Module 3- FAR

SUBJECT FINANCIAL ACCOUNTING AND REPORTING

CHAPTER/UNIT Chapter 4 /Part 1
LESSON TITLE Analyses of Transactions and Rules of Debit and Credit
LESSON OBJECTIVES At the end of this module, you are expected to:
a. Describe the different definitions of Accounting
b. Differentiate between the works of a bookkeeper and a professional
accountant;
c. Identify, analyse and measure a business transaction;
d. Discuss the purpose of T-account and describe the debit and credit
balances of accounts; and
e. Describe and apply the accounting equation, the debit and credit
rules.

OVERVIEW/INTRODUCTION As early as November 1494, Franciscan monk named Luca Pacioli had
published a book which contained the principles of Mathematics and
incidentally a set of accounting procedures. The title of the book was
“Summa de Arithmetica, Geometria, Proportioni et Proportionalita”
(Everything about Arithmetic, Geometry, Proportions and
Proportionality).

The present recording systems to fit the changing need of current time
are already innovative in nature which gives growth to the development
in the practice of accounting profession worldwide.
ACTIVITY Looking back:

In our module 1 we have defined what accounting is, now in this module
we will mention some of the definitions given to Accounting:

The Accounting Standards Council (ASC) in its old Statement of Financial

Accounting Standards (SFAS) No. 1 defines accounting as follows:

“It is a service activity. Its function is to provide quantitative information,

primarily financial in nature, about economic entities that is intended to
be useful in making economic decisions.”

The American Accounting Association (AAA) which comprises primarily

of accounting educators who sponsored the Accounting Education
Change Commission which currently is new and innovative ways to
enhance accounting education defines accounting as:

“It is the process of identifying, measuring and communicating economic

information to permit informed judgments and decisions by users of the
information.”

The widely accepted and time honoured definition of accounting is the

 one formulated by the Committee on Accounting Terminology of the
American Institute of Certified Public Accountants (AICPA) which is the
largest organization of practicing accountants defined accounting as:

”It is an art of recording, classifying, summarizing in a significant manner

and in terms of money, transactions and events which are, in part at
least, of a financial character, and interpreting the results thereof.”

ANALYSIS Not all business activities are accountable or needs to be recorded. That
is why it is very important and critical to identify or analyse which
transactions needs to be recorded and how much is to be recorded. But
who record and analyse these documents?
1. What is the difference between the works of a bookkeeper and
a professional accountant?
2. How do we identify, analyse and measure a business
transaction?
3. How will we record these “accountable” business transactions or
events?
4. What is basic accounting equation and what are the rules for
debit and credit? And how are they applied?
5. What is the purpose of using T-account and how will we get the
debit and credit account balances?

ABSTRACTION Let us proceed to the discussion proper:

All the above definitions in the activity section touch the most important
points of Accounting as:
1. accounting is about quantitative information
2. the information is of financial in character
3. usefulness of information in decision making

The AICPA definition made by their Committee on Accounting

Terminology stands the test of time and still holds true because it is
tailored to fit exactly the steps of accounting process. The definition
mentions the four (4) of accounting which are recording, classifying,
summarizing, and interpreting.

Recording – is the phase of accounting which involves the routine and

mechanical process of writing down the business transactions and
events in the books of accounts in chronological manner called
Journalizing.

Before business transactions and events could be recorded, the

documents should first be identified, analysed and measured.

By identifying, it means, there should be a basis of determining whether

such were a business transactions and events or not. As a rule, only
transactions and events with financial bearing to the business are
recognized.

By analysing, it means that there should be a “dual effect”, normally the

value received (debit) and the value parted with (credit) of the
transactions.

By measuring, it means the assigning of monetary values involved in a

transaction. In the Philippines, we used the peso as the common
financial denominator.

Classifying – is the phase of accounting which involves sorting or

grouping of similar and interrelated transactions and events into their
respective kind and classes. This is actually the process of transferring
the entries from the journal to the ledger called Posting.

Summarizing – is the phase of accounting which involves the completion

of the financial statements and the accounting requirements as well.
This starts from striking of a trial balance, plotting down of adjusting
entries in the worksheet and the preparations of closing entries, post-
closing trial balance and reversing entries.

Interpreting – is the phase of accounting which involves the “analytical

and interpretative works.” It is when financial statements are analysed,
interpreted and are communicated to those interested parties where
these could be of great help to management as a basis for making a
sound decision.

BOOKKEEPING DIFFERS FROM ACCOUNTING

Bookkeeping is the process of recording “systematically” the business

transactions in a “chronological manner”.

It is systematic because “it follows procedures and principles”.

It is chronological because the transactions are recorded in “order of the

date of occurrence.”

The recording aspect is just one of the four major functions of

Accounting. Since bookkeeping traditionally assumes the responsibility
of recording functions, it runs short of classifying and summarizing
aspects which form part in the completion of bookkeeping work.

Accounting on the other hand, requires complete and accurate

bookkeeping records necessary in the performance of its responsibility
which is the analysis and interpretation of the financial reports.
Accounting could not reach at this final point without first passing
through the bookkeeping process and bookkeeping alone could not
arrived at the desired result of the entire accounting process. Hence, the
relationship of Bookkeeping and Accounting can be transcribed into a
common saying that “one is useless without the other”.

In short, while the bookkeeper does the “how accounting is done” which
refers to the mechanical aspects, the professional accountant does the
“why accounting is done” which refers to the analytical and
interpretative aspects of accounting. In other words, accounting begins
where bookkeeping ends.

BUSINESS TRANSACTIONS AND EVENTS

Not all business activities are “accountable”. For example, the hiring of
employees, death of company president and the entering into contract
are all business activities that cannot be quantified or expressed in terms
of unit of measure, thus cannot be recorded in the books of the
enterprise.

Business activities are said to be accountable and are called business

transactions and events when they affect the assets, liabilities and
owner’s equity or what we previously termed as accounting elements or
accounting values.

Business events are the occasional occurrence in the life of business like
for example, inventory loss due to theft and robbery, decline in market
valuation of inventory, calamities affecting the enterprise, etc. Business
transactions on the other hand, are exchanges of equal monetary
values. This definition implies the following concept of understanding:
1. For every value received, another value is given away as an
exchange;
2. These values are measured in terms of pesos which are
presumed to be equal.

To summarize, in every transaction, there is a Value Received, we call a

Debit and Value Parted With, we call a Credit. This is the “give and take”
process of accounting as expressed in an equation:

Debit, Value Received = Credit, Value Parted With

The word debit and credit came from the Latin words”debere” and
“credere”. The former is abbreviated Dr. and the latter as Cr.
ANALYSIS OF BUSINESS TRANSACTIONS

Business transactions are analysed from the view point of the business.

IF the transaction is “Purchased” or “Bought”, it is the business that is

buying;

If the transaction is “Sold”, it is the business that is selling;

If the transaction is “Paid”, it is the business that is paying;

If the transaction is “Collected”, it is the business that is collecting;

IF the transaction is “Rendered Services”, it is the business that is

rendering services, etc. and not the other way around.

DON’T FORGET:
“ALWAYS CONSIDER YOURSELF AS THE BUSINESS” when making the
analysis.

The value received or debit should first be determined before the value
parted with or credit. To test your analytical ability on transaction
analysis, let us try this:

“If I will give you an eraser and you will give me a piece of
chalk in return as an exchange, can you determine the value
received and the value parted with?

If your answer is, the value received is an eraser and the

value parted with is a piece of chalk, you have answered it
correctly. You will then say,

“Debit, eraser and Credit, a piece of chalk”

Let’s try it again, before we go into the business transaction analysis

proper:

“If I will give a ball pen and you will give me a piece of paper
in return as an exchange, can you determine the value
received and the value parted with?

If your answer is, the value received is a ball pen and the
value parted with is a piece of paper, you are correct! You
will then say;

“Debit, ball pen and Credit, a piece of paper”

It is easy right? We will just have to follow the following simple steps:

1. Before anything else, let us determine what item that we are

going to record. This is Identifying;

2. We should determine the value received and the value parted

with. This is Analyzing;

3. The item should have an assigned peso value. This is Measuring

and

4. We record the transaction in the Journal. This is Journalizing.

Let us have this illustration:

Bought a car for cash, P900,000

1. Who bought the car?

Answer: the business Identifying

2. What is the value received?

Answer: car Analyzing

3. What is the value parted with?

Answer: money-cash

4. What is the peso equivalent of these exchanges?

Answer: P 900,000 Measuring

We then say,

Debit, value received – car P900,000 Journalizing

Credit, value parted with – money-cash P900,000

Another final illustration:

Sold a car for cash, P700,000

The following questions are answered as your guide:

1. Who sold the car?

Answer: the business Identifying

2. What is the value received?

Answer: money-cash Analyzing

3. What is the value parted with?

Answer: car

4. What is the peso equivalent of these exchanges?

Answer: P700,000 Measuring

We then say,

Debit, value received - money-cash P700,000 Journalizing

Credit, value parted with - car P700,000

From this point, whenever we mention transactions and events, they

are understood to be referring all to business.

EXTENDED ILLUSTRATION ON TRANSACTION ANALYSIS:

The following transactions with corresponding analyses are given to

illustrate the principle of debit and credit with ready recognition of
various forms of accounting values:
_______________________________________________________

Transaction 1 – Bought a delivery car for cash P600,000.

Analysis: In this transaction, the value we received is a form of an

Asset which is delivery car, we call this Delivery Equipment
and the value parted with is another form of an Asset which
is Cash.

We then say,
Debit, Asset-Delivery Equipment P600,000
Credit, Asset-Cash P600,000

Transaction 2 – Sold an old computer for cash, P20,000.

Analysis: In this transaction, the value we received is a form of an
Asset which is Cash and the value parted with is another
form of an Asset which is Computer, we call this Office
Equipment.

We then say,
Debit, Asset-Cash P 20,000
Credit, Asset-Office Equipment P 20,000

Transaction 3 – Bought laundry supplies on credit from SM City-Gensan,

P 35,000.

Analysis: In this transaction, the value we received is a form of an

Asset which is Laundry Supplies and the value parted with is
in the form of a Liability which is our “oral promise to pay”,
we call this Accounts Payable.

We then say,
Debit, Asset-Laundry Supplies P 35,000
Credit, Liability-Accounts Payable P 35,000

Transaction 4 – Paid our account with SM-Gensan P 35,000.

Analysis: In this transaction, we get back our “oral promise to pay” as

a cancellation of our account. The value we received,
therefore, is a Liability, we call this Accounts Payable and
the value parted with is a form of an Asset which is Cash.

We then say,
Debit, Liability-Accounts Payable P 35,000
Credit, Asset-Cash P 35,000

Transaction 5 – Bought an office table on account from Emcor, P25,000

and a promissory note was issued.

Analysis: In this transaction, the value we received is a form of an

Asset which is office table, we call this Office Furniture &
Fixtures and the value parted with is our “written promise
to pay” which is a Liability, we call this Notes Payable.

We then say,
Debit, Asset-Office Furniture & Fixtures P 25,000
Credit, Liability-Notes Payable P 25,000
Transaction 6 – Paid our account with Emcor, P25,000 and get back the
promissory note we issued.

Analysis: In this transaction, we will get back our “written promise to

pay” as a cancellation of our account. The value we
received, therefore, is a form of Liability, which is our
promise to pay, we call this Notes Payable and the value
parted with is a form of an Asset which is Cash.

We then say,
Debit, Liability-Notes Payable P 25,000
Credit, Asset-Cash P 25,000

Transaction 7 – Received cash, P15,000 for services rendered to a

customer.

Analysis: In this transaction, the value we received is a form of an

Asset which is Cash and the value parted with is a form of
an Income which is our “services rendered”.

We then say,
Debit, Asset-Cash P 15,000
Credit, Income – Service Income P 15,000

Transaction 8 – Rendered services to a customer, P 12,000. The

customer made an oral promise to pay.

Analysis: In this transaction, the value we received is a form of an

Asset which is “our right to collect” from a customer’s
account, we call this Accounts Receivable and the value
parted with is a form of an Income which is our “services
rendered”.

We then say,
Debit, Asset-Accounts Receivable P 12,000
Credit, Income-Service Income P 12,000

Transaction 9 – Collected the customer’s account, P 12,000 (Refer to

transaction 8).

Analysis: In this transaction, the value we received is a form of an

Asset which is Cash and the value parted with is another
form of an Asset which is cancellation of our “right to
 collect” from the customer, we call this Accounts
Receivable.

We then say,
Debit, Asset-Cash P 12,000
Credit, Asset-Accounts Receivable P 12,000

Transaction 10 – Rendered services to a customer, P16,000. The

customer gave us his written promise to pay.

Analysis: In this transaction, the value we received is a form of an

Asset which is our “right to collect” from a customer’s
account, we call this Notes Receivable and the value parted
with is a form of an Income which is our “services
rendered”.

We then say,
Debit, Asset-Notes Receivable P 16,000
Credit, Income-Service Income P 16,000

Transaction 11 – Collected the customer’s promissory note, P16,000.

(Refer to transaction 10)

Analysis: In this transaction, the value we received is a form of an

Asset which is Cash and the value parted with is another
form of an Asset which is the returned promissory note by
the customer as a cancellation of our “right to collect”, we
call this Notes Receivable.

We then say,
Debit, Asset-Cash P 16,000
Credit, Asset-Notes Receivable P 16,000

Transaction 12 – Mr. Alfred Miao invests cash of P1,000,000 in the

business.

Analysis: In this transaction, the value we received is a form of an

Asset which is Cash and the value parted with is an “implied
interest” of the proprietor, Mr. Miao to safeguard the
amount of capital he puts into the business, we call this
Owner’s Equity.

We then say,
Debit, Asset-Cash P1,000,000
Credit, Owner’s Equity-Miao, Capital P1,000,000
Transaction 13 – Mr. Alfred Miao withdraws cash of P25,000 from the
business for his personal use.

Analysis: In this transaction, the value we received is the “reduction

of the proprietor’s capital”, we call this Drawing and the
value parted with is a form of an Asset which is Cash.
(Drawing is a factor that will decrease Owner’s Equity).

We then say,
Debit, Drawing-Miao, Personal P 25,000
Credit, Asset-Cash P 25,000

Transaction 14 – Paid salaries to employees for the month, P 20,000.

Analysis: In this transaction, the value we received is a form of an

Expense which is the “benefits we get from the services
rendered by our employees”, we call this Salaries Expense
and the value parted with is Asset-Cash.

We then say,
Debit, Expense-Salary Expense P 20,000
Credit, Asset-Cash P 20,000

THE T-ACCOUNT

The effect of changes in Assets, Liabilities, and Owner’s Equity are being
summarized in an accounting device called account. This device will
group these accounting values with their amounts belonging to one item
only.

In the item “cash” for example, all amounts representing increases and
decreases in cash are entered in the account cash.

An account is divided into two (2) sides:

The left-hand side which is called the debit side (value received) and

The right-hand side which is called the credit side (value parted with).

The device is commonly called T-Account because it resembles a capital

letter “T”.

An account title is written above the T-Account.

Shown below is the formation of an Account

ACCOUNT TITLE

Left-Hand Side Right-Hand Side

or or
Debit Side Credit Side
is for is for
VALUE RECEIVED VALUE PARTED WITH

An amount entered on the left-hand side of the account is called a Debit

Entry while

The amount entered on the right-hand side is called a Credit Entry.

The moment an “account” is assigned to an item to which a title has

already been designated, such account becomes identical to the item
thereafter. For instance, the account assigned to the item “Cash”
becomes known as Cash Account;

the account assigned to the item “Notes Receivable” becomes known as

Notes Receivable Account;

the account assigned to the item “Rent Expense” becomes known as

Rent Expense Account and so forth.

To Illustrate:

Shown below is a T-Account for the item “Cash”

CASH

Dr. Cr.
P25,000 P10,000

As the item “Cash” was written on top of the account, it becomes a Cash
Account.

The P25,000 that is being entered at the left-hand side of the account is
called Debit Entry.

The P10,000 that is being entered at the right-hand side of the account
is called a Credit Entry.
The total of the debit amounts or the debit entries of an account is
called debit total while the total of the credit amounts or credit entries
of an account is called credit total.

Let us assume, “cash account” has the following entries:

CASH

Dr. Cr.
P25,000 P10,000
20,000 5,000
debit total P45,000 P15,000 credit total

We then say,

“Cash account has a debit total of P45,000 and a credit total of

P15,000”.

ACCOUNT BALANCE

The difference between the debit total and credit total of an account is
called an Account Balance.

IF the total of the debit side exceeds the total of the credit side, the
account is said to be in a Debit Balance.

Conversely, if the total of the credit sides exceeds the total of the debit
side, the account is said to be in a Credit Balance.

If the debit total equals with that of the credit total, the account is said
to be In-Balance or Closed Account.

To illustrate:

The three (3) cases are being presented to illustrate an account

balance.

Case 1: The “Cash account” is used.

Let us assume, Cash account has the following debit and

credit entries.
 CASH

Dr. Cr.
P25,000 P10,000
10,000 5,000
debit total P35,000 P15,000 credit total
debit balance P20,000

In as much as the debit total of P35,000 exceeds the credit of P15,000,

Cash account is said to be in a debit balance by P20,000.

Hence, the account balance of P20,000 was placed on the debit side of
the account.

We then say,

“Cash account has a debit balance of P20,000”.

Case 2: The “Accounts Payable” account is used.

Let us assume, Accounts Payable account has the following debit

and credit entries:

ACCOUNTS PAYABLE

Dr. Cr.
P25,000 P40,000
10,000 10,000
debit total P35,000 P50,000 credit total
P15,000 credit balance

In as much as the credit total of P50,000 exceeds the debit total of

P35,000, the Accounts Payable account is said to be in a credit balance
by P15,000.

Hence, the account balance of P15,000 was placed on the credit side of
the account.

We then say,

“Accounts Payable account has a credit balance of P15,000.”

Case 3: The “Accounts Receivable” account is used.

Let us assume, Accounts Receivable account has the following

debit and credit entries.

ACCOUNTS RECEIVABLE

Dr. Cr.
P12,000 P10,000
4,000 6,000
debit total - P16,000 P16,000 - credit total

In as much as the debit total of P16,000 equals with its credit total of
P16,000, the Accounts Receivable accounts is said to be in-balance or
closed account.

We then say,

“Accounts Receivable account has a “zero” balance or the Account

Receivable account is closed.”

THE BASIC ACCOUNTING EQUATION

In Algebra, we have studied about algebraic equation and it is the

finding of the unknown value of “x”. The left side is the place for the
unknown and the right side is for the known.

In Accounting, we also have to study the accounting equation. The left

side which is called the debit side is for the Assets and the right side
which is called the credit side is for the Liabilities and Owner’s Equity.
The accounting equation is stated as follows:

Assets = Liabilities + Owner’s Equity

or

A = L + OE

The accounting equation is applicable to all economic entities regardless

of size, nature of business or forms of business organization. Assets,
Liabilities and Owner’s Equity are called “Accounting Values”.

Assets tell us of what the business owns.

Liabilities tell us of what the business owes.

Owner’s Equity tell us how much is the claim of the owner.

Therefore:

What it owns? = What it owes + What is the owner’s claim?

Assets = Liabilities + Owner’s Equity

The accounting equation states that the Assets of the business is equal
to the claims of both creditors and the owner.

NOTE: Attached scanned-Accounting equation illustration

THE RULES OF DEBIT AND CREDIT IN ACCOUNTING

The term Debit refers to the left-hand side and Credit refers to the
right-hand side of the accounting equation.

If the left weighs 75 lbs., the right must also weighs 75 lbs.

There could be no instance where the left is heavier than the right and
vice versa.

IF it happens to be a “seesaw”, it is in the state of equilibrium.

The accounting equation, A = L + OE has developed the rules to be

followed in the study of accounting.

The equation stands for the “normal balances” or “increase sides” in

each of the accounting elements.

In other words, the normal balances refer to the increase sides of the
accounts which may either be a debit or a credit.

For Assets, the increase side is the debit side (left) while

For Liabilities and Owner’s Equity, the increase sides are on the credit
side (right).

Conversely, the decrease side of an asset is on the credit (right) while

the decrease side of the liabilities and owner’s equity is on the debit
(left)

The increases and decreases of the account balances are diagrammed

below:

Normal Increase Decrease

Balances recorded by recorded by
Account Category Debit Credit Debit Credit Debit Credit
Asset
Liabilities
Owner’s Equity
Owner, Capital
Owner, Drawing
Income
Expense

Factors that will cause the Owner’s Equity to increase:

1. Investment by owner
2. Revenues

Factors that will cause the Owner’s Equity to decrease:

1. Withdrawal by owner
2. Expenses

DRAWING OR PERSONAL – the reduction of an Owner’s Equity account

arising from cash or property withdrawal of an owner is not debited to
Owner’s Equity account to affect the decrease but instead debited to
“Drawing Account”.

The debit to drawing account increases the said account with

corresponding decrease in owner’s equity.

TEMPORARY ACCOUNTS

INCOME or REVENUE – all income earned of the same nature are

summarized in this account.

EXPENSES – all expenses incurred of the same nature are summarized in

this account.

To summarize,
Income and Expenses are factors that affect Owner’s Equity.

Income increases Owner’s Equity while Expenses decreases Owner’s

Equity while
 Expenses decreases Owner’s Equity.

Owner’s Equity is increase by a credit to Income and is decreased by a

debit to Expense.

To recapitulate the developed rules of debit and credit are again re-
stated as follows:

We debit to We credit to
Real Accounts:
Rule 1 increase in Asset decrease in Asset
Rule 2 decrease in Liability increase in Liability
Rule 3 decrease in Owner’s Equity increase in Owner’s Equity
Rule 4 increase in Drawing decrease in Drawing

Temporary Accounts:
Rule 5 decrease in Income increase in Income
Rule 6 increase in Expenses decrease in Expenses

NOTE: See attached scanned pages for the Application to the rules of
debit and credit

APPLICATION 1. Self-Check Activity

______1. True or False. The relationship of bookkeeping and
accounting can be transcribes into a common saying that “one is useless
without the other”.

_______2. True or False. Business activities are said to be accountable

when they affect the accounting elements.

_______3. True or False. Financial Statements can be prepared without

completing the accounting cycle.

_______4. Multiple Choice. It is the assigning of peso or monetary values

involved in a transaction—
a. Classifying b. Identifying c. Measuring d. Summarizing

_______5. Multiple Choice. The amount entered on the left-hand of an

account is called –
a. Debit side b. debit entry c. credit side d. credit entry

_______6. Multiple Choice. Based on the equation A = L + P, when asset

decreases and liability remains the same—
a. capital decreases c. no effect on capital
b. capital increases d. asset = liability
 Determine the value received or debit and the value parted with or
credit:
Value Value
Received / Parted with /
Debit Credit
a.Princess invested cash in the business. ___________ _____________
b. Bought shop supplies on account. ___________ _____________
c. Rendered service on account. ___________ _____________
d. Borrowed money from a friend and
issued a promissory note. ___________ _____________
e. Received a note from Janaya for
services rendered on account. ___________ _____________

Transactions Affecting Accounting Values

At the beginning of the year, Jeyzhel Exterprises had a total assets of
P700,000 and total liabilities of P500,000. Answer the following
questions:
1. IF total assets decreased by P50,000 and owner’s equity
remained the same, how much is total liabilities at the end of
the year? Answer: ________________________
2. During the year, total liabilities increased by 40%, and owner’s
equity decreased by 30%, what is the amount of total assets at
the end of the year? Answer: ______________________
3. IF assets increased by P60,000 and liabilities decreased by
P40,000, how much is the owner’s equity balance before these
changes took place? Answer: _________________________

Answer key will be given in the Announcement – Moodle tomorrow for

you to check your answers.

ASSESSMENT Problem solving quiz online – check instruction (Announcement)

REFERENCES Financial Accounting and Recording by. R. Lopez

Basic Financial Accounting & Reporting by W. Ballada
Accounting Principles by Weygandt, Kimmel and Kieso