10 | Basic Financia! Accounting and Reporting by Pr. 4 equity) and in the income statement (income and expenses), ine an zen may } defined as a detailed record of the increases, decreases ae ee ee a Se ene } that appears in an entity's financial statements. The simplest (ON & the account i known as the "T” account because of its similarity to the letter "T". The account ha, three parts as follows: Account Title Left side or | Right side or Debit side | Credit side ‘THE ACCOUNTING EQUATION Financial statements tell us how a business is performing. They are the final products the accounting process. But how do we arrive at the items and amounts that make w the financial statements? The most basic tool of accounting is the accounting equation This equation presents ‘the resources controlled by the enterprise, the preset obligations of the enterprise and the residual interest in the assets. It states that asse ‘must always equal liabilities and owner's equity. The basic accounting model is: Assets = abilities + Owner's Equity Note that the assets are on the left side of the equation opposite the liabilities at ‘ owner's equity. This explains why increases and decreases in assets are recorded inte opposite manner (“mirror image”) as liabilities and owner's equity are recorded. Tt i ‘equation also explains why liabilities and owner’s equity follow the same rules of debt and credit. The logle of debiting and creciting is related to the accounting equation, Transaction ‘may require additions to both sides (left and right sides), subtractions from both sie (left and right sides), or an addition and subtraction on the same side (left or right sil ; but in all cases the equality must be maintained as shown below: Owner's ns Uabinties EauityThe Accounting Equation and the Double Entry System | DEBITS AND CREDITS—THE DOUBLE-ENTRY SYSTEM. ‘Accounting is based on a double-entry system which means that the dual effects of a business transaction is recorded. A debit side entry must have a corresponding credit side entry. For every transaction, there must be one or more accounts debited and one or more accounts credited. Each transaction affects at least two accounts. The total debits for a transaction must always equal the total credits. ‘An account Is debited when an amount is entered on the left side of the account and credited when an amount is entered on the right side. The abbreviations for debit and credit are Dr. (from the Latin debere) and Cr. (from the Latin credere), respectively. ‘The account type determines how increases or decreases in it are recorded. Increases in assets are recorded as debits (on the left side of the account) while decreases in assets are recorded as credits (on the right side). Conversely, increases in liabilities and owner's equity are recorded by credits and decreases are entered as debits. The rules of debit and credit for income and expense accounts are based on the relationship of these accounts to owner's equity. Income increases owner's equity and ‘expense decreases owner's equity. Hence, increases in income are recorded as credits ‘and decreases as debits. Increases in expenses are recorded as debits and decreases as credits, These are the rules of debit and credit. The following summarizes the rules: Balance Sheet Accounts Uabilities and Owner's Equity Debie Great Debi Treat " 0 | | 0 «9 Increases | Decreases Decreases | Increases Norma Bolonce Normal lance Income Statement Accounts Ceditfor Dewi. ses in own uit decreases in owner's equity increases in owner's equity aes Income pen ; ar] edt credit one ae | | 0 «) { incscises | Decreases Decreases | Increases Normal Blance ‘Normal Balanceé 2-12 | Bosic Financial Accounting and Reporting by Prof. WIN Ballada. Accounts Debit Creat Increases in Increases in Assets Liablities Expenses ‘Owner's Capital Income Decreases in Liabilities Decreases in omerscmtl J] J te Income Expenses NORMAL BALANCE OF AN ACCOUNT The normal balance of any account refers to the side of the account—debit or credit where increases are recorded. Asset, owner's withdrawal and expense accouns normally have debit balances; liability, owner's equity and income accounts normaly have credit balances. This result occurs because increases in an account are usualy {eater than or equal to decreases. Increases Recorded by Normal Balance | Recount Category Debit ‘Credit Debit Credit ‘Assets 4 v bilities z Z ‘Owners Equity 1 ‘Owner's Capital ca z withdrawals Zz 7 : income. 7 z Expenses v 7 ACCOUNTING EVENTS AND TRANSACTIONS 4n accounting event isan economic occurrence that causes changes in a enterpti#® assets, lables, and/or equity. Events may be intemal actions. such as the ost © eaulpment for the production of goods or services. it can also be an extemal evel of event that involves the transfer of something Examples of transactions include acquiring assets f i «reditors, and purchasing or sling goods and senices, "borrowing fund ‘TYPES AND EFFECTS OF TRANSACTIONS, It willbe beneficial in the long-term to be abl > be able to understand oa that emphasizes the effects of accounting events rather than treo eet involved, This approach is quite pioneering. Although toes age humerous wansactons,lltransaction cn be dassiied inte mo ein el 1 of four types,ont The Accounting Equation and the Double Entry System | 2-13 k 1. Source of Assets (SA). An asset account Increases and @ corresponding claims {liabliities or owner's equity) account Increases. Examples: (1) Purchase of supplies: an account; (2) Sold goods on cash on delivery bass. 2. Exchange of Assets (EA). One asset account increases and another asset account decreases, Example: Acquired equipment for cash 3, Use of Assets (UA). An asset account decreases and a corresponding claims (lablties or equity) account decresses. Example: (1) Settled actounts payable; (2) Paid salaries of employees. 4. Exchange of Claims (EC). One glans (lables or ners eaulty) account Increases and another claims (lables or owners equity) account decreases. Example: Received utiles bill ut didnot pay. Every accountable event has a dual but self-balancing effect on the accounting equation. Recognizing these events will not in any manner affect the equality of the basic accounting model. The four types of transactions above may be further expanded into nine types of effects as follows: 11. Increase in Assets = Increase in Liabilities (SA) 2, Increase in Assets = Increase in Owner's Equity (SA) 7 3. Increase in one Asset = Decrease in another Asset (EA) 4, Decrease in Assets = Decrease in Liabilities (UA) 5. Decrease in Assets = Decrease in Owner's Equity (UA) 16. Increase in Liabilities = Decrease in Owner's Equity (EC) 7. a a Increase in Owner's Equity = Decrease in Liabilities (EC) Increase in one Liablity = Decrease in another Liability (EC) Increase in one Owner's Equity = Decrease in another Owner's Equity (EC) TYPICAL ACCOUNT TITLES USED STATEMENT OF FINANCIAL POSITION Assets ‘Assets are should be classified only into two: current assets and non-current assets. Per resed Philippine Accounting Standards (PAS) No. 3, an entity shall classify assets &s current when |. it expects to realize the asset, or intends to sell or consume it, in its normal operating cycle; , itholds the asset primarily forthe purpose of trading; €._itexpects to realize the asset within twelve months after the reporting period; or G.the asset is cash or a cash equivalent (as defined in PAS No. 7) unless the asset is restricted from being exchanged or used to settle a liability for at least twelve ‘months after the reporting period, Alother assets should be classified as non-current assets. Operating cycle Is the time between the acquisition of assets for processing and thelr realization in cash or cash tauivalents, When the entity's normal operating cycle Is not clearly identifiable, itis ®ssumed tobe twelve months: :od ‘The Accounting Equation and the Double Entry System | 2-39 NAME: SCORE: . [SECTION: PROFESSOR: Problem #2 Elements of Financial Statements 1. Using the accounting equation, complete the following table: i Assets Tabiities Equity a ___P457,000 P270,000, » fb 1,006 000 500,000 # fe 303,000 120,000 % fe 756,000 'P451,000 & [e 395,000 | P148,000 it 668,000 222,000 2. The following figures are extracted from various sole proprietorships. Using the ‘expanded accounting equation, complete the following table: ‘Assets Liabilities Equity a Capital income Expenses _| 2 = 756,000 56,000 46,500) 732,500, b. | pasiooo| => 86,000 48,000 | «. | _P182,000| 5,000 37,000 725,500, | P123,000[ _P54,000 Fie 26,000 e.| 94,000 25,000 P67500[ 1A Nr The Accounting Equation and the Double Entry System | 2-43 NAME: SCORE: SECTION: : PROFESSOR: Problem #6 ‘Transaction Effects on the Basic Accounting Model ‘The following are some transactions of Maricel Supan Services: A OF a.- - Recelved cash as additional investment. p, Purchased supplies on account. Charged customers for services made on “ account. 4, Rendered services to cash customers, Paid cash for rent on building. 4, Collected on account receivable in full, _-” Paid cash for supplies. rn. Returned supplies purchased on account, 1, ~ Pald cash to settle accounts: MLE LTTE | A HLT J, Pald cash to owner for personal use. Required: For each transaction, indicate whether the assets (A), liabilities (L) or owner's equity (OE) increased (4), decreased (-) or did not change (0) by placing the appropriate sign in the appropriate columnNAME: SCORE: SECTION: PROFESSOR: Problem #7 Effects of Transactions , The following selected transactions were completed by Roberto Orcajada Deliv Service during July 2019: 1. Cash received from delivery services, P92,700. 2. Paid creditors on account, P20,000. 3. Received cash from owner as additional investment, P600,000. 4. Paid advertising expense, P5,000. 5. Billed customers for delivery services on account, P55,200. 6. Purchased supplies for cash, P6,000. 7. Paid rent for July, P20,000. 8. Received cash from customers on account, P25,440. 9. Determined that the cost of supplies on hand was P1,440 so 10. 4,560 of supplies were used during the month. Owner withdrew cash for personal use, P20,000. Indicate the effects of each transaction on the space provided: a. b. c d. e. Increase an asset, decrease another asset. Increase an asset, increase a liability. Increase an asset, increase owner's equity. Decrease an asset, decrease a liability. Decrease an asset, decrease owner's equity.