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Accounting Plus | 2022

Lesson 2:
THE ACCOUNTING EQUATION
Course Learning Outcome
Apply the concepts and procedures in the proper recording of business transactions.
Student Learning Outcomes
1. Determine the correct normal balance of the accounts
2. Classify the accounts according to their correct accounting element
3. Analyze business transactions using the accounting equation

ACCOUNT
– basic storage of information in accounting
– the basic summary device
– is an accounting device used to record the increases and decreases of a specific asset, liability, owner’s
equity, revenue or expense.

ACCOUNTING EQUATION: Assets = Liabilities + Owner’s equity

Assets = Liabilities + Owner’s equity

Expanded Accounting Equation:
Owner, Capital – Owner, Withdrawals + Revenues - Expenses

NORMAL BALANCE OF AN ACCOUNT

Normal Balance- usual position of an account in a T-account

Normal Balance Increases Recorded By
Debit Credit Debit Credit
Asset ✓ ✓
Contra-Asset Account ✓ ✓
Liabilities ✓ ✓
Capital ✓ ✓
Withdrawal ✓ ✓
Income ✓ ✓
Expenses ✓ ✓

CLASSIFICATION OF ACCOUNTS
• Real/Permanent Accounts (assets, liabilities and owner’s equity accounts)
- These are not closed at the end of the accounting period
• Nominal/ Temporary Accounts (income and expenses)
- These are temporary because they are closed or put to zero balance at the end of the
accounting period
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REAL ACCOUNTS
A. Assets – are present economic resources controlled by the entity as a result of past events [revised]
Current Assets
PAS 1, Par. 66 provides that an entity shall classify assets as current when:
1. It is cash or cash equivalent which is not restricted for current use
2. It is expected to be realized, or is held for sale or consumption in the normal course of the enterprise’s
operating cycle
3. It is held primarily for the purpose of trading
4. It is expected to be realized within twelve months after the reporting period.
The following are some of the current assets:
a) Cash - any medium of exchange that a bank will accept for deposit at face value.
• Cash on hand - includes coins and currencies, personal checks, money orders, traveler’s
check which are awaiting deposit
• Cash in bank - includes demand deposit/checking account and saving deposit which are
unrestricted as to withdrawal
• Cash fund - cash set aside for current purposes. It includes petty cash fund, payroll fund,
change fund and dividend fund
b) Cash Equivalents - are short-term and highly liquid investments that are readily convertible into
cash and so near their maturity that they present significant risk of changes
in value because of changes in interest rates. (PAS 7, Par.6)
- Examples: Three-month BSP Treasury Bill, Three-month time deposit,
Three-month money market placement
c) Financial Assets at Fair - Financial assets at fair value through profit or loss include financial assets
Value through Profit or held-for-trading and financial assets designated upon initial recognition at fair
loss value through profit or loss. Financial assets are classified as held-for-trading
if they are acquired for the purpose of selling in the near term.
d) Receivables
• Trade Receivables - Are claims arising from sale of merchandise or services in the ordinary course
of business
Includes
• Accounts Receivable - open accounts or those not supported by
promissory notes (formal promise to pay)
• Notes receivable - those supported by promissory notes
• Allowance For Bad - Are used to record customer accounts that may not be collected.
Debts (a Contra Asset
Account)
• Non-Trade receivables - Are claims arising from sources other than the sale of merchandise or
services in the ordinary course of business
• Interest Receivable - Refers to the interest that has been earned by investments, loans, or overdue
invoices but has not actually been paid yet.
• Other Receivables
e) Inventory - are assets which are held for sale in the ordinary course of business, in the
process of production for such sale or in the form of materials or supplies to
be consumed in the production process or in the rendering of services. (PAS
2, Par.6)
Merchandising business: Merchandise inventory
Manufacturing business:
• Raw Materials Inventory
• Work-in-Process/Goods-in-process Inventory
• Finished Goods
• Factory Supplies
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f) Prepaid Supplies - supplies which have been bought for use in the office but are still unused.
Examples: Unused ink, ball pen, Janitorial supplies, etc.
g) Prepaid Expenses - are assets created by the early payment of cash or assuming a liability. They
expire and are charged to expenses based on the passage of time, usage, or
other factors. They also list as current assets, as long as the company
envisions receiving the benefit of the prepaid items within 12 months of the
balance sheet date. Examples: Prepaid Rent, Prepaid Interest, Prepaid
Insurance, Prepaid Advertising
Non-Current Assets
These assets do not meet the criteria of current asset. (PAS 1, Par.66) The following are some of the non-current
assets:
a) Land - site owned by the business on which the business building is constructed. This
asset is not subject to depreciation
b) Building - long term depreciable asset that is part of plant property and equipment. It is a
structure permanently attached to the land, has a roof, is partially or completely
enclosed by walls, and is not intended to be transportable or moveable
c) Furniture and Fixture - Furniture includes more substantial items such as movable office furniture.
- Fixtures are anything that may be secured, such as cubicle partitions or attached
shelving, that have no permanent connection to the structure or building.
Examples are counters, bookcases, chairs, desks, filing cabinets, and tables
d) Accumulated - the sum of the periodic depreciation charges. The balance in the account is
Depreciation (a Contra deducted from the cost of the related asset.
Asset Account)
e) Intangible Assets - an identifiable nonmonetary asset without physical substance (PAS 38, Par.8)
Examples: goodwill, patents, copyrights, trademark, franchise, leasehold or lease
right, computer software, broadcasting license, secret processes, airline rights
f) Deferred tax asset - items that may be used for tax relief purposes in the future. Usually, it means that
your business has overpaid tax or has paid tax in advance, so it can expect to
recoup that money later.

B. Liabilities – are present obligations of an entity to transfer an economic resource as a result of past events.
Liabilities are settled over time through the transfer of economic benefits including money, goods or services.
Current Liabilities
PAS 1, Par.69 provides that an entity shall classify liabilities as current when:
1. The entity expects to settle the liability within the entity’s normal operating cycle
2. The entity holds the liability primarily for the purpose of trading
3. The liability is due to be settled within twelve months after the reporting period
4. The entity does not have an unconditional righto defer settlement of the liability for at least twelve months
after the reporting period.

The following are current liabilities:

a) Accounts payable - obligation to creditors for money borrowed or merchandise and other assets
bought on credit
b) Notes payable - a promissory note issued by the business to its creditors for money borrowed or
merchandise and other assets bought on credit
c) Accrued interest Payable - interest incurred in the current period but not yet paid
d) Loans Payable - is an arrangement under which the owner of property (usually cash) allows
another party the use of the property in exchange for an interest payment and the
return of the property at the end of the lending arrangement. The loan is
documented in a promissory note.
e) Unearned Revenue/Income - is a liability account that reports amounts received in advance of providing goods
or services. When the goods or services are provided, this account balance is
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decreased and a revenue account is increased. Examples: Unearned Interest

Income, Unearned Rental Income
f) SSS Premium Payable - the amount of employee and employer contribution to SSS which are not yet
remitted to SSS
g) Withholding tax payable - 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
h) Dividend Payable - amount payable to shareholders arising from declaration of dividends
i) Accrued - expenses already incurred but not yet paid
Liabilities/Expenses
j) Provision - a liability of uncertain timing or amount
k) Current Portion of Long- - the amount of unpaid principal from long-term debt that has accrued in a
Term Debt company's normal operating cycle
l) Current Tax Liability - taxes that are payable to a taxing authority, or which are accrued for payment
on a future date.

Non-Current Liabilities PAS 1, Par.69 provides that all liabilities not classified as current are classified as non-
current.
a) Mortgage Payable - A long-term debt of the business entity for which the business entity has pledged
certain assets as security to the creditor.
b) Bonds Payable - A long-term contract of debt. A bond is a formal contract that requires the
issuing corporation to pay the bondholders principal repayment and interest
c) Non-current portion of long-term debt
d) Finance Lease liability
e) Deferred tax liability
f) Long-term obligations to company officers
g) Long-term deferred revenue

C. Equity – is the residual interest in the assets of the entity after deducting all of its liabilities.
The terms used in reporting the equity of an entity depending on the form of the business organization are:
• Owner’s equity in a sole proprietorship
• Partners’ equity in a partnership
• Stockholders’ equity or Shareholders’ equity in a corporation
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.
Income Summary - is a temporary account used at the end of the accounting period to close income and expenses.

NOMINAL ACCOUNTS
A. Revenue – represents the earnings of the business from sales of goods or services rendered.
a. Service Income - amount realized from selling of services
b. Sales - The amount realized from selling goods/merchandise

Contra-revenue accounts – deductions against the revenue account:

• Sales Discounts – reduction in sales price arising from prompt payment
• Sales Returns – reduction in sales price arising from physical return of previously purchased
merchandise
• Sales Allowance – reduction in sales price without physical return of merchandise to the supplier
B. Expenses – are money spent or cost incurred in an organization's efforts to generate revenue, representing the
cost of doing business.
a. Cost of Sales – the accumulated total of all costs used to create a product or
service, which has been sold.
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b. Salaries or Wages Expense – reports the salaries/wages that employees have earned during the
period indicated in the heading of the income statement, whether or not the company has yet paid the
employees.
c. Utilities Expense – the cost consumed in a reporting period related to the following
types of expenditures: Electricity, Heat (gas), Sewer, Water, Telephone, Internet
d. Rent Expense- the cost incurred by a business to utilize property.
e. Supplies Expense – the amount of supplies that were used/consumed
f. Uncollectible Accounts/Doubtful Accounts Expense- represents the amount of receivables estimated
to be doubtful of collection
g. Depreciation Expense – The portion of a tangible capital asset that is deemed to have been
consumed or expired, and has thus become an expense. Depreciation is a method of allocating the cost of
a tangible asset over its useful life.
h. Marketing and Advertising Expense – represent expenses associated with promoting an industry, entity,
brand, product name, or specific products or services in order to stimulate a desire to buy the entity's
products or services.
i. Insurance Expense – is the cost of insurance that has been incurred, has expired, or has
been used up during the current accounting period.
j. Repairs and maintenance Expense – are expenses incurred in repairing or servicing the buildings,
machineries, vehicles, equipment, etc., which are owned by the business.
k. Gas and Oil Expense – is the account title for gasoline, diesoline, lubricants, grease, fluids,
lube oils, etc., for use by company vehicles.
l. Interest Expense – is the cost of debt that has occurred during a specified period of
time.
m. Taxes and Licenses – are the amounts paid for business permits, licenses and other
government dues except Income tax paid which is not allowable by law as a deduction.

CHART OF ACCOUNTS - listing of all accounts. An example is shown below:

ABC ENTERPRISE
Chart of Accounts
Account No. Account Title/Name Account No. Account Title/Name
ASSETS LIABILITIES
110 Cash on Hand 310 Accounts Payable
111 Cash in Bank 320 Notes Payable-Current
112 Petty Cash 330 Loans Payable-Current
120 Accounts Receivable 340 Interest Payable
121 Allowance for Doubtful Accounts 350 Salaries Payable
123 Notes Receivable-Current 351 Accrued Rent Payable
124 Interest Receivable 360 Income Tax Payable
130 Inventories 361 Withholding Tax Payable
140 Supplies 362 SSS Contribution Payable
150 Prepaid Insurance 364 Philhealth Contribution Payable
160 Prepaid Rent 365 Pag-ibig Contribution Payable
210 Notes Receivable-Non-current 370 Unearned Service Income
220 Land 371 Unearned Rental Income
230 Building 410 Notes Payable-Non-Current
231 Accumulated Depreciation-Bldg. 420 Loans Payable-Non-Current
240 Office Furniture & Equipment
241 Accumulated Depreciation-Furn. &Eqpt. CAPITAL
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250 Service Vehicle 510 ABC, Capital

251 Accumulated Depreciation-Service Vehicle 520 ABC, Drawings
260 Delivery Truck 530 Income and Expense Summary
261 Accumulated Depreciation-Delivery Truck
EXPENSES REVENUES
810 Marketing and Advertising Expense 610 Rental Income
820 Salary Expense 620 Service Income
830 Rent Expense 630 Interest Income
840 Utilities Expense 640 Miscellaneous Income
850 Uncollectible Accounts Expense
860 Insurance Expense
870 Taxes and Licenses Expense
880 Supplies Expense
890 Depreciation Expense
910 Employee Benefit Expense
920 Interest Expense
930 Miscellaneous Expense

Exercises
Exercise 2.1 Accounting Equation
Use the accounting equation to compute the missing financial statement amounts.
Assets Liabilities Equity
P 150,000 1) P 40,000
2) P 200,000 P 30,000
P 195,000 P 80,000 3)
4) P 16,000 P 23,000
P 1,075,000 P 815,000 5)

Exercise 2.2 Expanded Accounting Equation

Use the expanded accounting equation to compute the missing financial statement amounts.
Assets Liabilities Equity Owner, Owner, Revenues Expenses
Capital Withdrawals
P 150,000 1) P 60,000 P 20,000 P 5,000 2) P 34,000
P 310,000 3) P 110,000 P 90,000 4) P 110,000 P 75,000
P 195,000 P 80,000 5) 6) P 16,000 P 98,000 P 52,000
7) P 20,000 P 23,000 P 15,000 P 4,500 P 30,000 8)
P 1,075,000 P 675,000 9) P 530,000 P 20,000 P 240,000 10)
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Exercise 2.3 Normal Balance of accounts

Identify which accounting element of the financial statements the specific account belongs and identify its normal
balance.
Account Element Normal Balance
1. Interest Income
2. Marketing Expense
3. Mortgage Payable
4. Land
5. Investment Property
6. Drawings
7. Prepaid Advertising
8. Accrued Interest Income
9. Accrued Rent Expense
10. Deferred Service Revenue
11. Allowance for uncollectible accounts
12. Depreciation Expense
13. Gain on Sale of Machinery
14. Accrued Interest Payable
15. Cost of Sales
16. Accumulated Depreciation-Machinery
17. Fixtures
18. Accrued interest receivable
19. Unused Supplies
20. Amortization Expense
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Lesson 3:
BUSINESS TRANSACTIONS AND THE BOOKS OF ACCOUNTS
Course Learning Outcome
Apply the concepts and procedures in the proper recording of business transactions.
Student Learning Outcomes
1. Define what is a business transaction
2. Determine the source documents of business transactions
3. Differentiate a journal from a ledger
4. Describe the use of the general journal and special journals
5. Describe the use of the general ledger and subsidiary ledgers

BUSINESS TRANSACTIONS
– events which affect a business financially.
– these economic activities cause a change in its assets, liabilities and/or equity. Any event which does not
affect the business financially is not recorded in accounting system. Business transactions are recorded in
a special type of register called journal.3
Two (2) major categories of business transactions:
1) External transaction takes place between two entities and do change the financial position of both
companies.
2) Internal transaction is an economic activity within in a company that can affect the accounting equation.

SOURCE DOCUMENTS

Source Documents are the original records containing the details

to substantiate a transaction entered in an accounting system. The
most common business documents are as follows.

Purchase Requisition Form- is a written request for items of

goods needed by the user department and shall be ordered by the
purchasing department
Purchase Order – is a commercial document and first official offer
issued by a buyer to a seller, indicating types, quantities, and
agreed prices for products or services. 4

3
http://accountingexplained.com/financial/introduction/transaction
4 https://en.wikipedia.org/wiki/Purchase_order
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Sales Invoice – can be simply defined as the request of payment by the customer for goods sold or services provided
the seller. An invoice generally lists the description and the quantity of the item sold or service provided. The document
is also a record of the sale for both the seller and the buyer.5

Bill of lading – is a document issued by the carrier

specifying the contractual conditions and terms of
delivery (freight terms, time, place and person
authorized to receive the goods).i

Delivery Receipt – is a document that is typically

signed by the receiver of a shipment to indicate that
they have in fact received the item being shipped
and have taken possession of it. 6

5 www.smallbusiness.chron.com/accounting-definition-sales-invoice-23865.html
6 www.businessdictionary.com/definition/delivery-receipt.html
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Receiving Report – is a
document that contains
information about the goods
received from the supplier. iii

Statement of Account/ Billing Statement – a report indicating the

account status of an agreement between creditor and debtor. The
statement is usually issued by the creditor indicating details such
as the unpaid balance due and payment history. 7

Check – Demand draft drawn on a bank against its maker's

(drawer's) funds, to pay the stated amount of money to the bearer
or named party, on presentment (demand) on a stated date or after.
8

7 https://www.allbusiness.com/barrons_dictionary/dictionary-statement-of-account-4947334-1.html
8 http://www.businessdictionary.com/definition/check.html
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Bank Deposit Slip – A deposit slip indicates

the date, the name of the depositor, the
depositor's account number and the amounts of
checks, cash, and coin being deposited. 9

Official Receipt – hard

copies of financial
transactions used by
businesses for tax and
accounting purposes. These
documents include the
vendor's name, goods sold,
purchase price, the date,
receipt number and other
pertinent information.10

Petty Cash voucher – is usually a small form that

is used to document a disbursement (payment)
from a petty cash fund. 11

9 www.investopedia.com/terms/d/deposit-sliPasp

10 www.ask.com/business.../definition-official-receipt-a7f98fb8de5c55bb
11 www.accountingcoach.com/blog/petty-cash-voucher
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Promissory Note – is a signed document containing a written promise to pay a stated sum to a specified person
or the bearer at a specified date or on demand.

BOOKS OF ACCOUNTS
There are two main books of accounts, Journal and Ledger. Journal used to record the economic transaction
chronologically. Ledger used to classify economic activities according to nature.

Purchases Journal
Books of Accounts

General Journal

Journal Sales Journal

Special Journals

Cash Receipts Journal

General Ledger
Cash Disbursements
Ledger
Journal
Subsidiary Ledger (Ex.
Subsidiary ledger for A/R

1. Journal- it is known as the “book of original entry” because it is the book where the economic transactions are first
recorded. It contains the chronological record of transactions with explanations and clear references to their
supporting documents with corresponding debits and credits.

Classifications of journals:
a. General Journal- The general journal is the master journal that all company transactions or journal entries
are recorded in. A typical general journal has at least five columns: one for the date, account titles, posting
reference, debit, and credit columns.
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Date Description Column Posting Reference Page Number

Column
GENERAL JOURNAL
Page _01___
Transaction
Date DESCRIPTION PR
Debit Credit
20x1
6/15 Cash GL-110 10,000 00
Service Income GL-620 10,000 00
To record services for cash OR#014254
6/16 Accounts Payable GL-310 2,700 50
Cash GL-110 2,700 50
To record payment to suppliers

b. Special Journals- are designed as a simple way to record the most frequently occurring transactions.

There are four types of Special Journals that are frequently used by merchandising businesses: Sales
journals, Cash receipts journals, Purchases journals, and Cash payments journals. Transactions that cannot
be recorded in the special journals are recorded in the general journal.
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2. Ledger- it is known as the “book of the final entry”. This book provides a classified record of accounts with their
respective running balances. The basic form of a ledger account is the T-account.

Kinds of ledgers:
a. General ledger – grouping of all accounts used in preparing the financial statements
GENERAL LEDGER
ACCOUNT: CASH Account No. 110

Date 20x1 ITEM PR Date ITEM PR Credit

Debit
6/1 Beg. Bal. 25,000 00 6/16 Payment to suppliers GJ-01 2,700 50
6/15 Service income for cash GJ-01 10,000 00

b. Subsidiary ledger – is a group of like accounts that contains independent data of a specific General ledger.
Whenever individualized data must be maintained for a specific general ledger account, a subsidiary ledger
is created.

GENERAL LEDGER
ACCOUNT: ACCOUNTS RECEIVABLE Account No. 120
Date
ITEM PR Debit Date ITEM PR Credit
20XX

6/1 Beg. Bal. 4,000 00

6/15 Service income GJ-01 13,500 00
6/17 Service income GJ-01 15,000 00
32,000 00

A/R - Customer A A/R - Customer B A/R - Customer C

Date Amount Date Amount Date Amount Date Amount Date Amount Date Amount
15- 19- 15-
May 2,500 May 1,500 Jun 3,000
17-
15-Jun 4,200 15-Jun 5,800 Jun 7,100
17-Jun 1,200 17-Jun 6,700 Dr.bal 10,100
Dr.bal 7,900 Dr.bal 14,000

(Subsidiary Ledgers for Accounts Receivable)

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Relationship between journals, ledgers and subsidiary ledgers

Presented below is an illustration of how transactions in the journals (ex. purchases journal) are being recorded in
the corresponding general ledgers and subsidiary ledgers.