Lesson 3

Accounts and their classification

Topics:
 Accounts in the Statement of Financial Position
 Accounts in the Statement of Comprehensive Income
 Business Transactions and Events
 Dual Aspect Concept
 Analysis and Effects of Business Transactions

Learning Objectives
 Discuss the five major accounts needed to prepare the financial statements.
 Describe the nature and effect of business transactions.
 Analyze common business transactions using the debit and credit rule.
 Compute and solve simple problems in the analyses of business transactions.

In the previous lesson, we discussed the basic elements of accounting namely, assets, liabilities
and owner’s equity. The relationship of these elements was presented as A = L + OE. In
addition, the rules of debit and credit in relation to the basic elements were covered that for every
value received, there should also be a value given up.

In this module, we are going to discuss the list of account titles that is contained in each of the 5
major accounts which we need to familiarize before we proceed with analyzing and recording
business transactions.

The Accounts

An account is a place where all the information referring to a particular asset, liability or capital
is entered. The name given to an account is called an “account title” or “account name”. Account
titles are used within each of the accounting elements so that we can accurately record the effect
of a transaction of the business. (Salosagcol, 2018)

Chart of Accounts – a list of accounts used by an entity to record its transactions. It serves as a
guide in determining which particular account to use when recording business transactions.

Accounts in the Statement of Financial Position (Balance Sheet)

Assets are classified into two: current assets and non-current assets. Current assets are those that
are expected to be realized or used within the company's normal operating cycle or 1 year,
whichever is longer. They include properties that are held primarily for the purpose of selling
them in the near future. In essence, current assets are short-term in nature. Non-current assets, on
the other hand, are properties held for a long period of time (i.e. more than 1 year)
Current Assets

1. Cash and Cash Equivalents

 Cash on Hand - consists of un-deposited collections
 Cash in Bank - made up of bank accounts that are unrestricted as to withdrawal
 Short-term cash funds such as Petty Cash Fund, Payroll Fund, Tax Fund, etc.
 Cash Equivalents are short-term investments with very near maturity dates
making them assets that are "as good as cash".

2. Trading Securities or "Financial Assets at Fair Value"

 Trading Securities are investments in stocks that are held with the purpose of
trading (speculative investments)

3. Trade and Other Receivables

 Accounts Receivable - receivables from customers arising from rendering of
services or sale of goods
 Notes Receivable - receivables from customers which are backed up by
promissory notes
 Other receivables representing claims from other parties such as: Rent
Receivable, Interest Receivable, Dividend Receivable, etc.
 Allowance for Bad Debts - a contra-asset account deducted from Accounts
Receivable. It represents the estimated uncollectible amount of the receivable.

4. Inventories
 Inventories are assets that are held for sale in the normal operations of the
business. A service business normally has no inventory account.
 Merchandising businesses normally maintain one inventory account
– Merchandise Inventory.
 Manufacturing businesses have several inventories: Raw Materials
Inventory, Work in Process Inventory, Finished Goods Inventory, and Factory Supplies
Inventory.

5. Prepaid Expenses or Prepayments

 Prepayments consists of costs already paid but are yet to be used or incurred.
Common prepaid expense accounts include: Office Supplies, Service Supplies, Prepaid
Rent, and Prepaid Insurance.

Non-Current Assets

1. Property, Plant, and Equipment (PPE) also known as Fixed Assets

 PPE includes tangible assets that are expected to be used for more than one year.
PPE accounts include: Land, Building, Machinery, Service Equipment, Computer
Equipment, Delivery Equipment, Furniture and Fixtures, Leasehold Improvements, etc.
  Take note that land that is not used by the business in its operations but is rather
held for appreciation is not part of PPE but of investments.
 Accumulated Depreciation - a contra-asset account deducted from the related
PPE account. It represents the decrease in value of the asset due to continuous use, passage
of time, wear & tear, and obsolescence.

2. Intangibles
 An intangible has no physical form but from which benefits can be derived and its
cost can be measured reliably.
 Intangibles include Patent for inventions, Copyright for authorship, compositions
and other literary works, Trademark, Franchise, Lease Rights, and Goodwill.

Liabilities are classified into two: current liabilities and non-current liabilities. Current
liabilities are those that entity expects to settle within the entity's normal operating cycle or 1
year, whichever is longer. They also include liabilities that are held for trading purposes. Current
liabilities are short-term in nature. In contrast, non-current liabilities are long-term obligations,
i.e. expected to be settled beyond one year.
Here is a list of current and non-current liabilities.

Current Liabilities

1. Accounts Payable - refers to indebtedness that arise from purchase of goods, materials,
supplies or services and other transaction in the normal course of business operations.

2. Notes Payable - obligations that are evidenced by promissory notes that are to be paid within
1 year.

3. Income Tax Payable - current income tax obligation of the company payable to the
government.

4. Withholding Tax Payable - includes wage taxes withheld from employees that will be
remitted to the appropriate government agency. Separate accounts for Social Security
Payable and Medicare Payable are also often used.

5. Accrued Expenses - expenses already incurred but not yet paid. Accrued expense accounts
include: Salaries Payable, Rent Payable, Utilities Payable, Interest
Payable, Telecommunications Payable, and other unpaid expenses.

6. Unearned Revenues - represents advanced payments from customers which requires

settlement through delivery of goods or services in the future.

7. Any other short-term payable, i.e. any obligation that is to be paid within 1 year after the
balance sheet date.
Non-Current Liabilities

1. Long-Term Notes Payable - obligations evidenced by promissory notes which are to be

paid beyond 1 year; also commonly referred to as Loans Payable.

2. Bonds Payable - liabilities supported by a formal promise to pay a specified sum of money
at a future date and pay periodic interests. A bond has a stated face value which is usually the
final amount to be paid. Bonds can be traded in bond markets.

3. For serial bonds (bonds paid in installments), the portion which is to be paid within one year
is considered as a current liability; the rest are non-current. The same rule applies to other
long-term obligations paid in installments.

4. Mortgage Payable - long-term obligation to a bank or other financial institution, secured by

real properties of the business.

5. Any other long-term payable, i.e. any obligation that is to be paid beyond 1 year.

Equity (or capital) refers to the residual interest of the owners in the assets of a company after
all liabilities are settled.
In other words, equity is equal to assets minus liabilities.

The term used for equity depends upon the form of business organization.

1. For sole proprietorships, it is known as owner's equity.

2. For partnerships, it is called partners' equity.
3. For corporations, we use stockholders' equity.

Accounts in the Statement of Comprehensive Income (Income Statement)

Revenues (or income) refer to economic benefits received from business activities. Revenues are
"increases in economic benefits during the accounting period in the form of increases in assets or
decreases in liabilities that result in increases in equity, other than those relating to contributions
from equity participants".

1. Service Revenue - revenue earned from rendering services. Other account titles may be used
depending on the industry of the business, such as Professional Fees for professional practice
and Tuition Fees for schools.

2. Sales - revenue from selling goods to customers. It is the principal revenue account of
merchandising and manufacturing companies.
  Sales Discounts - a contra-revenue account that represents reduction in the amount
paid by customers for early payment. It is shown in the income statement as a
deduction to Sales.
 Sales Returns and Allowances - also a contra-revenue account and therefore shown
as a deduction to Sales. Sales return occurs when there is actual return of a defective
item. Sales allowance happens when the customer is willing to keep the item with a
reduction in its selling price.

3. Rent Income - earned from leasing out commercial spaces such as office space, stalls, booths,
apartments, condominiums, etc.

4. Interest Income - revenue earned from lending money.

5. Commission Income - earned by brokers and sales agents.

6. Royalty Income - earned by the owner of a property, patent, or copyrighted work for
allowing others to use such in generating revenue.

Expenses refer to costs incurred in conducting business. Technically, expenses are "decreases in
economic benefits during the accounting period in the form of decreases in assets or increases in
liabilities that result in decreases in equity, other than those relating to distributions to equity
participants".

1. Cost of Sales - also known as Cost of Goods Sold, it represents the value of the items sold to
customers before any mark-up. In merchandising companies, cost of sales is normally the
purchase price of the goods sold, including incidental costs. In manufacturing businesses, it is
the total production cost of the units sold. Service companies do not have cost of sales.

 Purchases - cost of merchandise acquired that are to be sold in the normal course of
business. At the end of the period, this account is closed to Cost of Sales.

 Freight in - If the business shoulders the cost of transporting the goods it purchased,
such cost is recorded as Freight-in. This account is also closed to Cost of Sales at the
end of the period.

2. Advertising Expense - costs of promoting the business such as those incurred in newspaper
publications, television and radio broadcasts, billboards, flyers, etc.

3. Bank Service Charge - costs charged by banks for the use of their services.

4. Delivery Expense - represents cost of gas, oil, courier fees, and other costs incurred by the
business in transporting the goods sold to the customers. Delivery expense is also known
as Freight-out.

5. Depreciation Expense - refers to the portion of the cost of fixed assets (property, plant, and
equipment) used for the operations of the period reported.
6. Insurance Expense - insurance premiums paid or payable to an insurance company who
accepts to guarantee the business against losses from a specified event.
7. Interest Expense - cost of borrowing money.

8. Rent Expense - cost paid or to be paid to a lessor for the right to use a commercial property
such as an office space, a storeroom, a building, etc.

9. Repairs and Maintenance - cost of repairing and servicing certain assets such as building
facilities, machinery, and equipment.

10. Representation Expense - entertainment costs for customers, employees and owners. It is
often coupled with traveling, hence the account title Travel and Representation Expense.

11. Salaries Expense - compensation to employees for their services to the company.

12. Supplies Expense - cost of supplies (ball pens, ink, paper, spare parts, etc.) used by the
business. Specific accounts may be in place such as Office Supplies Expense, Store Supplies
Expense, and Service Supplies Expense.

13. License Fees and Taxes - business taxes, registration, and licensing fees paid to the
government.

14. Telecommunications Expense - cost of using communication and telephony technologies

such as mobile phones, land lines, and internet.

15. Training and Development - costs for the enhancement of employee skills.

16. Utilities Expense - water and electricity costs paid or payable to utility companies.

Business Transactions and Events

Not all business activities as accountable events. The hiring of employees, death of the company
president and entering into contracts are business activities but these activities cannot be
quantified or expressed in terms of a unit of measure. These events are not recorded in the books
of the business. (Lopez, 2016)

Business activities are said to be accountable are those business transactions and events that can
affect the assets, liabilities, owner’s equity, income and expense. Business transactions are
analyzed from the view point of the business.

If the transaction is purchased or bought, it means that the business is “buying”. If the transaction
is “sold”, it is the business that is selling. If the transaction is “paid”, it means that the business is
paying. If the transaction is “collected”, it means that the business is collecting. If the transaction
is “rendered services”, it is the business that is rendering services to its customers. Always put
yourself on the shoes of the business in making the analysis.

Dual Aspect Concept

A transaction always involves the exchange of goods and services measurable in money. A
transaction entails exchanges in value, remember that for every value received there is also a
corresponding equal value given up. This means that there are always two aspects of a
transaction. (Salosagcol, 2018)

Ex. Santos Trading needs a van to deliver its goods to customers. The business bought a second
hand van amounting to ₱70,000 and paid cash.

In this example, we can observe the dual aspect of the transaction.

What is the value received? Answer: Car

What is the value given up? Answer: Cash

Analysis of Transactions

In analyzing business transactions, always remember the dual aspect concept. We can also make
use of these guide questions to help us in our analysis.

1. Is the transaction an accountable event?

Make sure to that the transaction meets the criteria for recognition in accounting.

2. What are the accounts affected?

You need to determine what is the value received and given up. Then identify which
specific accounts are affected by the transaction.

3. What are the effects of the transaction?

Once you determine which specific account is affected, analyze the transaction
carefully if it will increase or decrease the amount of the affected account.

DEBIT CREDIT
Transactions Value/s received Value/s given up

1. J. Cruz, invests P200,000 to Cash J. Cruz, Capital

start an auto repair business. (Ownership right)

2. Cruz buys repair equipment Equipment Accounts payable

on credit, P100,000. (Obligation to pay)

3. Cruz bought Shop Supplies Shop Supplies Cash

 for cash, P62,000.

4. Paid partial on equipment Accounts payable Cash

bought on account, P60,000. (Reduction of obligation)

5. Cruz received a bank loan for Cash Loan payable

business use, P100,000. (Promise to pay)

6. Cruz withdrew P20,000 for J. Cruz, Drawing Cash

personal use. (Ownership right taken)

Effect of Transactions

The 5 major accounts namely, assets, liabilities, owner’s equity, income and expense has its
corresponding normal balances presented below:

5 Elements Normal balance Debited Credited

Asset Debit ↑ ↓
Liability Credit ↓ ↑
Owner's Equity Credit ↓ ↑
Income Credit ↓ ↑
Expense Debit ↑ ↓

It is important to understand their respective normal balances so that you will be able to picture
out the effect of changes on these values in terms of Pesos. The normal balances refer to the
increase side of the accounts which may wither be a debit or credit.

Receipt of asset from owners

Increase
Receipt of asset from customers
Asset
Payment of liabilities
Decrease
Payment of expenses

Obtaining a bank loan

Increase
Purchase of supplies on account
Liabilities
Payment of loan
Decrease
Settlement of accounts

Investment of owner
Increase
Net profit
Owner's Equity
Withdrawal of owner
Decrease
Net loss
Example: The following are the transactions of Mr. Perez for the first week of January 2019.

Jan-01 Mr. Perez started his laundry business by investing ₱200,000 cash.
Jan-02 Mr. Perez took ₱80,000 cash from the business for his personal use.
Jan-03 Mr. Perez made an additional investment of ₱50,000 cash.
Jan-04 The laundry business borrowed money amounting to ₱70,000 from Urban Bank.
Jan-05 The laundry business bought laundry powder worth ₱5,000 from GT Trading to be
paid after 15 days.
Jan-06 The laundry business bought washing machine worth ₱15,000 for cash.

Asset = Liabilities + Owner's Equity

Jan-01 ↑ 200,000 ↑ 200,000
Jan-02 ↓ 80,000 ↓ 80,000
Jan-03 ↑ 50,000 ↑ 50,000
Jan-04 ↑ 70,000 ↑ 70,000
Jan-05 ↑ 5,000 ↑ 5,000
↑ 15,000
Jan-06
↓ 15,000

Total 245,000 = 75,000 + 170,000

Review Questions

1. What is meant by business transaction?

2. What is an account?
3. What is the dual aspect concept of accounting?
4. What is meant by the words debit and credit?
 Name: Score:
Block: Date:

Exercise 1. Classify the following account titles as to assets, liabilities and owner’s equity. Place
a “ √ ” on the corresponding line .

Asset Liability Owner's Equity

1. Cash in Bank      
2. Valdez, Capital      
3. Accounts Receivable      
4. Accounts Payable      
5. Unused Office Supplies      
6. Tan, Drawing      
7. Notes Receivable      
8. Unearned Services Income      
9. Prepaid Rent      
10. Accrued Salaries      
11. Land      
12. Building      
13. Loans Payable      
14. Machinery      
15. Prepaid Taxes      
16. Accrued Utilities      
17. Notes Payable      
18. Laundry Supplies      
19. Inventory      
20. Mortgage Payable      
Name: Score:
Block: Date:

Exercise 2. Classify the following account titles according to its normal balances. Write the
Debit or Credit on the space before the number.

  1. Notes Receivable   11. Notes Payable

  2. Cash in Bank   12. Prepaid Rent
  3. Taxes and Licenses   13. Professional Income
  4. Accounts Payable   14. Utilities Expense
  5. Ang, Capital   15. Land
  6. Interest Income   16. Rent Expense
  7. Used Supplies   17. Office Equipment
  8. Prepaid Insurance   18. Interest Receivable
  9. Unearned Income   19. Salaries Expense
  10. Insurance Expense   20. Accrued Salaries

Exercise 3. Analyze the following business transactions. Determine the value received “debit”
and value given up “credit” and write the account title on the allotted space.

Debit Credit
1 Mr. Lacson invested cash in the business.
2 Bought shop supplies on account from WW Trading.
3 Sold an old computer for cash to Mrs. Ibanes.
4 Bought a new computer on accout from Mr. Palma
5 Paid the account with Mr. Palma.
6 Sold office supplies on account to Mrs. Abad.
7 Collected in full the the account of Mrs. Abad.
8 Mr. Lacson withdrew cash from the business.
9 Paid the light and water bills for the month.
10 Received payment from a customer for a service rendered.

References:
Lopez, R. M. Jr. (2016). Fundamentals of Accounting. Davao City: MS Lopez Printing and
Publishing.

Salosagcol, J (2018). Accounting. Manila: Re Leone Publishing.