The Accounting

Equation and the Double

Entry-System
Elements of Financial Statement
Financial Position
 Assets
 Resources controlled by the enterprise as a result of past events and from which
future economic benefits are expected to flow to the enterprise
 Liabilities
 Present obligation of the enterprise arising from the events, the settlement of
which is expected to return in an outflow form the enterprises of resources
embodying economic benefits.
 Equity
 Is the residual interest in the assets of the enterprise after deducting all its
liabilities.
Elements of Financial Statement
Financial Performance
 Income
 Increases in economic benefits during the accounting period in the form of inflows
or enhancement of assets or decreases of liabilities that results in increases in
equity, other than those relating to contributions from equity participants.
 Revenue and gains
 Revenue arises in the course of the ordinary activities of an enterprise and is
referred to by a variety of different names including sales, fees, interests,
dividends, royalties, and rent.
 Gains represent other items that meet the definition of income and may, or may
not arise in the course of ordinary activities of an enterprise.
Elements of Financial Statement
Financial Performance
 Expenses
 Decreases in economic benefits during the accounting period in the form of
outflows or depletions of assets or incurrences of liabilities that result in decreases
in equity, other that those relating to distributions to equity participants.
 This definition of expenses encompasses losses as well as those expenses that arise
in the course of the ordinary activities of the enterprise.
 Losses represent other items that meet the definition of expense and may or may
not, arise in the course of the ordinary activities of an enterprise.
The Account

 The basic summary device of accounting

 A detailed record of the increases and decreases and balance of each element
that appears in an entity’s financial statements.
 The simplest form of the account is known as the “T” account because of its
similarity to the letter “T”

Account Title
Left side or Debit side Right Side or Credit Side
The Accounting Equation

 Accounting Equation is the most basic tool of accounting

 It states that assets must ALWAYS equal liabilities and owner’s equity
 Assets = Liabilities + Owner’s Equity
DEBIT AND CREDITS – THE DOUBLE ENTRY
SYSTEM
Assets
Debit Credit
(+) (-)
Increase Decrease
Normal Balance

Liabilities or Owner’s Equity

Debit Credit
(-) (+)
Decrease Increase
Normal Balance
DEBIT AND CREDITS – THE DOUBLE ENTRY
SYSTEM
Expenses
Debit Credit
(+) (-)
Increase Decrease
Normal Balance

Income
Debit Credit
(-) (+)
Decrease Increase
Normal Balance
Accounting Events and Transaction

 An accounting event is an economic occurrence that causes change in

enterprise’s assets, liabilities and/or equity.
 Events may be internal actions or external actions.
 A transaction is a particular kind of event that involves transfer of something
of value between two entities.
Types of Transaction

 Source of Assets (SA)

 An asset account increases and a corresponding claims (liabilities or owner’s equity)
account increases
 Exchange of Assets (EA)
 One asset account increases and another account decreases
 Use of Assets (UA)
 An asset account decreases and a corresponding claims (liabilities or equity)
decreases
 Exchange of Claims (EC)
 One claims (liability or owner’s equity) account increases and another claims
(liabilities or owner’s equity) account decreases.
Effect of Transaction

 1. Increase in assets = increase in liabilities (SA)

 2. Increase in assets = increase in owner’s equity (SA)
 3. Increase in one asset = Decrease in another asset (EA)
 4. Decrease in Assets = Decrease in liabilities (UA)
 5. Decrease in Assets = decrease on owner’s equity (UA)
 6. Increase in Liabilities = Decrease in Owner’s equity (EC)
 7. Increase in Owner’s equity = decrease in liabilities (EC)
 8. Increase in one liability = decrease in another liability (EC)
 9. Increase in one Owner’s equity = Decrease in another owner’s equity (EC)
Assets

 Assets should be classified only into two: current assets and non-current assets.
 Per revised Philippine Accounting Standard (PAS) No. 1, an entity shall classify
assets as current when:
 A. it expects to realize the asset, or it intends to sell or consume it, in its normal
operating cycle
 B. it holds the assets primarily for the purpose of trading
 C. it expects to realize the asset within twelve months after the reporting period; or
 D. the asset is cash or a cash equivalent (as defined as PAS No. 7) unless the asset is
restricted from being exchanged or used to settle liability for at least twelve months
after the reporting period.
Operating Cycle

 Operating cycle is the time between the acquisition of assets for processing
and their realization in cash or cash equivalent.
 When the entity’s normal operating cycle is not clearly identifiable, it is
assumed to be twelve months
Current Assets

 Cash – is any medium of exchange that a bank will accept for deposit at face
value. It includes coins, currency, checks, money orders, bank deposits and
drafts.
 Cash Equivalent – per PAS No. 7, these are short-term highly liquid
investments that are readily convertible to known amounts of cash and which
are subject to all insignificant risk of change in value.
 Notes Receivable – is a written pledge that the customer will pay the business
a fixed amount of money on a certain date.
 Accounts Receivable – These are claims against customers arising from sale of
services or goods on credit. This type of receivable offers less security than
promissory notes.
Current Assets

 Inventories – Per PAS No. 2, these are assets which are (a) held for sale in the
ordinary course of business; (b) in the process of production for such sale; or
(c) in the form of materials or supplies to be consumed in the process or in
the rendering of services.
 Prepaid expenses – These are expenses paid for by the business in advance. It
is an asset because the business avoids having to pay cash in the future for a
specific expense. These includes insurance and rent. These prepaid items
represent future economic benefits – assets – until the time these start to
contribute to the earning process; these, then, become expenses.
Non-current assets

 Property, Plant and Equipment – per PAS No. 16, these are tangible assets that
are held by an enterprise for use in the production or supply of goods or services,
or for rental to others, or for administrative purposes and which are expected to
be used during more than one period. Included are such items as land, building,
machinery and equipment, furniture and fixtures, motor vehicles and
equipment.
 Accumulated Depreciation – it is contra account that contains the sum of the
periodic depreciation charges. The balance in this account is deducted from the
cost of the related asset to obtain book value.
 Intangible Assets – Per PAS No. 38, these are identifiable, nonmonetary assets,
without physical substance held for use in the production or supply of goods or
services, for rental to others, or for administrative purposes. These includes
goodwill, patents, copyrights, licenses, franchises, trademarks, brand names,
secret processes, subscription lists, and non-competition agreements.
Liabilities

 Per revised Philippine Accounting Standards (PAS) No. 1, an entity shall

classify a liability as current when:
 It expects to settle the liability in its normal operating cycle;
 It holds the liability primarily for the purpose of trading;
 The liability is due to be settled within twelve months after the reporting period;
or
 The entity does not have an unconditional right to defer settlement of the liability
for at least twelve months after the reporting period.
 All other liabilities should be classified as non-current
Current Liabilities

 Accounts Payable – This account represents the reverse relationship of

accounts receivable. By accepting the goods and services, the buyer agrees to
pay for them in the near future.
 Notes Payable – A note payable is like a note receivable but in a reverse
sense. In the case of a note payable, the business entity is the maker of the
note; that is, the business entity is the party who promises to pay the other
party a specified amount of money on a specific future date.
 Accrued Liabilities – Amounts owed to others for unpaid expenses. This
account includes salaries payable, utilities payable, interest payable and
taxes payable.
Current Liabilities

 Unearned Revenues – When the business receives payment before providing

customers with goods and services, the amount received are recorded in the
unearned revenue account (liability method). When the goods or services are
provided to the customer, the unearned revenue is reduced and income is
recognized.
 Current portion of long-term debt – These are portions of mortgage notes,
bonds, and other long-term indebtedness which are to be paid within one
year from the balance sheet.
Non-current Liabilities

 Mortgage Payable – This account records long-term debt of the business entity
for which the business entity has pledged certain assets as security to the
creditor. In the event that the debt payments are not made, the creditor can
foreclose or cause the mortgaged assets to be sold to enable the entity to
settle the claim.
 Bonds Payable – Business organizations often obtain substantial sums of money
from lenders to finance the acquisition of equipment and other needed
assets. They obtain these funds by issuing bonds. The bond is a contract
between the issuer and the lender specifying the terms of repayment and the
interest to be charged.
Owner’s Equity

 Capital (from the Latin capitalis, meaning “property”). This account is used
to record the original and additional investments of the owner of the business
entity. It is increased by the amount of profit earned during the year or is
decreased by a loss. Cash and other assets that the owner may withdraw from
the business ultimately reduce it. This account title bears the name of the
owner. (example: Castino, Capital)
 Withdrawals – When the owner of a business entity withdraws cash or other
assets such are recorded in the drawing or withdrawal account rather than
directly reducing the owner’s equity account. (example: Castino, Withdrawal)
 Income Summary – It is a temporary account used at the end of the
accounting period to close income and expenses. This account shows the
profit or loss for the period before closing to the capital account.
Income

 Service Income – Revenues earned by performing services for a customer or

client; for example accounting services by a CPA firm, laundry services by a
laundry shop.
 Sales – revenues earned as a result of sale of merchandise; for example sale
of building materials by a construction supplies firm.
Expenses

 Cost of Sales – The cost incurred to purchase or to produce the products sold
to customers during the period; also called cost of goods sold.
 Salaries and Wages Expense. Includes all payments as a result of an employer-
employee relationship such as salaries and wages, 13 th month pay, cost of
living allowances and other related benefits
 Telecommunications, electricity, fuel and water expenses – Expenses related
to use of telecommunication facilities, consumption of electricity, fuel and
water
 Rent expense – Expenses for space, equipment and other asset rentals
 Supplies expense – Expense of using supplies (e.g. office supplies) in the
conduct of daily business.
Expenses

 Insurance Expense – Portion of premiums paid on insurance coverage (e.g. in

motor, health, life, fire, typhoon or flood) which has expired.
 Depreciation Expense – This portion of the cost of a tangible asset (e.g.
building and equipment) allocated or charged as expense during the
accounting period.
 Uncollectible Accounts Expense – The amount of receivables estimated to be
doubtful of collection and charged as expense during an accounting period.
 Interest Expense – An expense related to use of borrowed funds.
Accounting for Business Transactions

 Business transaction
 Is the occurrence of an event or a condition that affects financial position and can
be reliably recorded
 Financial Transaction worksheet
 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.
Distinction between Revenues and
Receipts
Transaction Amount Cash Receipts Sales Revenue
(This Year) (This Year)
1. Cash sales made 200,000 200,000 200,000
this year
2. Credit sales 300,000 300,000 -
made last year;
cash received this
year
3. Credit sales 400,000 400,000 400,000
made this year;
cash received this
year
4. Credit sales 100,000 - 100,000
made this year;
cash to be
received next year