MODULE 2

THE ACCOUNTING PROCESS:

ANALYZING BUSINESS TRANSACTIONS

Intended Learning Outcomes

After the end of this module, you should be able to:

1. identify the phases of accounting process;
2. define business transactions and its sources;
3. define double-entry system
4. describe the accounting equation; and
5. analyze business transactions.

Phases of the Accounting Process

There are four basic phases of accounting: recording, classifying, summarizing and interpreting
financial data. Communication may not be formally considered one of the accounting phases, but it is a
crucial step as well. All accounting information should be communicated properly to the appropriate parties
after analyzing.
1. Recording. It is a basic phase of accounting that is also known as bookkeeping. In this phase, all
financial transactions are recorded in a systematical and chronological manner in the appropriate
records. Accounting recorders are the documents and books involved in preparing financial
statements.
2. Classifying. It involves sorting and grouping similar items under the designated name, category or
account. This phase uses systematic analysis of recorded data in which all transactions are grouped
in one place.
3. Summarizing. It involves summarizing the data after each accounting period, such as a month,
quarter or year. This is the process involves preparation of financial statements.
4. Interpreting. It is concerned with analyzing financial reports, and is a critical tool for decision-
making. This final function interprets the recorded data in a manner which allows end-users to make
meaningful judgments regarding the financial conditions of a business or personal account, as well
as the profitability of business operations.

Business Transactions and Its Sources

A business transaction is an event that has some effects on the resources of a firm (Hernane, 2008). It
is also an economic occurrence that causes changes in an enterprise’s asset’s liabilities and/or equity. It
normally involves exchange of values. If this transaction is between an outsider and the business, these are
known as external transactions While if it happens only within the business, these are known as internal
transactions.
Source documents are the evidences of a transaction that contains the details of a transaction. Examples
of these source documents are receipts, invoices, checks, vouchers, promissory notes and memorandum
(credit or debit). Each source document connotes a business transaction and this triggers the start of the
accounting process.
The business transaction must always have a dual effect and that is for every value received, there is an
equal value parted. Accounting is based on double-entry bookkeeping, which means that accountants record
the dual effect of a business transaction. Let us try to understand it first by looking into the accounting
equation.
The Accounting Equation
Financial statements tell us how a business is performing. They are the end product of the account
process. But how do we arrive at the items and amounts that make up the financial statements? The basic
tool of accounting is the accounting equation. This equation represents resources controlled by the business,
the present obligation of the business and the residual interest of the owners in the assets. It states that assets
must always equal to the liabilities and capital.

Assets = Liabilities + Capital

The left side of the equation shows the assets and the right side shows who provides the funds needed
by the business. This explains why increases and decreases in assets are recorded in the opposite manner as

Module 2 ABM 1203 - Fundamentals of Accountancy, Business and Management 1 1- NAB

liabilities and capital are recorded. Every accountable event has a dual but self-balancing effect on the
accounting equation. Recognizing these events will not in any manner affect the equality of the equation.

Analyzing the Business Transaction

Once a source document which connotes a business transaction was received, an accountant needs to
analyze what are the affected items of this transaction. In acquiring an asset, a business mat give another
asset or incur a liability requiring payment later or both. A liability is decreased by paying cash or by
assuming another liability, requiring payment later or both. Capital increases because of investment and net
income. Withdrawal of cash or other assets by the owner for his personal use decreases the capital.
Every transaction is analyzed with respect to its effects on the assets, liabilities and capital of the
business. Please observe that every transaction affects two or more items in the accounting equation and
the equation remain in balance after each transaction. If the equation does not balance, you know an error
has been made.

To illustrate, assume the following transaction:

On November 1, 2017, Oscar Bergonia started his graphic design shop named Oscar Graphical Design.

Nov. 1 – Oscar invested cash of P200,000 to start his business.

Assets = Liabilities + Capital
Cash Oscar, Capital
P200,000 P200,000

The financial transaction is analyzed as follows:

❖ An entity separate and distinct from Oscar’ personal financial affairs is created.
❖ An economic resource- cash of P200,000 is invested in the business entity. The source of this asset
is the contribution made by the owner, which represents the capital. The capital account is Oscar,
Capital.
❖ The dual nature of the transaction is the cash is invested and capital created. The effect on the
accounting equation are as follows: increase in asset- cash from zero to P200,000 and increase in
capital from zero to P200,000.
❖ At this point, the entity has no liabilities, and assets is equal capital.

Nov. 3 – Purchased computer equipment for P65,000.

Assets = Liabilities + Capital

Cash Equipment Oscar, Capital
Balance P200,000 P200,000
Nov. 5 (65,000) 65,000
Balance P135,000 P65,000 P200,000

This transaction did not change the total asset but it did change the composition of the assets- it decreased
one asset (cash) and increased another asset (equipment) by P65,000. Note that the sums of the balances on
both sides of the equation are equal. This equality must always exist.

Nov. 9 – Computer supplies in the amount of P25,000 are purchased on account.

Assets = Liabilities + Capital

Cash Supplies Equipment Accounts Payable Oscar, Capital
Balance P135,000 P65,000 P200,000
Nov. 9 P25,000 P25,000
Balance P135,000 P25,000 P65,000 P25,000 P200,000

Assets don’t have to be purchased in cash. It can also be purchased on credit. Acquiring the supplies with
the promise to pay the amount due later is called buying on account. This transaction increases both the
assets and the liabilities of the business. The asset affected is supplies and the liability created is an accounts
payable.

Nov. 12 – Collected P12,000 in cash for services performed.

Module 2 ABM 1203 - Fundamentals of Accountancy, Business and Management 1 2- NAB

 Assets = Liabilities + Capital
Cash Supplies Equipment Accounts Payable Oscar, Capital
Balance P135,000 P25,000 P65,000 P25000 P200,000
Nov. 12 12,000 12,000
Balance P147,000 P25,000 P65,000 P25,000 P212,000

The business earned a service income. Oscar rendered his professional services and collected revenues in
cash. The effect on the accounting equation is an increase in the asset (cash) and an increase in capital.
Income increases capital. This transaction caused the business grow.

Nov. 15 – Oscar paid P8,000 to 7/11 Bills Express, for the semi-monthly utilities.

Assets = Liabilities + Capital

Cash Supplies Equipment Accounts Payable Oscar, Capital
Balance P147,000 P25,000 P65,000 P25,000 P212,000
Nov. 15 (8,000) (8,000)
Balance P139,000 P25,000 P65,000 P25,000 P204,000

Expenses are recorded when they are incurred. Expenses can be paid in cash when they occur, or they can
be paid later. The payment for utilities is an expense for the month of November. It represented an outflow
of resources and a reduction of capital.

Nov. 19 – Oscar made a partial payment of P15,000 for the Nov. 9 purchase on account.

Assets = Liabilities + Capital

Cash Supplies Equipment Accounts Payable Oscar, Capital
Balance P139,000 P25,000 P65,000 P25,000 P204,000
Nov. 19 (15,000) (15,000)
Balance P124,000 P25,000 P65,000 P10,000 P204,000

This transaction is a payment on account. The effect on the accounting equation is a decrease in asset (cash)
and a decrease in liability (accounts payable). The payment of cash on account has no effect on the supplies
because the payment does not increase or decrease the supplies available to the business.

Nov. 21 – The company has service agreement with a several people to maintain and update their websites
weekly. Oscar billed these clients P45,000 for services already rendered during the month.

Assets = Liabilities + Capital

Accounts Oscar,
Cash Receivable Supplies Equipment Accounts Payable Capital
Balance P124,000 P25,000 P65,000 P10,000 P204,000
Nov. 21 P45,000 45,000
Balance P124,000 P45,000 P25,000 P65,000 P10,000 P249,000

The business has performed services to clients so income should already be recognized. Oscar is entitled to
receive payment for these but the clients did not pay immediately. Performing services creates an economic
resource, the client’s promise to pay the amount which is called accounts receivable. This transaction
resulted to an increase in asset and an increase in capital of P45,000.

Nov. 24 – Amount of P29,000 were received from clients for billings dated Nov. 21.

Assets = Liabilities + Capital

Accounts Accounts Oscar,
Cash Receivable Supplies Equipment Payable Capital
Balance P124,000 P45,000 P25,000 P65,000 P10,000 P249,000
Nov. 24 29,000 (29,000)
Balance P153,000 P16,000 P25,000 P65,000 P10,000 P249,000

Module 2 ABM 1203 - Fundamentals of Accountancy, Business and Management 1 3- NAB

Last, Nov. 21 Oscar billed clients for services already rendered. On Nov. 24, the business has collected
P29,000 from them. The asset (cash) is increased by P29,000. The business should not record the income
on Nov. 29 since it has already recorded the income last Nov. 21. Total assets are unchanged. The business
merely reduced one asset (accounts receivable) and increased another asset (cash).

Nov. 26 – Oscar paid his assistant designer salaries of P16,000 for the month.

Assets = Liabilities + Capital

Accounts Accounts Oscar,
Cash Receivable Supplies Equipment Payable Capital
Balance P153,000 P16,000 P25,000 P65,000 P10,000 P249,000
Nov. 26 (16,000) (16,000)
Balance P137,000 P16,000 P25,000 P65,000 P10,000 P233,000

This transaction resulted to a reduction in capital as well as in cash. By providing his services to Oscar for
the month, the assistant designer has created for the business an expense- salaries expense.

Nov. 29 – Oscar withdrew P15,000 from the business for his personal use.

Assets = Liabilities + Capital

Accounts Accounts Oscar,
Cash Receivable Supplies Equipment Payable Capital
Balance P137,000 P16,000 P25,000 P65,000 P10,000 P233,000
Nov. 29 (15,000) (15,000)
Balance P122,000 P16,000 P25,000 P65,000 P10,000 P218,000

Withdrawal of cash or other assets for personal use is the way by which the owner of the entity receives
advance distribution of the profits. On Nov. 1, Oscar invested P200,000; both cash and capital increased.
The transaction was an investment by the owner and not an income-generating activity. Oscar simply
transferred funds from his personal account to the business. A cash withdrawal is exactly opposite. The
P15,000 cash withdrawal transaction resulted to a reduction in both cash and capital.

To summarize the effects of the transactions, below is the tabular analysis that can also be used in
analyzing stage:

Assets = Liabilities + Capital

Accounts Accounts Oscar, Remarks
Date Cash Receivable Supplies Equipment Payable Capital
2017
Nov. 1 P200,000 P200,000 Investment
3 (65,000) P65,000
9 P25,000 P25,000
12 12,000 12,000 Revenue
15 (8,000) (8,000) Expense
19 (15,000) (15,000)
21 P45,000 45,000 Revenue
24 29,000 (29,000)
26 (16,000) (16,000) Expense
29 (15,000) (15,000) Withdrawal
Total P122,000 P16,000 P25,000 P65,000 P10,000 P218,000

--- END OF DISCUSSION ---

/NABergonia2018

Module 2 ABM 1203 - Fundamentals of Accountancy, Business and Management 1 4- NAB

 EXERCISES

Exercise 1
For each transaction, tell whether the assets, liabilities and capital will increase (I), decrease (D) or is not
affected (NE).

Business Transactions A L C
1. The owner invests personal cash in the business.
2. The owner withdraws business assets for personal use.
3. The company receives cash from a bank loan.
4. The company repays the bank that had lent money.
5. The company purchases equipment with its cash.
6. The owner contributes her personal truck to the business.
7. The company purchases supplies on credit.
8. The company purchases land by paying half in cash and signing
a note.
9. The owner withdraws cash for personal use.
10. The company repays the suppliers.

Exercise 2
Describe the transactions based on the tabular analysis. Write your answers on the space provided.

Assets
Date Liabilities Capital
Cash Supplies Equipment
1 150,000 150,000
2 (20,000) 20,000
3 (112,500) (112,50)
4 5,000 5,000
5 (15,000) (15,000)
6 (3,000) (3,000)
7 (8,000) (8,000)

1. ____________________________________ 5. ________________________________
2. ____________________________________ 6. ________________________________
3. ____________________________________ 7. ________________________________
4. ____________________________________

Exercise 3
Determine the missing amounts on each of the following items.
Assets Liabilities Capital
1. P279,000 P56,400 ?
2. P213,600 ? P111,600
3. ? P52,200 P154,800
4. P871,200 P136,800 ?
5. P655,200 ? P462,600
6. ? P56,400 P285,000

Exercise 4
Use the accounting equation to answer each of the following questions.
1. At the beginning of the year, the assets of Momshie Monica Services were P360,000 and its capital
was P200,000. During the year, the assets increased by P120,000 and liabilities increased by
P20,000. What is the capital at the end of the year?
2. At the beginning of the year, Lolo Ryan Calling Station had liabilities of P100,000 and the owner’s
equity of P96,000. If the asset increased by P40,000 and liabilities decreased by P30,000, what was
the owner’s equity at the end of the year?
3. The liability of Louie Madilim Company is equal to one-third of the total assets, and the owner’s
equity is P240,000. What is the amount of the liability?

Module 2 ABM 1203 - Fundamentals of Accountancy, Business and Management 1 5- NAB

Exercise 5
Jerome Garcia started a new business and completed these transactions during August:
1 Garcia invested P48,000 cash in the business.
1 Rented office space and paid P800 cash for the August rent.
3 Purchased exploration equipment for P22,000 by paying P12,000 cash and agreeing to pay the balance
in 3 months.
5 Purchased office supplies by paying P1,500 cash.
6 Completed exploration work and immediately collected P420 cash for the work.
8 Purchased P1,350 of office equipment on credit.
15 Completed exploration work on credit in the amount of P8,000.
18 Purchased P700 of office supplies on credit.
20 Paid cash for the office equipment purchased on August 8.
24 Billed a client P2,400 for work completed; the balance is due in 30 days.
28 Received P5,000 cash for the work completed on August 15.
30 Paid the assistant’s salary of P1,100 cash for this month.
30 Paid P340 cash for this month’s utility bill.
30 Garcia withdrew P1,050 cash from the business for personal use.

Instruction: Complete the table.

Accounts Office Office Exploration Accounts Garcia,
Date Cash Receivable Supplies Equipment Equipment Payable Capital

Total

Exercise 6
Identify the foregoing transactions by identifying each as either one of the following: owner’s investment
(OI), owner’s withdrawal (OW), income (I), expense (E) or not an owner’s equity transaction (NO).
1. Received cash for rendering services
2. Withdrew cash for personal expenses.
3. Received cash from a customer who have been rendered service on account.
4. Transferred personal assets to the business.
5. Paid a service station for gasoline for a business service vehicle.
6. Performed a service and received a promise of payment.
7. Paid cash to acquire equipment.
8. Paid cash to an employee for services rendered.
9. Bought supplies for cash.
10. Paid loans to the bank.

Module 2 ABM 1203 - Fundamentals of Accountancy, Business and Management 1 6- NAB