The Accounting Equation and the Double Entr ACCOUNTING FOR BUSINESS TRANSACTIONS Accountants observe many events that they identify and measure in financial terms. A business transaction is the occurrence of an event or a condition that affects financial position and can be reliably recorded. Financial Transaction Worksheet Every financial transaction can be analyzed or expressed in terms of its effects on the accounting equation. The financial transactions will be analyzed by means of a financial transaction worksheet which is a form used to analyze increases and decreases in the assets, liabilities or owner's equity of a business entity. Mlustration. Edgar Detoya decided to establish a sole proprietorship business and named it as Detoya Graphics Design. Detoya is a graphic designer who has extensive experience in drawing, layout, typography, lettering, diagramming and photography. He possesses the talent to visually communicate to a target audience with the right combination of words, images and ideas. Detoya Graphics Design can do the layout and production design of newspapers, magazines, corporate reports, journals and other publications. The entity can create promotional displays; marketing brochures for services and products; packaging design for products; and distinctive logos for businesses. He also enters into agreements with clients for the progressive development and maintenance of their web sites. His initial revenue stream comes from web designing. The owner, Edgar Detoya, makes the business decisions. The assets of the company belong to Detoya and all obligations of the business are his responsibility. Any income that the entity earns belongs solely to Detoya, When a specific asset, liability or owner's equity item is created by a financial transaction, it is listed in the financial transaction worksheet using the appropriate accounts. The worksheet that follows shows the first transaction of the Detoya Graphics Design. The dates are enclosed in parentheses. During March 2014, the first month of operations, various financial transactions took place. These transactions are described and analyzed as follows: Mar.1 —Detoya started his new business by depositing P350,000 in a bank account in the name of Detoya Graphics Design at BP! Poblacion Branch.Detoya Gral Financial Trans Month of action March 2014 + Owner’s Equity Assets Detoya, Capital cash : £350,000 () 350,000 “ 7 jon is analyzed as follows: aa The financial transaction is analy: val financial affairs is created, + Anentity separate and distinct from Detoya’s person? the business entity. The + An economic resource—cash of P350,000 is invested in which represents source of this asset is the contribution made by the own 2 owner's equity. The owner's equity account is Detoya, Capital. os eau + The dual nature of the transaction is that cash is invested and owner's equity created. The effects on the accounting equation are as follows: increase in asset— cash from zero to P350,000 and increase in owner's equity from zero fo P350,000, + Atthis point, the entity has no liabilities, and assets equal owner's equity. Mar.5 Computer equipment costing P145,000 is acquired on cash basis. The effect of the transaction on the basic equation is: Assets = Liabilities + Owner's Equity cash + Computer = Detoya, Capital Equipment Bal. P350,000 * (s) (145,000) P145,000 = pees Bal. — P205,000 + ? = ae =a - . P350,000 This transaction did not change the total assets but it did change the composition of the position of assets—it decreased one asset—cash and. ine reas, equipment by P145,000. Note that the sums of the balan eee eS on equation are equal. This equality must always exist. both sides of the Mar. 9 Assets = Uabilities + Cash + Computer + Computer ro Owner's Equity plies Equipment unts 1 Payabi Detoya, Capital Bal. 205,000 145,009 le (9) 25,000 ai Bal. 7205000. + “925,000 + FRE 225,000 ie See S000 P P: 25,004 —_— ——8BE.000 ae v 350,000, E00The Accounting Equation and the Double Entry System | 3-19 oe OE ‘Assets don’t have to be purchased in cash. It can also be purchased on credit. Acquiring the computer supplies with a 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 computer supplies and the liability created is an accounts payable. Mar.11 Detoya Graphics Design collected P88,000 in cash for designing interactive web sites for two exporters based inside the Naga Ecozone. Assets = abilities + Owner's Equity Cash + Computer + Computer = Accounts + —_—Detoya, Capital Supplies Equipment Payable Bal. 205,000 25,000 145,000, P25,000, 350,000 (a1) 88,000 88,000 Bal. _293,000_ + P25000_ + __P145,000 725000. + 736,000 463,000 463,000 The entity earned service income by designing web sites for clients. Detoya 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 owner’s equity. Income increases owner's equity. This transaction caused the business to grow, as shown by the increase in total assets from P375,000 to P463,000. Mar. 16 Detoya paid P18,000 to Bills Express, a one-stop bills payment service company, for the semi-monthly utilities. : Assets = Liabilities + + Owner's Equity cash + Computer + Computer = Accounts +_—Dettoya, Capital Supplies Equipment Payable Bal. 293,000 25,000 145,000, 25,000 438,000 (16) __ (18,000) (18,000) Bal. — 275,000 + 25,000 + P1850. = P25,000_ + 420,000, 445,000_ = Pa45,000 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 March. It represented an outflow of resources and a reduction of owner's equity. Expenses have the opposite effect of income; they cause the business to shrink as shown by the smaller amount of total assets of P445,000. Mar. 17 The entity has service agreements with several Netpreneurs to maintain and update their web sites weekly. Detoya billed these clients P35,000 for services already rendered during the month.A Cash + Accounts. + Computer Receivable Supplies Bal. 275,000 25,000 (a7) 35,000 Bal. _ P275,000_ + _P35,000_ + __P25,000 ‘computer Equipment + 145,000 a + P145,000 L Accounts Payable 25,000 —— a 25,000 ——— 480,000, + + + OF Detoya, Capital 420,009 35,000 PASS ee 480,000_ = SS | i | e recogni | The entity has pérformed services to clients so income should already © aeredianay Detoya is entitled to receive payment for these but the clients dle NOt PEL a Performing the services creates an economic resource, the clients, Pl t h amount which is called accounts receivable. This transaction resulted to an increase in an asset—accounts receivable and an increase in owner's equity of P35,000. | Mar. 19 Detoya made a partial payment of P17,000 for.the Mar. 9 purchase on account. rN = L + OE Cash + Accounts. + Computer + Computer = Accounts + " Detoya, Receivable Supplies Equipment Payable Capital Bal. 275,000 35,000 25,000 P145,000 = 25,000 455,000 (19) __(17,000) = _.(17,000) Bal. __P258,000_ + 35,000 + P2500 + Pi45000_ = P8000 + _PAS5000 463,000 = ~ p463,000 This transaction is a payment on account. The effect on the accounting equation is a decrease in the asset—cash and a decrease in the liability—accounts payable, The payment of cash on account has no effect on the asset—computer supplies because the payment does not increase or decrease the supplies available to the business, Mar. 20 Checks totaling P25,000 were received from clients for billings dated Mar. 17 A : . = L + OE | Cash + Accounts. + Computer + Computer | Receivable Supplies Equipment” ‘panunts_ + Detoys . le Bal. P258,000 35,009 25,000 145,000 co (20) 25,000 (25,000) = P8,000 pA55,000 Bal. __P283,000 + __P25,000" + —paas,0007 ar . page .000_ + 5000 Pa63.000 2e0 Pa55, | ; ee 2863.00 Last Mar. 17, Detoya billed clients for services alrea was able to collect P25,000 from them. The asset business should not record service income on Mar, dy rendered, ©, cash is incre 20 since it ha N Mar. 20, theventitY ‘sed -by P25,000. The 's already recorded theThe Accounting uation and the Double Entry System | 3-21 income last Mar. 17. Total assets are unchanged. The business merely reduced one asset—accounts receivable and increased another—cash. Mar. 21 Detoya withdrew P20,000 from the business for his personal use. A = L + OE Cash + Accounts + Computer + Computer = Accounts + —Detoya, Receivable Supplies Equipment Payable Capital Bal. P283,000 10,000 25,000, 145,000 8,000 455,000 (21) __ (20,000) (20,000) Bal, __P263,000_ + P10,000_ + _P25,000_ + __p145,000 P8,000_ + P435,000 P443,000_ = __P443,000, 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 Mar. 1, Detoya invested 350,000; both cash and owner’s equity increased. The transaction was an investment by the owner and not an income-generating activity. Detoya simply transferred funds from his personal account to the business. A cash withdrawal is exactly the opposite. The P20,000 cash withdrawal transaction resulted to a reduction in both cash’ and owner's equity. Mar. 27 Edman Flores Publishing submitted a bill to Detoya for P8,000 worth of newspaper advertisements for this month. Detoya will pay this bill next month. A L + OE Cash + Accounts + Computer + Computer = Accounts + Detoya, Receivable Supplies Equipment Payable Capital Bal. P263,000 10,000 25,000 145,000 P 8,000 435,000 (27) 8,000, (8,000) Bal, _ P263,000_ + _P10,000 + P25,000_ + P145,000 P16,000_ + __P427,000 443,000, 443,000 Edman Flores rendered services on account, Detoya Graphics Design has incurred an expense in the amount of P8,000 by availing of Edman Flores’ services. There was Pe payment during the month, This advertising expense resulted to a decrease in owner's equity and an increase in the liability—accounts payable. Mar. 31 Detoya paid his assistant designer salaries of P15,000 for the month.2_| Basic Accounting -e kl +) OF A 7 = Accounts + Detoya, + computer = ca Cash + Accounts regiment Payable ae Receivable = P16,000 427,009 til rassa00 ——ragom spo PSY sg a = PB. 000 (28) _se00) oo. = SOO + Poor Bal. 248,000" + P10}000_ + 725.000 + _ R= | 428,000 ae 228,000 ity as well as a reduction in cash i a i r's e This transaction resulted to a reduction in owner's Uy 05 ee ted fr By providing his services to Detoya for the month, the the business an expense—salaries expense. Use of T-Accounts Analyzing and recording transactions using the accounting equation is useful in conveying a basic understanding of how transactions affect the business. However, it is not an efficient approach once the number of accounts involved increases. Double. entry system provides a formal system of classification and recording, business transactions. Mlustration. The rules of debit and credit will be applied to the Detoya Graphics Design illustration for comparison. Three transactions will be added to the example. Before being recorded, a transaction must be analyzed to determine which accounts must be increased or decreased. After this has been determined, the rules of debit and credit are applied to effect the appropriate increases and decreases to the accounts. Mar.1 _ Detoya started his new business by depositing P350,000 in a bank account in the name of Detoja Graphics Design at BP| Poblacion Branch, Assets (Increase) = Owner’s Equity (Increase) Cash Detoya, Capital Debit Credit Debit i () a 0) ail B41 350,000 3. 1 350,000 This transaction increased both the asset—ca: 1 rules of debit and credit, an increase in asset see nes EAuity. According to the owner's equity is recorded as credit; thus, th Detoya, Capital. The transaction dates are place reference. Mar.2 Computer equipment is acquired bThe Accounting Equation and the Double Entry System | 3-23 Assets (Increase) ® Liabilities (Increase) Computer Equipment Notes Payable Debit Credit Credit (+) O i) 32 50,000 32 50,000 The transaction increased by 50,000 the asset—computer equipment and the liability—notes payable. Computer equipment must be debited and notes payable must be credited. Mar.3 — Detoya paid P15,000 to Grande Suites for rent on the office studio for the months of March, April and May. Assets (Decrease) = Assets (Increase) Cash Prepaid Rent Debit Credit Debit + Credit (+) O () 0 3-1 350,000 | 3-3 15,000 33 15,000 The entity paid advance rent for three months. A resource having future economic benefit—prepaid rent, is acquired for a cash payment of P15,000. Increases in assets are recorded by debits and decreases in assets are recorded by credits. The transaction resulted to a debit to prepaid rent and a credit to cash for P15,000. The prepaid rent is consumed based on the passage of time so that after one month, P5,000 of the prepaid rent will be transferred to the rent.expense account. Mar.4 Received advance payment of P18,000 from Marco Polo Naga Hotel for web site updating for the next three months. Assets (Increase) = Liabilities (Increase) Cash Unearned Revenues Debit Credit Debit “Credit (+) 0 W (4) 3-1 350,000 | 3-3 15,000 34 18,000 34 18,000 The entity has an obligation to Marco Polo Naga Hotel for the next three months. This liability is called unearned revenues. The asset—cash is increased by a debit of P18,000 and the liability—unearned revenues is increased by a credit of P18,000. As it renders service, the entity discharges its obligation at a rate of P6,000 per month for the next three months.24 | Basic Accounting aired cash ba: Mar.$ — Computer equipment costing P2145) ‘assets (increase) mputer Equipment Credit 0 Assets (Decrease) co Cash pebit Debit credit () “) 0 50,000 Ba 350,000 | 3-3 15,000 2 145,000 3 18,000 | 3-5 145,000 ment and decreased the asset— computer equi thus, computer ts and decrease xd for P145,000. This transaction increased the ase d by credits; cash. Assets are increased by debi equipment is debited and cash is credite ount of P25,000 are purchase Liabilities (Increase) d on account. Mar.9 Computer supplies in the am: Assets (Increase) Accounts Payable Debit Credit Debit Credit ic) (+) +) O 39 25,000 3.9 25,000 Computer Supplies The asset—computer supplies is increased by a debit of P25,000 while the liability account—accounts payable is increased by a credit for the same amount. Mar. 11 Detoya Graphics Design collected P88,000 in cash for designing web sites. Assets (Increase) * ‘Owner's Equity (Increase) Cash Design Revenues Debit Credit Debit Credit “) 0 oO “) 3-1 350,000 | 3.3 15,000 2 34 18,000 | 3-5 145,000 co oe 341 88,000 The transaction increased the asset—cash and increased the j Tevenues. Assets are increased by debits, income are increanrr® account —design debit of PB8,000 to cash and credit of P88,000 to design revcs ese edits; hence, @ in income increase owner's equity, Fevenues is made, Increases Mar. 16 Detoya paid P18,000 to Bills Express fo the semi-moy nthly utiliti ies.The Accounting Equation and the Double Entry System | 3-25 SSE Assets (Decrease) ‘Owner's Equity (Decrease) Cash Utilities Expense Debit Credit Debit Credit (+) QO () Q 34 350,000 | 3-3 * 15,000 3-16 18,000 34 18,000 | 3-5 145,000 311 88,000 | 3-16 118,000 Expenses are increased by debits and assets are decreased by credits; therefore, utilities expense is debited and cash credited for P18,000. Increases in expenses decrease ‘owner's equity. Mar. 17 Detoya billed clients P35,000 for services already rendered during the month. Assets (Increase) . ‘Owner's Equity (Increase) Accounts Receivable Design Revenues Debit Credit : Debit Credit iS) 0 ) (+) 347 35,000 3-41" 88,000 317 35,000 Assets are increased by debits, income are increased by credits. Increases in income increase owner's equity. A debit of P35,000 to accounts receivable and a credit of P35,000 to the income account—design revenues is needed. Mar. 19 Detoya partially paid P17,000 for the Mar. 9 purchase of computer supplies. Assets (Decrease) = lial ies (Decrease) Cash Accounts Payable Debit Credit Debit Credit . (+) O 0 (+) 34 350,000 | 3-3 15,000 3-19 17,000 | 3-9 25,000 3-4 18,000 | 3-5 145,000 3-11 88,000 | 3-16 18,000 3-19 17,000 Assets are decreased by credits while liabilities are decreased by debits. The transaction is recorded by debiting accounts payable and crediting cash for P17,000 each.3:26 | Basic Accounting ings dated Mar. 17, m clients for Mar. 20 Received checks totaling P25,000 fro assets (Decrease) eceivable credit 0 Assets (Increase) Accounts Re Cash Debit Credit (+) 0 25,000 34 350,000 | 3-3 15,000 34 18,000 | 3-5 145,000 3-1 88,000 | 3-16 18,000 3-20 25,000 | 3-19 17,000 ivable but increased the Collections on account reduced the asset—accounts re by credits; thus, a debit to asset—cash. Assets are increased by debits and decrease‘ ry 5 is made. cash for P25,000 and a credit to accounts receivable for P25,000 is m: Mar. 21 Detoya withdrew P20,000 from the business for his personal use. = ‘Owner's Equity (Decrease) Assets (Decrease) = Cash Detoya, Withdrawals Debit Credit Debit Credit (+) oO (+) 0 3-1 350,000 | 3.3, 15,000 3-21 20,000 34 38,000 | 3-5 145,000 3-11 88,000] 3-16 —18,000 - 3:20 25,000 3-19 17,000 321 20,000 Withdrawals are reductions of owner's equity A withdrawal is a personal transaction entity. of an investment: 'Y but are not expenses of the business of the owner that is exactly the opposite This transaction increased the withdrawals account but reduced cash. Debits record increases in the withdrawals account and credits record decreases in asset 2 Sam iccounts; thus, a debit to withdrawals and a credit to cash for P20,009 ead Mar. 27. Edman Flores billed Detoya for P8,000 ads, Deto, Liabilities (Increase) Accounts Payable 3-19 his necessary. 'va will pay next month. Owner's Equity (Decrease) . Advertising Expense Credit ()The Accounting Equation and the Double Entry System | 3-27 This transaction increased the expense—advertising expense and increased the liability—accounts payable by P8,000. Expenses are increased by debits while liabilities are increased by credits; hence, an entry to debit advertising expense and to credit accounts payable for P8,000 is needed. Mar. 31 Detoya paid his assistant designer salaries of P15,000 for the month. Assets (Decrease) = Owner's Equity (Decrease) Cash Salaries Expense Debit Credit Debit Credit a) 0 ) O 34 350,000 | 3-3 15,000 331 15,000 34 18,000 | 3-5 145,000 341 88,000 | 3-16 18,000 3-20 25,000 | 3-19 17,000 321 20,000 3-31 15,000 Expenses are increased by debits and assets are decreased by credits. Hence, salaries expense is debited for P15,000 and cash credited for the same amount. Increases in salaries expense decrease owner's equity. DISTINCTION BETWEEN REVENUES AND RECEIPTS At this point, it will be useful to learn the distinction between revenues and receipts as illustrated in the following table. The table shows various types of sales transactions and classifies the effect of each on cash receipts and sales revenues for “this year”: This Year Transaction ‘Amount Cash Sales Receipts Revenue 1. Cash sales made this year. 200,000 . P200,000 200,000 2, Credit sales made last year; 300,000 300,000 o ‘cash received this year. 3, Credit sales made this year; 400,000 400,000 «400,000 ‘cash received this year. 4, Credit sales made this year; 100,000 2 100,000 ‘cash to be received next year. Total 900,000 ___P700,000