ANALYSES OF TRANSACTIONS AND RULES OF DEBIT AND CREDIT

DEFINITION OF 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 follows:

“It is the process of identifying, measuring and communicating economic information to permit
informed judgments and decisions by users of the information.”

The time-honored and widely accepted definition of accounting is the one formulated by the Committee
on Accounting Terminology of the American of Institute of Certified Public Accountants (AICPA) which
is the largest organization of practicing accountants made the definition of accounting as follows:

“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.”

All of the above definitions touch the most touch the most important points of Accounting as:

1. Accounting is about quantitative information

2. The information is of financial character
3. Usefulness of information in decision making

The definition made by the Committee on Accounting Terminology of the AICPA stands the test of time
and still holds true because it is tailored to fit exactly the elaboration of the steps of accounting process.
The definition mentions the four (4) phases of accounting which are recording, classifying, summarizing
and interpreting. These are being outlined below:

Recording- this is the phase of accounting which involves the routine and mechanical process of writing
down the business transactions and events in the books of account in a chronological manner called
Journalizing.

Before business transactions and events could be recorded, firstly, the documents should be identified,
analyzed and measured. By identifying, we mean, there should be a basis of determining whether such
were business transactions and events or not. As a rule, only transactions and events with financial
bearing to the business are recognized. By analyzing, we mean that there should be a “dual effect”,
normally the value received and the value parted with of the transactions. By measuring, we mean the
assigning of monetary values involved in a transaction. In the Philippines, we used the peso as the
common financial denominator.

Classifying- this is the phase of accounting which involves sorting and 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- this 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- this is the phase of accounting which involves the “analytical and interpretative works.” It
is then, that when financial statements are analyzed, interpreted and is 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 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 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 arrive 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.”

BUSINESS TRANSACTIONS AND EVENTS

Not all business activities are “accountable”. 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 which are classified into two (2)
categories namely,

1. External Transactions- these involve exchanges of economic resources by a business enterprise

with another business enterprise. Examples are selling of services and commodities to
customers, payment of store or office rents, etc.

2. Internal Transactions- these are transactions or events that happened or take place within the
business enterprise only. Examples are conversion of raw materials into finished product,
unanticipated loss from fire and flood, etc.

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

Debit, Value Received = Credit, Value Parted With

ANALYSIS OF BUSINESS TRANSACTIONS

Business transactions are analyzed 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. 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 have a series of dry run or drill. Below are
few illustrations.

Bought a car for cash, P1, 000, 000.

The following questions are answered for your guide:

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 changes?

Answer: P1, 000, 000 Measuring

We then say,

Debit, value received Car P1, 000, 000

Credit, value parted with Cash P 1, 000, 000 Journalizing

Sold a car for cash, P600, 000.

The following questions are answered for 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 changes?

Answer: P600, 000 Measuring

We then say,

Debit, value received Cash P 600, 000

Credit, value parted with Car P 600, 000 Journalizing
AN EXTENDED ILLUSTRATION ON TRANSACTION ANALYSIS

The following transactions with corresponding analysis 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 P 600, 000.

Analysis: In this transaction, the value we received is a form of an Asset which is the delivery of the 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 P 600, 000

Credit, Asset- Cash P 600, 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- Cebu, P 35, 000.

Analysis: In this transaction, the value we received is a form of an Asset which is Laundry Supplies and
the vale 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, 0000

Credit, Liability- Accounts Payable P 35, 000

Transaction 4- Paid our account with SM City- Cebu P 35, 000.

Analysis: In this transaction, we will get back our

out “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, 0000

Credit, Asset- Cash P 35, 000

Transaction 5- Bought an office table on account from Home and Fashion, 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
thus Office Furniture and 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
Transactions 6- Paid our account with Home and Fashion, P 25, 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 a Liability, which is our promise to pay,
we call this Notes Payable and 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 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 service to a customer, P12, 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 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 the 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 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, P 16, 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 to 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. Rudy Gutierrez 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. Gutierrez to safeguard the amount
of capital he puts into the business, we call this Owner’s Equity.

We then say,

Debit, Asset- Cash P 1, 000, 000

Credit, Owner’s Equity- Gutierrez, Capital P 1, 000, 000

Transaction 13- Mr. Rudy Gutierrez withdraws cash of P 25, 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- Gutierrez, Drawing (Personal) P 25, 000

Credit, Asset- Cash P 25, 000

Transaction 14- Paid salaries to employees for the month, P20, 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- Salaries Expense P 20, 000

Credit, Asset- Cash P 20, 000

THE THEORY OF DEBIT AND CREDIT

The term debit means “left” and credit means “right”. This refers to an equation where the left side is
equal to the right side. If the left weighs 60 pounds, correspondingly the right also weighs 60 pounds.
There could be no instance that the left side weighs heavier or lighter than the right and vice versa. The
final rule is that, the “left will always equal to the right.”

When transactions are being recorded, there also developed a related Equation as:

DEBIT = CREDIT

(The amount entered on the debit side of an item’s account will always have a corresponding amount
entered on the credit side of another item’s account. Hence, the amount of debit will always equal to
the amount of credit.)
To simplify, there are two basic elements of a business. These are:

1. What it OWNS
2. What it OWES

Assets are the resources owned by the business (what it owns). Equities are rights or claims against
these resources (what it owes). Hence, if put to an equation: ASSETS = EQUITIES

Equities may be further sub-divided into two categories: claim of creditors and claim of the owner. The
claim of the creditors is called Liabilities. The claim of the owner is called Owner’s Equity. Therefore,
liabilities and owner’s equity are Equities of the business which means that the assets of the business as
a separate entity can be the claim of both the outside creditors and the owner. Because the creditor’s
claim are paid before ownership claims if a business is liquidated, liabilities are shown first before the
owner’s equity.

ASSETS = LIABILITIES + OWNER’S EQUITY

This equation is referred to as the basic accounting equation. This accounting equation is applied to all
economic entities regardless of size, nature of business or forms of business organizations. This means
that:

ASSETS -the normal balance is DEBIT

LIABILITIES -the normal balance is CREDIT
OWNER’S EQUITY -the normal balance is CREDIT

The understanding of their respective normal balances is very important so that you can picture the
effect of changes on these values in terms of Pesos.

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 sides. The left- hand side which is called the debit side and the right-hand
side which is called the credit side. The left-hand or debit side shows the value received while the right-
hand or credit side shows the value parted with of a transaction analysis. The device is commonly called
T-Account because it resembles a capital letter “T”.

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 and so forth.

To illustrate:

CASH
Dr. Cr.
P 25, 000 P 10, 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 a Debit Entry. The P10, 000 that is being
entered at the right-hand side of the account is called a Credit Entry.

The words Debit and Credit came from the Latin words debere and credere. The former is abbreviated
as Dr. and the latter as Cr. 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.

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 following cases are being presented to illustrate an account balance.

Case 1: The “Cash account” is used.

CASH
Dr. Cr.
P 55, 000 P 15, 000
P10, 000 15, 000
Debit Total P65, 000 P30, 000 Credit Total
Debit Balance P35, 000

In as much as the debit total of P65, 000 exceeds the credit total of P30, 000, Cash account is said to be
in a debit balance by P35, 000. Hence, the account balance of P35, 000 was placed on the debit side of
the account.

We then say, “Cash account has a debit balance of P35, 000.”

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

ACCOUNTS PAYABLE
Dr. Cr.
P20, 000 P 50, 000
P5, 000 25, 000
Debit Total P25, 000 P75, 000 Credit Total
P50, 000 Credit Balance
In as much as the credit total of P75, 000 exceeds the debit total of P25, 000, the Accounts Payable
account is said to be in a credit balance by P50, 000. Hence, the account balance of P50, 000 was placed
on the credit side of the account.

We then say, “Accounts Payable account has a credit balance of P50, 000.

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

ACCOUNTS RECEIVABLE
Dr. Cr.
P20, 000 P 10, 000
P20, 000 30, 000
Debit Total P40, 000 P40, 000 Credit Total

In as much as the debit total of P40, 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 Accounts Receivable account is
closed.”