities and owner’s equity.

Using the illustration above, it could be observed that the two sides of accounting equation are
always equal. The total assets amounting to P100,000 are equal to the totals of liability and capital
which are P30,000 and P70,000, respectively.
 The “two sides” of accounting equation is an application of the dual concept of accounting
which provides that every value received must have a corresponding value parted with. This concept
is the basis of the debit and credit in recording economic transaction and event.

-------------------------------------------------------------------
DEBIT = CREDIT

Assets = Liabilities and Capital

The Normal Balance of Balance Sheet Accounts

Debit means the value received. Assets
are initially recorded in the debit side of
the equation. To debit an asset is to
increase an asset. To credit an asset is
to decrease it.
Credit means the value parted with. Liabilities
and capital are initially recorded in the credit
side. To credit a liability and/or capital is to
increase them. To debit liability and/or capital
means to decrease them.

The two equal sides define the foundation of the rules of debit and credit.

Debit is the value received in a business transaction which must be recorded in the journal.
This word is derived from a Latin word for borrower, “debitum” (a debtor). The place of debit in the
equation is on the left-hand side. The word “charge” in accounting would also mean debit.

Credit (Lat. Creditum, “a creditor”) is the value parted with in a business transaction, which
must be recorded in the journal. The place of credit in the equation is on the right-hand side.

Assets are initially debited, as they must be received first before they can be parted with by the
business, in the same manner that liabilities and capital are initially credited because they must be
acknowledged first before they are cancelled or withdrawn.

It could be gleaned from the foregoing that the business is presumed to be a borrower of
resources (assets) lent by its creditor(s) and owner(s). Therefore, whenever there changes in the net
amount of assets, the business must recognize their corresponding effects to the equities of lender(s)
and owner(s).

Subject Matter: The Rules of Debit and Credit

Learning Objectives:
1. Explain the nature of the Rules of Debit and Credit;
2. Enumerate the five rules of Debit and Credit;
3. Demonstrate the table of the summary of debit and credit analysis; and
4. Demonstrate cooperation, accuracy and patience during class discussion and the
preparation of the table of summary of debit and credit analysis.

Reference: Basic Accounting Concepts, Principles, Procedures and Applications

By Edwin G. Valencia pages 98-105

CONTENT:

THE RULES OF DEBIT AND CREDIT

BASIS OF THE RULE

The rules of debit and credit are based on the normal balance of an accounting element or
account. The term “normal balance of account” refers to the usual position of an account in the
accounting equation or in the T-account. Asset accounts are normally in the debit balance while the
liability and owner’s capital accounts are normally in the credit balance.

The normal balance of an account provides the basis in analyzing when to debit and credit an
account. The following rules must be observed when to debit or credit an asset, liability and capital
accounts.

Rule 1 – Assets: Debit to increase the amount of asset. Credit to decrease its amount.

Any Asset Account

Debit Credit

Increases Decreases

To illustrate, assume the following information:

1. January 5, Pearl Services bought P3,000 worth of supplies on account.

2. Pearl used P2,500 worth of supplies during the month.

The journal entries to effect the increase and decreased of prepaid supplies account would be:

GENERAL JOURNAL
Date Page Number 10
200x Descriptions PR Debit Credit Increase
1/5 Prepaid Supplies P3,000
Accounts Payable P3,000 in Asset
Purchase of supplies on account.

1/30 Supplies Expense 2,500

Prepaid Supplies 2,500 Decrease
To record supplies used in Asset

It is to be noted that the remaining unused supplies at the end of the month amount to P500.
Using the T-account method, the analysis would be:

Increase Prepaid Supplies Decrease

Debit Credit
Remaining balance 1/5 P3,000 1/30 P2,500
of unused supplies. 1/30 500

Rule 2: Liability: Credit to increase the amount of liability. Debit to decrease its amount.

Any Liability Account

Debit Credit

Decreases Increases

To illustrate, assume the following information:

1. January 5 - Pearl Services bought P3,000 worth of supplies on account.

2. January 18 – Pearl paid P1,800 for the obligation incurred on January 5.

The journal entries to effect the increase and decrease of accounts payable account are as
follows:
 GENERAL JOURNAL
Date Page Number 10
200x Descriptions PR Debit Credit Increase in
1/5 Prepaid Supplies P3,000 liability
Accounts Payable P3,000
Purchase of supplies on account.

1/30 Accounts Payable 1,800 Decrease

Cash 1,800 in liability
To record supplies used

It is to be noted that after the partial payment the remaining account payable decreases to
P1,200. Using the T-account method, the analysis would be:

Decrease Accounts Payable Increase

Debit Credit
Remaining balance 1/18 P1,800 1/5 P3,000
of accounts payable 1/30 1,200

Rule 3: Owner’s Equity: Credit to increase the capital account. Debit to decrease its
amount.

Any Owner’s Equity Account

Debit Credit

Decreases Increases

To illustrate, assume the following information:

1. January 1 – J. Pearl invested P90,000 cash into his business.

2. June 1 – J. Pearl withdrew P60,000 cash as permanent withdrawal from the business.

The journal entries to effect the increase and decrease of the owner’s capital account are as
follows:

GENERAL JOURNAL
Date Page Number 10
200x Descriptions PR Debit Credit Increase in
1/1 Cash P90,000 capital
J. Pearl, Capital P90,000
Owner’s capital contribution

6/1 J. Pearl, Capital 60,000 Decrease

Cash 60,000 in capital
Owner’s permanent withdrawal

It is to be noted that the remaining balance of capital after the permanent withdrawal by the
owner amounts to P30,000. Using the T-account method, the analysis would be:

Decrease J. Pearl, Capital Increase

Debit Credit
Remaining balance 6/1 P60,000 1/1 P90,000
of capital account 30,000
 Note: The owner’s equity (capital account) is increased by the owner’s additional investment and net income from operation. It
is decreased by owner’s withdrawals (drawings) and net loss from operation. This accounting concept is the basis of the
expanded accounting equation.

The Expanded Accounting Equation

It is to be noted that the basic accounting equation depicts only the balance sheet elements. It
is because they represent real (permanent) accounts, which are usually maintained at the end of the
accounting period.

The revenue (profit / income) and expense (loss) accounts, as elements of income statements,
are only nominal (temporary) accounts. They are usually closed to the capital account at the end of
the accounting period. Hence, the capital account is increased by any revenue (profit or income) and
decreased by any expense (loss). Accordingly, the accounting equation can be expressed in its
expanded form as follows:

ASSETS = LIABILITIES + CAPITAL + Additional

Investment + Revenue or
Income – Withdrawals
– Expenses or losses

Capital Account
Decreased by: Increased by:

Permanent Withdrawals Initial Investments

Temporary Withdrawals Additional Investments
Losses/expenses Income/revenue

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DEBIT = CREDIT

Expenses = Revenue

The Normal Balance of Income Statement Accounts

Expenses are initially recorded on the Revenues are initially recorded on the credit
debit side. To debit an expense means side. To credit revenue means to increase an
to increase an expense. To credit an income. To debit revenue means to decrease
expense is to decrease it. it.

Using the effect of revenue and expense to the capital account, the rules of debit and credit for
income statement elements can be stated as follows:

Rule 4: Revenue: Credit to increase the revenue account. Debit to decrease its amount.

Any Revenue Account

Debit Credit

Decreases Increases

To illustrate, assume the following information:

 1. December 1 – Pearl Service recorded service income of P10,000 on cash.
2. December 31 – Pearl determined that the recorded service income on December 31 should
not be P10,000. The correct amount is P1,000. Pearl reduced the service income by P9,000.

The journal entries to effect the increase and decrease of service income account are as follows:

GENERAL JOURNAL
Date Page Number 10
200x Descriptions PR Debit Credit Increase in
12/1 Cash P10,000 revenue
Service Income P10,000
Cash revenue from service.

6/1 Service Income 9,000 Decrease

Cash 9,000 in revenue
Correction of revenue account

It is to be noted that the remaining balance of service income account after decreasing it by
P9,000 is the correct amount of P1,000. Using the T-account method, the analysis would be:

Decrease Service Income Increase

Debit Credit
Remaining correct 12/31 P9,000 12/1 P10,000
balance of revenue 1,000

Rule 5 – Expense: Debit to increase expense account. Credit to decrease its amount.

Any Expense Account

Debit Credit

Increases Decreases

To illustrate, assume the following information:

1. December 15 – Pearl Service paid P12,000 for rent expense.
2. December 31 – The correct amount of rent expense is P1,200 instead of P12,000. Pearl
reduced the rent expense account by P10,800.
The journal entries to effect the increase and decrease of the expense account are as follows:

GENERAL JOURNAL
Date Page Number 10
200x Descriptions PR Debit Credit Increase in
expense
12/15 Rent expense P12,000
Cash P12,000
Payment of rent expense.

12/31 Cash 10,800 Decrease

Rent expense 10,800 in revenue
Reduction of rent expense

Observe that after the credit to the rent expense by P10,800 its balance was reduced to
P1,200. Using the T-account method, the analysis would be:

Increase Rent Expense Decrease

Debit Credit
Remaining correct 12/31 P12,000 12/15 P10,800
balance of expense 1,200
Summary of Debit and Credit Analysis
The T-account, when used as a tool to analyze the effect of business transaction, maintains
the equation that DEBITS = CREDITS. Reflecting the rules of debit and credit in the T-account could
be summarized as follows:
Accounting Elements
Debit Credit
Increases in: Decreases in:
Assets Assets
Expenses Expenses
Losses Losses

Decreases in: Increases in:

Liabilities Liabilities
Capital Capital
Revenue Revenue
Profit Profit

The T-account also depicts the relationship of each accounting elements in the basic
accounting equation, ASSETS = LIABILITIES + CAPITAL.