Silay Institute, Incorporated

Fundamentals of Accounting 1

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TOPIC: TYPES OF MAJOR ACCOUNTS

▰ Assets
▰ Liabilities
▰ Owner’s Equity
▰ Revenue
▰ Expenses

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 OBJECTIVES

a) Summarize the rules of debit and credit as applied to balance sheet and income
statement accounts.
b.)Analyze and state the effects of business transactions on an entity’s assets,
liabilities and owner’s equity and record these effects in accounting equation
form using the financial transaction worksheet and the T- accounts
c.)Distinguish between revenue and receipts
Silay Institute, Incorporated
 Introduction

Accounting plays a vital role in running a business because it helps

you track income and expenditures, ensure statutory compliance, and provide
investors, management, and government with quantitative financial
information which can be used in making business decisions.

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 TYPICAL ACCOUNT TITLES USED

Balance Sheet

Accountants use special accounting terms when they refer to property

and financial interests. For example, they refer to property that a business owns
as the business’s assets and to the debts or obligations of the business as its
liabilities. The owner’s financial interest is called owner’s equity; sometimes it
is called proprietorship or net worth. Owner’s equity is the preferred term used.

Silay Institute, Incorporated

Assets

Assets should be classified only into two: current assets and non-
current assets. An entity shall classify an asset as current when:
a. it expects to realize the asset, or intends to sell or consume it, in its normal
operating cycle;
b. it holds the asset primarily for the purpose of trading;
c. it expects to realize the asset within twelve months after the end of the
reporting period; or
d. the asset is cash or a cash equivalent unless it is restricted from being
exchanged or used to settle a liability for at least twelve months after
the end of the reporting period.
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▰
 An entity shall classify all other assets as non-current. Operating cycle
is the time between the acquisition of materials entering into a process and its
realization in cash or an instrument that is readily convertible to cash.

Silay Institute, Incorporated

 Current Assets:

Cash. 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 Equivalents. These are short-term, highly liquid investment that are
readily convertible to known amounts of cash and which are subject
to an insignificant risk of changes in value.

Notes Receivable. A note receivable is a written pledge that the customer will
pay the business a fixed amount of money on a certain date.
Silay Institute, Incorporated
 Current Assets:
Accounts Receivable. These are claims against customers arising from sale of
services or goods on credit. This type of receivable offers less security than 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.
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 Current Assets:

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 include 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.

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 Non-Current Assets

Property and Equipment. 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 a 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-equipment or buildings – to obtain book value.

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 Non-Current Assets

Intangible Assets. 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
include goodwill, patents, copyrights, licenses, franchises, trademarks, brand
names, secret processes, subscription lists and non-competition
agreements.

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 Liabilities

An entity shall classify a liability as current when:

a. it expects to settle the liability in its normal operating cycle;
b. it holds the liability primarily for the purpose of trading;
c. the liability is due to be settled within twelve months after the end
of the reporting period; or
d. the entity does not have an unconditional right to defer settlement
of he liability for at least twelve months after the end of the
reporting period.
An entity shall classify all other liabilities as non-current.
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Current Liabilities

Accounts Payable. This account represents the reverse relationship of

the accounts receivable. By accepting the goods or
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 15
amount of money on a specified future date.
Current Liabilities

Accrued Liabilities. Amounts owed to others for unpaid expenses. This

account includes salaries payable, utilities payable, interest payable
and taxes payable.
Unearned Revenues. When the business entity receives payment before
providing its customers with goods or services, the amounts 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 date. 16
 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 asset 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.
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 Owner’s Equity

Capital. 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
or other assets that the owner may withdraw from the business
ultimately reduce it. This account title bears the name of the owner
Withdrawals. When the owner of a business entity withdraws cash or other
assets, such as recorded in the drawing or withdrawal
account rather than directly reducing the owner’s equity account.
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. 18
 INCOME STATEMENT

Income
Revenue, or income, is the inflow of money or others assets (including claims
to money, such as sale made on credit) that results from sales of goods or
services or from the use of money or property. The result of revenue is an
increase in assets.
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. 19
Expenses

An expense involves the outflow of money, the use of other assets, or the
incurring of a liability. Expenses include the costs of any materials,
labor, supplies, and services used in an effort to produce revenue.

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 or Wages Expense. Includes all payments as a result of an
employer-employee relationship such as salaries, or wages, 13 th
month pay, cost of living allowances and other related benefits .

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 Expenses

Telecommunications, Electricity, Fuel and Water Expenses. Expenses

related to use of telecommunications facilities, consumption of
electricity, fuel and water.
Supplies Expense. Expense of using supplies (e.g. office supplies) in the
conduct of daily business.
Rent Expense. Expense for space, equipment or other asset rentals.
Insurance Expense. Portion of premiums paid on insurance coverage (e.g.
on motor vehicle, health, life, fire, typhoon or flood) which has expired.

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Expenses

Depreciation Expense. The portion of the cost of a tangible asset (e.g. buildings
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

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 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.

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 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.

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Illustration. Refozar Accounting Services is a firm that provides a wide range of
bookkeeping and accounting services. This sole proprietorship business
is owned by Dr. Ret Fernan Refozar, is also a CPA. The office is
managed by Jiexel Manongsong, CPA, MBA. The firm is located in a large
office complex that has easy public access.
To simplify record keeping and billing, Refozar permits clients to charge
accounting services that are provided by the firm. He bills clients on a monthly
basis for the services they have received during the period. Customers who
prefer may pay in cash immediately after services are provided.

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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. Note that the date of the transaction is enclosed in
parentheses. During October 2016, the first month of operations, various
financial transactions took place. These transactions are described and
analyzed as follows:

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 Initial Transactions

Starting a Business

Oct. 1 Rey Fernan Refozar obtained the funds to start the

business by withdrawing P 800,000.00from his personal
savings. He deposited the money in a new bank account that
he opened in the name of the firm, Refozar Accounting
Services.

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 Refozar Accounting Services

Refozar Accoutning Services

Financial Transaction Worksheet
Month of October 2016

Assets = Liabilities + Owner’s

Equity
Cash = Refozar,
Capital
(1) P 800,000 = P 800,000
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 The financial transaction is analyzed as follows:

▰ An entity separate and distinct from Refozar’s personal financial affairs is

created
▰ An economic resource – cash of P 800,000 is invested in the business entity.
The source of this asset is the contribution made by the owner, which represents
owner’s equity. The owner’s equity account is Refozar, Capital
▰ The dual nature of the transaction is that cash is invested and owner’s equity
created. The effects of this transaction on the accounting equation are as
follows: increase in asset – cash from zero to P 800,000 and increase in owner’s
equity from zero to P 800,000.
▰ At this point, the entity has no liabilities , and assets equal owner’s equity.
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 Purchasing Equipment on Credit

Oct. 3Manongsong bought a computer, a copy machine, a fax machine, calculators

and other necessary equipment from M. Medina, Inc. at a cost ofP100,000.
M. Medina, Inc., agreed to allow 60 days for the firm to pay the bill.
Assets = Liabilities + Owner’s Equity
Cash + Equipment = Accounts Payable + Refozar, Capital
Bal. P 800,000 = P 800,000
(3) ________ P 100,000 = P100,000 ____________
Bal. P 800,000 + P 100,000 = P100,000 + P 800,000
▰ P 900,000 = P 900,000
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This arrangement is sometimes called buying on account. The
business has a charge account, or open-account credit, with its
suppliers. Amounts that a business must pay in the future under
this agreement are known as accounts payable. The entities or
individuals to whom the amounts are owed are called creditors.

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Purchasing Supplies for Cash

Oct.5 Manongsong placed as order for toner, fax paper, bond

paper,CDs, pens, folders, and other supplies that had a total cost of P
20,000. The entity that sold the items, Cavite Supplies, Inc., requires
cash payments from businesses that are under six months old. Refozar
Accounting Services therefore included a check with its order.

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Assets = Liabilities + Owner’s Equity
Cash + Supplies + Equipment = Accounts Payable + Refozar, Capital
Bal.P 800,000 P 100,000 = P 100,000 P 800,000
(5) ( 20,000) P 20,000 ________ = ___________ ________
Bal. P 780,000 + P 20,000 + P100,000 = P100,000 + P 800,000
▰ P 900,000 = P 900,000

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 This transaction did not change the total assets but it
did change the composition of the assets – it decreased one
asset – cash and increased another asset – supplies by P
20,000. Note that the sums of the balances on both sides of
the equation are equal . This equality must always exist.

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 Paying a Creditor
Oct. 9 Manongsong decided to pay P 40,000 to M. Medina, Inc., to reduce the firm’s
debt to that business.
Assets = Liabilities + Owner’s Equity
Cash + Supplies + Equipment = Accounts Payable + Refozar, Capital
Bal. P 780,000 P20,000 P100,000 = P 100,000 P 800,000
(9) ( 40,000) _________= (40,000)
Bal. P 740,000 + P 20,000 + P100,000 = P 60,000 + P 800,000
P 860,000 = P 860,000

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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-
supplies because the payment does not increase or decrease the supplies
available to the business

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 Effects of Revenue and Expenses

Shortly after Refozar opened his business on Oct. 1, 2016, some of the
tenants in the office complex where the business is located became Refozar’s first
client. Refozar also used his contacts in the community to gain other clients.
Services to clients began a stream of revenue for the business.
However, keeping a business running costs money, and these expenses
reduce owner’s equity. The expense figures are kept separate from the figures for
the owner’s capital and revenue. The separate record of expenses is kept for the
same reason as the separate record of revenue is kept – to help analyze operations
for the period.
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THANK YOU!

Silay Institute, Incorporated