3 - THE ACCOUNTING PROCESS

CONTENT:
1. Definition of business transactions and source documents
2. The accounting equation
3. The accounting cycle
4. Typical account titles used
5. Rules of debit and credit and their applications
6. Journalizing

BUSINESS TRANSACTIONS
This is an accountable event or economic event which has an effect on assets, liabilities and equity of the
business entity.

This means that there are transactions or events which do not affect the elements of financial statements,
and are therefore not recorded. It can be recalled from the recognition principles that elements must at least
be measurable and have probable impact on business resources, obligations, and performance.

Each business transaction is identified, analyzed, measured, summarized and communicated to the data
users, all in accordance with the generally accepted accounting principles. Business transactions may be
1. Internal – only the business is involved in the business transaction
2. External – the parties involved are the business and a third party

Internal
Party involved Example of transactions
The business only The building was destroyed by fire
The business only Yearly Depreciation expense for the company’s
equipment was charged

External
Third party involved Example of transactions
Another business entity The business bought one ream of bond paper
from PASSERSBUY for P150
The owner The owner, Juan dela Cruz, invested additional
cash of P25,000 into the business
The creditor The business borrowed cash from LANDBANK to
finance business expansion, P200,000
The Government The business paid for business permits and
licenses, P2,500
The employees The business paid for salaries worth P12,000
The customers The business rendered service to a customer and
received cash of P3,500
*Note that parties that would be considered internal under a different discipline like the owner and the employees are
considered external parties since the business is treated as a separate being from its stakeholders under the
accounting entity assumption.

SOURCE DOCUMENTS
To meet the quality of objectivity, each transaction must be supported by a document. The document must
be properly compiled and controlled for easy reference. Where a good system of record keeping exists,
financial information becomes more reliable for it can easily be traced back to the source documents.

 Original documents are considered better source documents than duplicated or copies
  Source documents coming from independent outside parties are considered neutral and more
objective evidence of transactions than those documents coming from within the business entity
 Documents coming from within the business entity are to be recorded only when approved for
recording by authorized officer or officers of the business

Examples of Source Documents

1. Official receipt (OR)
This supports cash payments if the OR is
issued by other entities or it support cash
receipts when the OR is issued by the
business.

2. Charge Sales Invoice (CSI)

This supports purchases on account when
issued by other entities. When the CSI is
issued by the business, it supports sales on
account.

3. IOUs
This supports advances made by employees.

4. Promissory notes (PN)

This supports receivables from customers, if
the PN is issued by the customer. This
supports liability to a creditor, when the PN is issued by the business.

5. Statement of Account (SOA)

This supports liability to a creditor for purchases of goods or services on account, or to a service
provider like FICELCO and VIWAD.

6. Cash Sales Invoice (CI)

This supports cash purchases when issued by other
entities. When the CI is issued by the business, it supports
cash sales.

7. Delivery Receipt (DR)

This supports delivery of goods to customers.

8. Bank passbook, bank statements, validated deposit slips

and withdrawals
They support information about cash in bank.

9. Payroll sheet
Prepared to support payment of salaries of employees.

10. Registration papers

These support ownership of PPE like transport vehicles,
land, building. They also support payment of permits and
licenses.

The Accounting Process:

1. Identification – those events that is financial in nature that should be recognized and
recorded.
 2. Recording – transactions may be recorded manually, with the use of mechanical
devices, or with the use of computers.
3. Classifying – is the grouping of similar items together in order to make the recording of
many different events and transactions more efficient.
4. Summarizing – is the stating of groups of data in concise form
5. Interpretation – provides explanation and develops relationships that give meaning to the
information.

THE ACCOUNTING EQUATION

The relationship between the three basic accounting elements of the balance sheet – Assets,
Liabilities, and Owner’s Equity – can be expressed in the form of a simple equation known as the
Accounting Equation. All accounting information is recorded within the framework of the
Accounting Equation. This equation is

Assets = Liabilities + Owner’s Equity

P500,000 = P200,000 + P300,000 *assumed figures

Assets – are the resources owned by the business that will provide future benefits
Liabilities – are the rights of creditors that represent the debt of the business
Owner’s equity – are the rights of the owners in the business. This is the amount by which the
business assets exceed
business liabilities. The statement of changes in equity shows another way of computing capital:
Capital = beginning capital + additional investment + net income (–net loss) –
withdrawal
Derived formula
Net income (loss) = total revenues – total expenses and losses
Liabilities = assets – capital If,
Capital = assets – liabilities Total revenues > total expense = net income
Net assets = assets – liabilities Total expenses > total revenues = net loss
Net assets = capital

Who to pay How much to pay When to pay

Creditor Amount borrowed + interest Determinable future time
Owner Remaining assets after On termination of business
payment to the creditor* operation
*remaining assets may be equal, more, or less than the capital invested. If remaining assets are less than capital
invested, investors have incurred a loss. Needless to say, if there are no more assets remaining but there is still an
outstanding balance for liabilities the owners have incurred a loss equal to the amount of liabilities remaining .

The accounting equation must always balance. The peso amount on the left side of the equation
should always equal to the peso amount on the right side. If the assets decrease, liabilities and/or
equity must also decrease. An increase in an asset may also correspond to a decrease in another
asset, or an increase in a liability may also have a corresponding decrease in another liability.

Business transactions – economic events or condition that directly changes an entity’s financial
condition or directly affects its results of operations. An accounting transaction takes place when
a business exchanges a thing or things of value for another. In short, the business

Debit/s Credit/s
Value/s received = Value/s given up
Transactions are always looked upon from the business point of view, which is separate and
distinct from the owner’s point of view. This refers to the principle of Entity Concept. All business
transactions can be stated in terms of changes in the three elements of the accounting equation.

DOUBLE-ENTRY ACCOUNTING – is a record keeping system in which each business

transaction affects at least two accounts.
Account – is the record used to classify and store information about increases and decreases in
an item.
The T-Account – is so called because of its shape. It is used to show the increase or decrease in
an account caused by a transaction. It is a more efficient and convenient tool used by accountants
to analyze the parts of a transaction.

Account title
Top
Left side Right side Debit Credit

Rules of debit and credit – debits and credits are used to record the In other words,
increases and decreases in each account affected by a business
transaction. The rules of debit and credit vary according to whether
DEBIT:
an account is classified as an asset, liability, or an owner’s equity
 Increase in asset
account.
 Decrease in liability
Rules for asset accounts:  Decrease in capital
o Withdrawals
1. An asset account is increased on the debit side o Expenses and losses
2. An asset account is decreased on the credit side
3. The normal balance for an asset is a debit balance. CREDIT:
 Decrease in asset
Rules for Liability and Owner’s equity
 Increase in liability
1. The liability and capital accounts are increased on the credit
 Increase in capital
side. o Investment
2. The liability and capital accounts are decreased on the debit o Income and gains
side.
3. The normal balance for the liability and capital accounts is a
credit balance.
ILLUSTRATIVE PROBLEM
The following are transactions of Wahclass Boarding House for the month of May 2020, its first
month of operation:
DATE Type of
BUSINESS TRANSACTION Parties involved
2020 activity
May
Miss Wah invested the following: The business and the owner Financing
Cash, P150,000; Lot, P265,000 and
1
her house, P450,000 in her new
business venture, a boarding house
Cost of construction of 10 rooms, The business and the Investing
15 additional kitchen and toilets paid in contractor
cash, P108,000
Purchased tables and chairs from The business and the trade Investing
22 CATANDUANES BAZAAR, creditor (CATANDUANES
P12,500. Terms: on account. BAZAAR)
Business permit paid, P1,500 The business and the Operating
23
government
Thirty students applied as bed The business and the Not yet an
spacer. Two students will be customers (the students) accountable
25 accepted per room. Rent is P1,500 event
per student per month inclusive of
electricity and water costs
Twenty students were accepted to The business and the Not yet an
start on June 1. Bed spacers are customers (the students) accountable
28 required to pay rent in advance event
equivalent to one month every 1st
day of the month.
June
The twenty bed spacers paid their The business and the Operating
1
June rent today customers (the students)
Paid CATANDUANES BAZAAR the The business and the trade Operating
1 account in full creditor (CATANDUANES
BAZAAR)
The bill for electricity was paid The business and FICELCO Operating
25
today, P4,200
The bill for water usage was paid The business and VIWAD Operating
26
today, P1,800
Analysis of Business Transactions
2020
May 1 Miss Wah invested the following: Cash, P150,000; Lot, P265,000 and her house, P450,000
in her business venture, a boarding house

Analysis guide:

QUESTIONS ANSWERS
Who are the parties involved in the transaction? The business and the owners
Is this a business transaction? Yes, it is an external business transaction.
Did it affect the accounting elements? If so, which Yes. Two elements were affected:
elements were affected? CAPITAL is affected because of the investment by
the owners.
ASSETS were affected because the investment
was made in the form of cash, house, and lot
which are all assets.
What are the effects to the accounting elements? Total assets were increased because of the
receipt of cash, house, and lot.
Capital was also increased because an
investment is always an increase in capital.
What are the value received and value parted Increase in asset = value received or Debit
with? Increase in capital = value parted with or Credit
How much is the value received and value parted Value received (DEBIT):
with? Cash P150,000
Lot 265,000
House 450,000
Total P865,000

Value parted with (Credit):

Total investment P865,000
What are the accounts to be used to record the Assets
transaction? For cash, use CASH
For lot, use LAND
For house, use BUILDING

Investment
Use Wah, CAPITAL
How should you record the transaction in the T- Enter the value received on the left side of the
account? account, and enter the value parted with on the
right.

Cash Land
2020 2020
May 1 150,000 May 1 265,000

Wah, Capital Building

2020 2020
May 1 865,000 May 1 450,000
 Cost of construction of 10 rooms, additional kitchen and The business and the Investing
15
toilets paid in cash, P108,000 contractor

Cash Building
2020 2020
May 1 150,000 May 15 108,000 May 1 450,000
15 108,000

Purchased tables and chairs from CATANDUANES The business and the Investing
22
BAZAAR, P12,500. Terms: on account. trade creditor

Furniture and Fixtures Accounts Payable

2020 2020
May 22 12,500 May 22 12,500

23 Business permit paid, P1,500 The business and the government Operating

Cash Taxes and Licenses

2020 2020
May 1 150,000 May 15 108,000 May 23 1,500
23 1,500

Thirty students applied as bed spacer. The business and the customers Not yet an
Two students will be accepted per room. (the students) accountable
25
Rent is P1,500 per student per month event
inclusive of electricity and water costs

Analysis:
This is not an accountable event. No accounting element has been affected yet. No value has been
received by the business from the business, nor has any value been parted with.

Twenty students were accepted to start The business and the customers Not yet an
on June 1. Bed spacers are required to (the students) accountable
28
pay rent in advance equivalent to one event
month every 1st day of the month.

Analysis:
This is not an accountable event. No accounting element has been affected yet. No value has been
received by the business from the business, nor has any value been parted with.
June
The twenty bed spacers paid their June The business and the customers Operating
1
rent today (the students)

Cash Rent income

2020 2020 2020
May 1 150,000 May 15 108,000 June 1 30,000
June 1 30,000 23 1,500

Paid CATANDUANES BAZAAR the The business and the trade creditor Operating
1
account in full (CATANDUANES BAZAAR)

Cash Accounts Payable

2020 2020 2020 2020
May 1 150,000 May 15 108,000 June 1 12,500 May 22 12,500
23
June 1 30,000 1,500
June 1
12,500

The bill for electricity was paid today, The business and FICELCO Operating
25
P4,200

Cash Utilities
2020 2020 2020
May 1 150,000 May 15 108,000 June 25 4,200
June 1 30,000 23 1,500
June 1 12,500
25 4,200

The bill for water usage was paid The business and VIWAD Operating
26
today, P1,800

Cash Utilities
2020 2020 2020
May 1 150,000 May 15 108,000 June 25 4,200
June 1 30,000 23 1,500 28 1,800
June 1 12,500
25 4,200
28 1,800
In summary, the general ledger (a group of accounts or T-accounts) will show the following at
the end of June 2020:

WAH BOARDING HOUSE

General Ledger
June 30, 2020

ASSETS: LIABILITIES: CAPITAL:

Cash Accounts Payable Wah, Capital
2020 2020 2020 2020
May 1 150,000 May 15 108,000 June 1 2,500 May 22 12,500 May 1 865,000
June 1 30,000 23 1,500 0
June 1 12,500
25 4,200
28 1,800
180,000 128,000
52,000

Land Rent income

2020 2020
May 1 265,000 June 1 30,000

Furniture and Fixtures Utilities

2020 2020
May 22 12,500 June 25 4,200

Building Taxes and Licenses

2020 2020
May 1 450,000 May 23 1,500
15 108,000
558,000

To facilitate the preparation of financial statements, a “Trial Balance” (this is a working paper,
not a financial statement) is prepared to prove the equality of debits and credits

WAH BOARDING HOUSE

Trial Balance
June 30, 2020

Cash ₱52,000
Land 265,000
Furniture and fixtures 12,500
Building 558,000
Wah, capital ₱865,000
Rent income 30,000
Utilities 6,000
Taxes and licenses 1,500
₱895,000 ₱895,000
TRIAL BALANCE – is a listing of all the asset, liability, capital, revenue, and expense account
balances at one point in time. All debits are summed, as are all credits, to ensure that total
debits equal total credits. Testing for the equality of total debits and credits is one way of finding
out whether you have made any errors in recording transaction amounts.

Purpose of the trial balance:

1. It indicates if the ledger is in balance by showing whether the total accounts with debit
balances equals the total accounts with credit balances.
2. It aids in locating errors.
3. It assists in the preparation of financial statements.

RECORDING BUSINESS TRANSACTIONS

Accounting Cycle – is the complete series of steps used to account for a business’ financial
transactions during a fiscal period. These are the steps:
1. Analysis of business transactions
Examples of source documents:
2. Journalizing
3. Posting to the ledger accounts 1. Invoices (purchases and sales)
4. Preparing the trial balance 2. Receipts
5. Preparing adjusting entries 3. Memorandum
6. Completing the worksheet 4. Deposit slip
7. Preparing the financial statements 5. Check stubs
8. Journalizing and posting closing entries 6. Cash register tapes
9. Preparing the post-closing trial balance 7. Payroll time cards

BUSINESS TRANSACTION FLOW

source journal ledger financial

trial balance
documents entries accounts statements

Source Documents – papers prepared as evidence to support business transactions. The type
of document depends on the nature of the transaction.
The Journal – book of original entry. It is the book where all transactions are initially recorded in
a chronological order of the day to day transactions. The process of recording transactions in a
journal is called journalizing.
The Ledger – is a book of final entry. It is a book or file with the business entire collection of
account records also referred to as general ledger.
The Trial Balance – is a listing of all the accounts in the general ledger and the sum of the debit
and credit amounts of their balances.

CHART OF ACCOUNTS – is a list of all accounts and their account (code) numbers used for
journalizing business transactions.

Order of the accounts – the accounts are normally listed in the order in which they appear in the
financial statements. The balance sheet accounts first, in the order of assets, liabilities and
owner’s equity. The income statement accounts are then listed in the order of revenues and
expenses.
Numbering of accounts – an account number identifies the account. Account numbers may
have two, three, four, or more digits. The number of digits used varies with the needs of the
business. The first digit 1 will represent Assets; 2 will represent Liabilities; 3 will represent Owner’s
Equity; 4 will represent Revenues; and 5 will represent Expenses. The second digit indicates the
location of the account within its class.

Example for CHART OF ACCOUNTS:

Giselle Dela Cruz, a lawyer, decided to open a law firm named Dela Cruz Law Firm. The partial
chart of accounts listed below is used:

Balance Sheet accounts Income Statement accounts

1 – Assets 4 – Revenues
11 – Cash 41 – Fees Earned
12 – Accounts Receivable
18 – Furniture and Equipment
5 – Expenses
51 – Salary Expense
2 – Liabilities
54 – Utilities Expense
21 – Accounts Payable
24 – Loan Payable 55 – Communication Expense
59 – Miscellaneous Expense
3 – Owner’s Equity
31 – Dela Cruz, Capital
32 – Dela Cruz, Drawing

TRIAL BALANCE – a statement not required by the standards, but only facilitates the
preparation of the financial statements.

A trial balance in which debits equals credits is not necessarily error-free. A trial balance may
contain errors but still look correct if:
1. No entry was made for a given transaction.
2. An entry was posted twice.
3. An amount was journalized or posted to the wrong account.
4. An incorrect amount was recorded for a given transaction.

Transposition Error – occurs when digits are incorrectly arranged. Example: P864 is written or
posted as P684 or P468.

Slide Error – occurs when the decimal point is put in the wrong place. Example: P684 is written
as P68.40 or P6.84.

Procedures to Correct Errors in Journalizing and Posting:

1. Draw a straight horizontal line through the error and insert the correct title or amount if
the entry is incorrect or the posting is incorrect.
2. Make a correcting entry and post it to correct wrong entry already posted.

Correcting Entry – an entry made to correct an error in a journal entry discovered after posting.

What do you call a trial balance that doesn’t balance? A late night.