CHAPTER 1

INTRODUCTION

Accounting – An Information System

Every individual or group in society must make economic decisions

about the future. One example is a manager of a company who has to
determine which product or products are not saleable. This information is
necessary for the manager who has to decide whether to stop selling them to
customers. Others will make investments only if a company is financially
sound. National and local governments need accounting information for tax
purposes. Non-profit entities such as churches, civic and charitable
organizations need meaningful and easily understood economic and
accounting information for planning and proper implementation of their
programs. Because accountants are known for their financial and analytical
capabilities, they are often asked to analyze the available financial data for
clues that will serve as guides to the future.

External and Internal Accounting Information

The users of financial information can be classified as either external

or internal decision makers.

External decision makers are people who lack direct access to the
information generated by the internal operations of a company. Examples
are present shareholders, potential investors, creditors, suppliers, rank-and-
file employees, customers, brokers, underwriters, labor unions, trade
associations, and the public. These external decision makers use accounting
information in deciding whether to invest in the business entity, extend it
credit, or even to do business with it.

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 The process of developing and reporting accounting information to
external decision makers is called financial accounting. The reports are
called general-purpose financial statements composed of the balance sheet,
the income statement and the statement of cash flows.

Internal decision makers are the managers of an entity. These

managers are responsible for planning the future of the business,
implementing those plans, controlling the daily operations of the business
and reporting information to other operating officers.

The process of developing and reporting financial information for

internal users is called management accounting. The reports are called
special-purpose reports.

Forms of Business Organization

Single or Sole Proprietorship - A business owned by one individual only.

It is the most basic form of business organization. It is the easiest form of
business to organize since there are only minimal legal requirements to
follow. It is less complicated to operate and decisions are made faster since
only one owner decides and all profits will go to one owner only.

Partnership - An association of two or more persons who bind themselves

to contribute money, property, or industry to a common fund, with the
intention of dividing the profits among themselves. Partnerships are
governed by the Civil Code of the Philippines. A partnership is easier to
organize than a corporation. Better decisions are made since there are two
or more owners. It is also less complicated to operate than a corporation.

Corporation - An artificial being created by operation of law, having the

right of succession and the powers and attributes expressly authorized by
law or incident to its existence. Corporation is the most complex form of
business organization. The owners of a corporation are shareholders.
Certificates of stock are issued to evidence ownership in a stock corporation.

2
Types of Business Operations

Service business - This is the simplest form of business. This business

renders services to customers or clients in exchange for a fee. Examples are
operators of public transport, beauty parlors, security agencies, janitorial
services and professionals who practice their professions like doctors,
nurses, accountants, lawyers, and engineers.

Merchandising business - This business buys goods or commodities from

suppliers and sells the same at a profit. Examples are sari-sari stores,
groceries, supermarkets, hardwares, drug stores, car dealers, real estate
dealers and appliance stores.

Manufacturing business - This business is quite similar to a merchandising

business in that both sell the goods at a profit. The difference is that a
manufacturing business actually produces the goods that it sells to its
customers.

Accounting Defined

Accounting definition changes. The traditional definition of

accounting is:

Accounting is the art of recording, classifying, and 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.

Other definition of accounting is:

Accounting 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.

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Specialized Accounting Fields

Public Accounting

Accountants and their staff who offer services on a fee basis are said
to be engaged in public accounting. In public accounting, an accountant
may practice as an individual or as a member of a public accounting firm.
Certified Public Accountants (CPAs) are public accountants who have met
the required education, experience and examination requirements for
obtaining a CPA certificate.

Services rendered by CPAs in public practice are:

 Auditing involves the independent examination of financial

statements by CPAs for the purpose of expressing an opinion on the
fairness of the financial statements.

 Tax services include not only the preparation of tax returns, but also
include tax planning for various clients.

 Management advisory services or management consulting involves

providing services to clients on matters relating to the accounting
records, budgeting, cost accounting, marketing, organizational
planning, personnel and recruiting, production and many other
business areas.

Private Accounting

Accountants employed by a business firm or a not-for-profit

organization are said to be engaged in private accounting. They may be
called controller or the chief accountant in a business. They may also be
employed as vice-presidents for finance, cost accountant, internal auditors or
even budget director.

4
Accounting Education

Accountants employed as instructors, professors, reviewers or

researchers are in the field of accounting education. Only Certified Public
Accountants can engage in this field of endeavor.

Government

Accountants employed in any governmental units are said to be in the

field of government accounting. They may be hired or employed as auditor,
budget officer or even consultant in government units like the Securities and
Exchange Commission, the Bureau of Internal Revenue, the Bureau of
Customs, the Department of Finance or the Department of Budget and
Management.

Accounting Development

Accounting traces its roots to the Middle East region, where as early
as 8500 BC, tradesmen use clay objects to represent commodities such as
flocks of sheep, jars of spices and oil, bolts of clothing and other goods.
Some archeologists later unearthed clay tablets marred with symbols and
other writings and interpreted them to mean records of goods sold and other
statistics kept at that time.1

The ancient civilizations of Babylon, Greece and Egypt also used clay
tablets ( in later years, papyri were used as the medium for record keeping ).
These records show wage payments, material requisitions and costs of labor,
which only shows that accounting has already been in use even during
Biblical times.1

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 In 1494, Friar Luca Pacioli wrote a book which contains discussions
on the double-entry bookkeeping system. The book was entitled Summa de
Arithmetica, Geometria, Proportioni et Proportionalita (Everything about
Arithmetic, Geometry, Proportions and Proportionlity) and it summarizes
the existing mathematical knowledge at the time. Friar Pacioli was
considered the father of Double-Entry Bookkeeping.1

In the mid-18th to the mid-19th centuries, the Industrial Revolution

altered the way goods are produced from the artisan/craftsman method to the
assembly-line method. Cost accounting, the specialized field of accounting
which deals with the assignment of costs to products, emerged during this
period.1

The corporate form of business organization was created to

accommodate the need for increasingly large amounts of funds which are
required to finance the expansion of business during the period.1

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 CHAPTER 2
THE ROLE OF ACCOUNTING
Accounting is a tool of management by providing for the orderly
accumulation, reporting and interpretation of data pertaining to the financial
operations of the business. Accounting furnishes management with information
needed for the planning and control. Such information enables management to
operate the business effectively and meet, as well, its responsibilities to the owners
of the firm, the employees, the creditors, suppliers, government and its agencies,
and the general public. How does accounting do all of these? Or simply what
processes or procedures are done in accounting?

In basic accounting, there are 4 steps in the accounting cycle namely: the
recording, classifying, summarizing and interpreting of business data. The first
three steps – recording, classifying and summarizing form the basic process by
which accounting information is created. These steps in the accounting process or
cycle are carried out in accordance with generally accepted accounting principles
and practices developed by the profession over time and which have found
universal acceptance.

The fourth step – interpreting – involves the use of analytical techniques as

a base for management decisions. The information taken from accounting data
serves management in making an appraisal of current operations and in planning
future activities. Outside parties can also analyze and interpret the past
performance of businesses through published financial statements – the income
statement, the balance sheet, the statement of changes in owner‟s equity and the
statement of cash flows.

FUNCTIONS OF ACCOUNTING

Accounting is classified into two categories:

 Accounting which is designed to serve all parties external to the operating

responsibility of the firm referred to as Financial Accounting.

 Accounting which is designed to serve operational needs of internal

management referred to as Management or Managerial Accounting.

The principal differences between financial accounting and managerial

accounting are summarized in Illustration 1-1.

7
 FINANCIAL MANAGERIAL
BASIS ACCOUNTING ACCOUNTING
Primary users of  External users :  Internal users :
Reports stockholders, creditors officers and managers
and regulators
Types of frequency  Financial statements  Internal reports
Of Reports  Quarterly and annually  As frequently as needed
Purpose of Reports  General – purpose  Special–purpose for
specific decisions
Sources of Data  Basic accounting system  Basic accounting
of the business and other system of the
sources from external business
information
Content of Reports  Pertains to business as a  Pertains to subunits of
whole the business
 Highly aggregated  Very detailed
(condensed)  Extends beyond
 Limited to double–entry double–entry
accounting and cost data accounting to any
 Generally accepted relevant data
accounting principles  Standard is relevance
to decisions
Verification Process  Audit by CPA  No independent audits
Illustration 1-1 Differences between financial and managerial accounting

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 CHAPTER 3

FINANCIAL STATEMENTS

The principal financial statements of a proprietorship are the income

statement, the statement of owner‟s equity, the balance sheet, and the
statement of cash flows.

Income statement – A summary of the revenue and expenses for a specific

period of time, such as a month or a year.

Statement of Owner’s Equity – A summary of the changes in the owner‟s

equity that have occurred during a specific period of time, such as a month
or a year.

Balance Sheet – A list of the assets, liabilities, and owner‟s equity as of a

specific date, usually at the close of the last day of a month or a year.

Statement of Cash Flows – A summary of the cash receipts and cash

payments for a specific period of time, such as a month or a year.

Elements of the Financial Statements

Balance Sheet

Assets - An asset is a resource controlled by the enterprise as a

result of past events and from which future economic
benefits are expected to flow to the enterprise.

Liabilities - A liability is a present obligation of the enterprise

arising from past events, the settlement of which is
expected to result in an outflow from the enterprise of
resources embodying economic benefits.

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Owner’s Equity - This is the residual interest in the assets of the
enterprise after deducting all its liabilities.

Income Statement

Income - Refers to increases in economic benefits during the

accounting period in the form of inflows or enhancements
of assets or decreases of liabilities that result in increase
in equity, other than those relating to contributions from
equity participants.

Expenses - Refer to decreases in economic benefits during the

accounting period in the form of outflows or depletion of
assets or increases of liabilities that result in decrease in
equity, other than those relating to distributions to equity
participants.

The definition of income encompasses both 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, interest,
dividends, royalties and rent. Gain represents other items that meet the
definition of income and may, or may not, arise in the course of the ordinary
activities of an enterprise.

The 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 expenses and may, or
may not, arise in the course of the ordinary activities of the enterprise.

10
Examples of Elements of the Financial Statements

Balance Sheet

 Assets

Cash - Cash is any medium of exchange that the

bank will accept at face value. It includes
coins and currencies. Checks, money orders,
bank drafts, and bank deposits.

Accounts Receivable - These are claims against debtors or

customers arising from the provision of
services or delivery of goods on credit.

Notes Receivable - These are claims against debtors or

customers evidenced by a written promise to
pay called a promissory note.

Inventories - 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 production process or in the
rendering of services.

Prepaid Expenses - These are expenses paid for by the business

in advance. Examples are Prepaid Rent,
Prepaid Insurance and Prepaid Interest.

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 Property, Plant and Equipment
- These are tangible assets held by a business
for use in the production of goods or
services, or for rental to others, or for
administrative purposes and which are
expected to be used during more than one
accounting period. Examples are: Land,
Building, Equipment, Truck, Automobile,
Furniture and Fixtures.

 Liabilities

Accounts Payable - These are amounts due to creditors arising

from the purchase of merchandise or services
on account.

Notes Payable - These are amounts due to creditors

evidenced by a written promise to pay.

Accrued Liabilities - These are amounts owed to others for unpaid

expenses. Examples are Salaries Payable,
Taxes Payable, Interest Payable and Utilities
Payable.

Unearned Revenues - These are revenues collected by the business

in advance. When a business receives
payments before providing services to
customers, there is an obligation created on
the part of the business to provide services.
Once the business provides the services, the
advance collections from customers will
become earned and will be recorded as
income.

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 Mortgage Payable - These are long-term debts secured by certain
assets as collateral.

 Owner’s Equity

Capital - This is used to record the initial or original

investments of the owner. Any additional
investments are also recorded in the Capital
account. Net income increases Capital while
net loss decreases Capital. Examples are
Juan Cruz, Capital; Jose Santos, Capital

Withdrawals - Another term is Drawing or Personal. This is

used to record any withdrawal of cash or
other assets of the business by the owner
intended for any personal or non-business
use. Examples are: Juan Cruz, Drawing;
Jose Santos, Drawing.

Income Statement

 Income

Service Income, Fees Income - These are revenues earned by

rendering services to customers or
clients.

Sales - These are revenues earned by selling

merchandise to customers.

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 Expenses

Rent Expense - This is used to record expense for

leased office spaces, building or
other assets.

Supplies Expense - This is used to record supplies used

by the business.

Depreciation Expense - This is used to record portion of the

cost of a tangible asset like building
allocated as expense during an
accounting period.

Interest Expense - This is used to record an expense

for using borrowed funds.

Uncollectible Accounts Expense- Other terms are Provision for

Doubtful Accounts, Bad Debts
Expense or Doubtful Accounts
Expense. This is used to record the
amount of receivables estimated to
be uncollectible and charged to
expense during an accounting
period.

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 EXERCISES

TRUE OR FALSE

Encircle T if the statement is true, F if the statement is false.

T F 1. A merchandising business is one which buys goods from

suppliers and sells them at a profit.

T F 2. Manufacturing businesses always earn more than

merchandising business.

T F 3. One of the advantages of a partnership over a single

proprietorship is the higher amount of capital that it can
accumulate during the formation stage.

T F 4. A sole proprietor is both the owner and manager of his

business.

T F 5. A partnership is always owned by two persons.

T F 6. All partnerships have an unlimited liability.

T F 7. Unlimited liability means that the personal properties of

general partners may be used in the settlement of the
liabilities of the partnership.

T F 8. The owners of a partnership are called stockholders.

T F 9. Stockholders have limited liability.

T F 10. A corporation may be formed to provide services to the

public.

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 IDENTIFICATION

_________________ 1. A type of business that changes basic inputs

into products that are sold to individual
customers.

_________________ 2. A type of business that purchases products

from other businesses and sells them to
customers.

_________________ 3. A business owned by one individual.

_________________ 4. A business owned by two or more individuals.

_________________ 5. An artificial being created by operation of law

having the right of succession and the powers
and attributes expressly authorized by law or
incident to its existence.

_________________ 6. Resources controlled by a business.

_________________ 7. The rights of creditors that represent debts of

the business.

_________________ 8. The rights of the owners.

_________________ 9. Assets = Liabilities + Owner‟s Equity.

_________________ 10. The liability created by purchase on account.

_________________ 11. Items such as supplies that will be used in the

business in the future.

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_________________ 12. A claim against the customer.

_________________ 13. Long-term debt secured by certain assets as

collateral.

_________________ 14. Another term is Drawing or Personal.

_________________ 15. The process of developing and reporting

accounting information to external decision
makers.

_________________ 16. People who lack direct access to the

information generated by the internal
operations of a company.

_________________ 17. Process of developing and reporting financial

information for internal users.

_________________ 18. These are the internal decision makers.

_________________ 19. A service activity whose function is to provide

quantitative information, primarily financial in
nature, about economic entities, that is
intended to be useful in making economic
decisions.

_________________ 20. Reports prepared by financial accounting.

17
 CHAPTER 4
ANALYZING BUSINESS TRANSACTIONS

Accounting Concepts

Accounting concepts are the generally accepted rules and assumptions

that assist accountants in the preparation of financial statements. It provides
the framework for recording the financial transactions of the business. In
layman terms, they are the fundamental building blocks of the accounting
system with the primary objective of providing uniform and consistent
financial information to relevant investors and all the stakeholders.

Accounting concepts are the basic rules, assumptions, and conditions

that define the parameters and constraints within which the accounting
operates. In other words, accounting concepts are the generally accepted
accounting principles, which form the fundamental basis of preparation of
universal form of financial statements consistently.

Because it is important that all who will receive accounting reports be

able to interpret them, a set of practices were developed that will provide
guidelines for financial accounting. The term used to describe these
practices is generally accepted accounting principles (GAAP).

Generally accepted accounting principles encompass the conventions,

rules, and procedures necessary to define accepted accounting practice at a
particular time. These “principles” are not like the unchangeable laws of
nature found in chemistry or physics. They are developed by accountants
and businesses to serve the needs of decision makers, and they can be
changed or altered as better methods are developed or as circumstances
change.

A few examples of these generally accepted accounting principles are:

18
1. Business Entity Concept

Under the business entity concept, the activities of a business are

recorded separately from the activities of the owner or owners. This concept
is important because it limits the economic data in the accounting system to
data related directly to the activities of the business. Thus, the accountant
for a business with one owner (a proprietorship) would record the activities
of the business only, not the personal activities, property, or debts of the
owner.

2. Going Concern or Continuity Assumption

To prepare financial statements for an accounting period, the

accountant must make an assumption about the ability of the business to
continue. Specifically, the accountant assumes that unless there is evidence
to the contrary, the business entity will continue to operate for an indefinite
period. This method of dealing with the issue is called the going concern or
continuity assumption. The justification for all the techniques of income
measurement rests on this assumption of continuity.

3. Time Period Assumption

The operating results of any business cannot be known with certainty

until the company has completed its life span and ceased doing business.
But financial reports covering shorter time periods are needed because
external decision makers require timely accounting information to satisfy
their analytical needs. Because of this, businesses have imposed the time-
period assumption, requiring that changes in a business‟s financial position
be reported over a series of shorter time periods like annually, semi-
annually, quarterly or monthly. An annual accounting period is the most
common which can be a calendar year or a fiscal year. Example: January 1,
2020 to December 31, 2020 is a calendar year; July 1, 2019 to June 30,
2020 is a fiscal year.

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4. Unit-of-Measure Assumption

The unit-of-measure assumption specifies that accounting should

measure and report the results of a business‟s economic activities in terms of
a monetary unit such as the Philippine peso. The assumption recognizes that
the use of a standard monetary unit throughout all financial statements is an
effective means for aggregating and communicating accounting information.
It is a standard practice to ignore changes in the purchasing power of a peso.

5. Accrual Basis

Under this basis, the effects of transactions and other events are
recognized when they occur (and not as cash or its equivalent is received or
paid) and they are recorded in the books of accounts or accounting records
and reported in the financial statements of the periods to which they relate.

In contrast, revenues and expenses may be accounted for on a cash

received and cash paid basis. This practice is known as the cash basis of
accounting. Under this method, revenues are reported as earned in the
period in which cash is received; expenses are reported in the period in
which cash is paid.

Example: Atty. Zachary started to practice his profession. On

January 5, Atty. Zachary rendered legal services to XYZ Company and
received P 10,000 as payment from XYZ Company on January 15.

Under the accrual basis, Atty. Zachary will recognize income on

January 5, the date when he rendered his services to XYZ Company. Under
the cash basis, Atty. Zachary will recognize income on January 15, the date
when he received the cash from XYZ Company.

So, we can see from the example, that under the cash basis, revenue is
recorded on the date the cash is received while under the accrual basis,
revenue is recorded on the date the service is rendered.

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BUSINESS TRANSACTIONS

A transaction is an economic event or condition that directly changes

an entity‟s financial condition or directly affects its results of operations. It
is an exchange of values stated in terms of money between two parties.
Business entities may have hundreds or even thousands of transactions
everyday. These transactions are the raw materials of accounting reports.

All business transactions can be stated in terms of changes in the

elements of the accounting equation.

The Accounting Equation

Business transactions are analyzed, recorded, classified and

summarized to be able to determine the financial position and the result of
operation of a business. Analysis of business transactions can be done
through the accounting equation.

What is the basic accounting equation? This equation states that:

ASSETS = LIABILITIES + OWNER‟S EQUITY

The two sides of the equation must always be equal or “in balance”.

Other ways of expressing the equation are:

OWNER‟S EQUITY = ASSETS - LIABILITIES

LIABILITIES = ASSETS - OWNER‟S EQUITY

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Some Illustrative Transactions

Let us now examine the effect of some of the most common business
transactions on the accounting equation. Suppose that Juan Cruz finished
law school, passed the bar examination and immediately set up his own law
practice in June, 2020.

During the first month of operation, he completed the following transactions:

June 1 Began the law practice by investing P 200,000 in a bank

account established for the business.

Assets = Liabilities + Owner‟s Equity

J. Cruz, Type of OE
Cash = Liabilities + Capital Transaction
P200,000 = P200,000 Owner‟s Investment
=========== ===========

June 5 Purchased a law library for P 90,000 cash.

Assets = Liabilities + Owner‟s Equity

J. Cruz, Type of OE
Cash Law Library = Liabilities + Capital Transaction
Bal. P200,000 P200,000
- 90,000 + 90,000 ________
Bal. P110,000 P 90,000 P200,000
============= ============ ==============

June 10 Purchased office supplies for P 4,000 on credit.

Assets = Liabilities + Owner‟s Equity

Cash Office Law Accounts J. Cruz,
Supplies Library = Payable Capital Type of OE Transaction
Bal P110,000 P 90,000 P200,000
+P 4,000 = +P 4,000
________________________ __________________ ______________________ _____________________ _________________________

Bal P110,000 P 4,000 P 90,000 P 4,000 P200,000

========== ======== ========= ======== ==========

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 June 15 Accepted P 50,000 in cash for completing a contract.

Assets = Liabilities + Owner‟s Equity

Cash Office Law Accounts J. Cruz,
Supplies Library = Payable Capital Type of OE Transaction
Bal P110,000 P 4,000 P 90,000 P 4,000 P200,000
+ 50,000 + 50,000 Service Revenue
________________________ __________________ ______________________ _____________________ _________________________

Bal P160,000 P 4,000 P 90,000 P 4,000 P250,000

========== ======== ========= ======== ==========

June 18 Billed clients P150,000 for services rendered during the month

Assets = Liabilities + Owner‟s Equity

Accounts Office Law Accounts J. Cruz, Type of OE
Cash Receivable Supplies Library Payable Capital Transaction
Bal P160,000 P 4,000 P90,000 P 4,000 P250,000
+P150,000 +150,000 Service Revenue
_______________________ __________________________ ____________________ ______________________ _____________________ _______________________

Bal P160,000 P150,000 P 4,000 P90,000 P 4,000 P400,000

========== =========== ======== ========= ========= ==========

June 20 Paid P2,000 of the amount owed for office supplies.

Assets = Liabilities + Owner‟s Equity

Accounts Office Law Accounts J. Cruz, Type of OE
Cash Receivable Supplies Library Payable Capital Transaction
Bal P160,000 P150,000 P 4,000 P90,000 P 4,000 P400,000
- 2,000 - 2,000
_______________________ __________________________ ____________________ ______________________ _____________________ _______________________

Bal P158,000 P150,000 P 4,000 P90,000 P 2,000 P400,000

========== =========== ======== ========= ========= ==========

June 25 Received P100,000 in cash from clients who had been

previously billed for services rendered.

Assets = Liabilities + Owner‟s Equity

Accounts Office Law Accounts J. Cruz, Type of OE
Cash Receivable Supplies Library Payable Capital Transaction
Bal P158,000 P150,000 P 4,000 P90,000 P 2,000 P400,000
+100,000 -100,000
_______________________ __________________________ ____________________ ______________________ _____________________ _______________________

Bal P258,000 P 50,000 P 4,000 P90,000 P 2,000 P400,000

========== =========== ======== ========= ========= ==========

23
 June 28 Paid rent expense for the month in the amount of P30,000.

Assets = Liabilities + Owner‟s Equity

Accounts Office Law Accounts J. Cruz, Type of OE
Cash Receivable Supplies Library Payable Capital Transaction
Bal P258,000 P 50,000 P 4,000 P90,000 P 2,000 P400,000
- 30,000 - 30,000 Rent Expense
_______________________ __________________________ ____________________ ______________________ _____________________ _______________________

Bal P228,000 P 50,000 P 4,000 P90,000 P 2,000 P370,000

========== =========== ======== ========= ========= ==========

June 30 Received the following bills for the month of June:

Meralco-P5,000 PLDT-P4,000
These bills will be paid next month.

Assets = Liabilities + Owner‟s Equity

Accounts Office Law Accounts J. Cruz, Type of OE
Cash Receivable Supplies Library Payable Capital Transaction
Bal P228,000 P 50,000 P 4,000 P90,000 P 2,000 P370,000
+ 9,000 - 9,000 Utilities Expense
_______________________ __________________________ ____________________ ______________________ _____________________ _______________________

Bal P228,000 P 50,000 P 4,000 P90,000 P11,000 P361,000

========== =========== ======== ========= ========= ==========

June 30 Paid salary of secretary for the month, P12,000.

Assets = Liabilities + Owner‟s Equity

Accounts Office Law Accounts J. Cruz, Type of OE
Cash Receivable Supplies Library Payable Capital Transaction
Bal P228,000 P 50,000 P 4,000 P90,000 P11,000 P361,000
- 12,000 - 12,000 Salary Expense
_______________________ __________________________ ____________________ ______________________ _____________________ _______________________

Bal P216,000 P 50,000 P 4,000 P90,000 P11,000 P349,000

========== =========== ======== ========= ========= ==========

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 June 30 Withdrew P40,000 from the practice for personal use.

Assets = Liabilities + Owner‟s Equity

Accounts Office Law Accounts J. Cruz, Type of OE
Cash Receivable Supplies Library Payable Capital Transaction
Bal P216,000 P 50,000 P 4,000 P90,000 P11,000 P349,000
- 40,000 - 40,000 Owner‟s Withdrawal
_______________________ __________________________ ____________________ ______________________ _____________________ _______________________

Bal P176,000 P 50,000 P 4,000 P90,000 P11,000 P309,000

========== =========== ======== ========= ========= ==========

The financial statements of Juan Cruz for the month of June are
shown below:

Juan Cruz
Statement of Comprehensive Income
For the Month Ended June 30, 2020

Service Income P 200,000

Less: Expenses
Rent Expense P 30,000
Salary Expense 12,000
Utilities Expense 9,000
__________________________________
51,000
_______________________________________

Net Income P 149,000

==================

Juan Cruz
Statement of Changes in Owner‟s Equity
For the Month Ended June 30, 2020

Capital, June 1, 2020 P 0

Add: Investment P 200,000
Net Income 149,000 349,000

Less Withdrawals 40,000

Capital, June 30, 2020 P 309,000
==================

25
 Juan Cruz
Statement of Financial Position
June 30, 2020

ASSETS
Cash P 176,000
Accounts Receivable 50,000
Office Supplies 4,000
Law Library 90,000
_________________

Total Assets P 320,000

==============

LIABILITIES
Accounts Payable P 11,000

CAPITAL
Juan Cruz, Capital 309,000
_________________

Total Liabilities and Capital P 320,000

===============

Juan Cruz
Statement of Cash Flows
For the Month Ended June 30, 2020

Cash flows from operating activities:

Cash received from customers P 150,000
Deduct cash payments for expenses and
payments to creditors 44,000
Net cash flow from operating activities P 106,000
Cash flows from investing activities:
Cash payments for acquisition of law
Library ( 90,000)

Cash flows from financing activities:

Cash received as owner‟s investment P 200,000
Deduct cash withdrawal by owner 40,000
Net cash flow from financing activities 160,000

Net cash flow and June 30, 2020 Cash Balance P 176,000
===========

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 When analyzing business transactions using the accounting equation,
the following points should be considered:

1) Determine whose point of view the transactions are to be analyzed.

2) Determine the account titles affected by the transaction. At least two

account titles may be affected by every transaction.

3) Determine the effect of the transaction on the account titles. The

effect can either be an increase or a decrease.

4) Determine the amount of the transaction.

5) Always remember that using this method of analysis, the left side of
the equation should always equal the right side.

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 EXERCISES
Exercise 1

Ms. Joy Villamor operates her printing business. Summary of financial data
for June are presented in equation form as follows. Each line designated by
a number indicates the effect of a transaction on the accounting equation.
Each increase and decrease in owner‟s equity, except transaction (5), affects
net income.

Office
Cash + Supplies + Equipment = Liabilities + Owner‟s Equity
Bal. 3,000 375 15,000 3,750 14,625
1 + 7,500 + 7,500
2 - 1,000 + 1,000
3 - 5,625 - 5,625
4 + 250 + 250
5 - 750 - 750
6 - 2,650 - 2,650
7 - 400 - 400
_________________ _______________ _________________ _______________ _____________________

Bal 475 225 16,000 1,350 15,350

============ =========== ========== ======== ==========

a. Describe each transaction.

1. _______________________________________________________

2. _______________________________________________________

3. _______________________________________________________

4. _______________________________________________________

5. _______________________________________________________

6. _______________________________________________________

7. _______________________________________________________

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b. What is the amount of net decrease in cash during the month? ____________

c. What is the amount of net increase in Owner‟s Equity during

the month? ____________

d. What is the amount of the net income for the month? _______________

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Exercise 2

Use the accounting equation to answer each question below. Show any
calculations you make.

1. The assets of Alaska Company are P650,000, and the owner‟s equity is
P360,000. What is the amount of the liabilities? ____________

2. The liabilities and owner‟s equity of Cleveland Company are P95,000 and
P32,000, respectively. What is the amount of the assets? _____________

3. The liabilities of Lakers Company equal to one-third of the total assets,

and owner‟s equity is P240,000. What is the amount of the liabilities?
What is the amount of the assets? _________________

4. At the beginning of the year, Miami Company‟s assets were P110,000,

and its owner‟s equity was P50,000. During the year, assets increased
P30,000, and liabilities decreased P5,000. What was the owner‟s equity
at the end of the year? _____________

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Exercise 3

Identify the following transactions by the type of owner‟s equity transaction

by marking each as either an owner‟s equity investment ( I ), owner‟s
withdrawal ( W ), revenue ( R ), expense ( E ), or not an owner‟s equity
transaction ( NOE ).

______ a. Received cash for providing a service.

______ b. Paid cash to employee for services performed.

______ c. Paid cash to purchase equipment.

______ d. Took assets out of business for personal use.

______ e. Performed a service and received a promise for payment.

______ f. Received cash from a customer previously billed for a

service.

______ g. Paid service station for gasoline.

______ h. Transferred assets to the business from a personal account.

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Exercise 4

Identify each of the following transactions as to:

A. Increase in one asset, decrease in another asset

B. Increase in an asset, increase in liability
C. Increase in an asset, increase in capital
D. Decrease in an asset, decrease in liability
E. Decrease in an asset, decrease in capital
F. Increase in liability, decrease in capital

During the month of August, West Company had the following transactions:

_______ a. Paid salaries for August, P 18,000.

_______ b. Purchased equipment on credit, P 30,000.

_______ c. Purchased supplies with cash, P 1,000.

_______ d. Additional investment by owner, P 40,000.

_______ e. Received payment for services performed, P 6,000.

_______ f. Paid for part of equipment previously purchased on credit,

P 10,000.

_______ g. Billed customers for services performed, P 16,000.

_______ h. Withdrew cash, P 15,000.

_______ i. Received payment from customers billed previously,

P 3,000.

_______ j. Received utility bill, P 700.

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Exercise 5

The following selected transactions were completed by Julie‟s Catering

Service during September of 2020.

1. Received cash for providing catering services, P 24,300.

3. Received cash from owner as an investment, P 150,000.
9. Paid advertising expense. P 5,000.
11. Billed customers for catering services on account, P 15,000.
15. Bought supplies on account, P 12,000.
19. Paid rent for the month, P 7,000.
22. Received cash from customers on account, P 7,500.
25. Paid creditors on account, P 8,000.
28. Bought equipment for cash, P 20,000.
30. The owner withdrew P 15,000 for personal use.

Required:
1) Using the accounting equation, analyze the above transactions of
Julie‟s Catering Service.

Assets = Liabilities + Owner‟s Equity

Accounts Office Accounts J. Abad, Type of OE
Date Cash Receivable Supplies Equipment = Payable + Capital Transaction

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Exercise 6
Listed below are the ledger accounts of Clean Company:

a. Cash l. Prepaid Advertising

b. Accounts Receivable m. Rent Expense
c. Chris Uy, Capital n. Fees Earned
d. Chris Uy, Drawings o. Office Supplies
e. Service Income p. Unearned Subscription
f. Prepaid Insurance q. Taxes Payable
g. Notes Payable r. Notes Receivable
h. Investment in Stocks s. Interest Expense
i. Mortgage Payable t. Salaries Payable
j. Building u. Interest Receivable
k. Insurance Expense v. Land

Complete the following table indicating with two Xs for each account its
classification and its normal balance (whether a debit or credit increases the
account).

Type of Account
Normal Balance
O W N E R „S E Q U I T Y (increases balance)
Owner‟s Owner‟s I
Item Asset Liability Capital Withdrawals Revenue Expense Debit Credit
a. X X
b.
c.
d.
e.
f.
g.
h.
i.
j.
k.
l.
m.
n.
o.
p.
q.
r.
s.
t.
u.
v.

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