THE ACCOUNTING EQUATION

AND THE
DOUBLE-ENTRY SYSTEM
Elements of Financial Statements

 Quantitative information shown in the

statement of financial position and
income statement
 “Building blocks” from which financial
statements are constructed
 Broad classes of events or transactions
that are grouped according to their
economic characteristics
Elements of Financial
Statements
 Assets – resources controlled by the entity
as a result of past transactions or events
and from which future economic benefits
are expected to flow to the entity
 Liabilities – present obligations of the
entity arising from past transactions or
events the settlement of which is expected
to result in an outflow from the entity of
resources embodying economic benefits
Elements of Financial
Statements
 Equity/Capital – residual interest in the
assets of the entity after deducting all of
its liabilities

 Income – increase in the economic

benefit during the accounting period in
the form of inflow or increase in asset or
decrease in liability that results in
increase in equity, other than
contribution from equity participants
Elements of Financial
Statements
 Expense – decrease in economic
benefit during the accounting period
in the form of an outflow or
decrease in asset or increase in
liability that results in decrease in
equity, other than distribution to
equity participants
Recognition of elements

 Recognition – reporting of an asset,

liability, income or expense on the face of
the financial statements of the entity.
 Asset recognition principle
 Liability recognition principle
 Income recognition principle
 Expense recognition principle
Asset Recognition Principle

a. It is probable that future economic

benefits will flow to the entity.*
b. The cost or value of the asset can be
measured reliably.
* The term “probable” means that the
chance of the future economic benefit
arising is more likely rather than less
likely.
Future economic benefits

a. Used singly or in combination with other

assets in the production of goods or
services to be sold by the entity
b. Exchanged for other assets
c. Used to settle a liability
d. Distributed to the owners of the entity
Cost principle

 In a cash transaction, cost is equivalent to

the cash payment.
 In a noncash or an exchange transaction,
the cost is equal to the fair value of the
asset given or the fair value of the asset
received, whichever is clearly evident. In
the absence of fair value, the cost is
equal to the book value of the asset
given.
Liability recognition principle

a. It is probable that an outflow of economic benefits

will be required for the settlement of a present
obligation.

a. Payment of cash
b. Transfer of noncash assets
c. Provision of services
d. Replacement of the obligation with
another obligation
e. Conversion of the obligation into equity
Liability recognition principle

b. The amount of the obligation can be measured

reliably.
Income recognition principle

a. It is probable that future economic benefits will flow

to the entity as a result of an increase in an asset or a
decrease in a liability.
b. The economic benefits can be measured reliably.
Definition of income

 The definition of income encompasses

both revenue and gains.
 Revenue arises in the ordinary regular
activities of an entity and is referred to
by a variety of different names including
sales, fees, interests, interest, dividends,
royalties and rent. The essence of
revenue is regularity.
Definition of income

 Gains represent other items that meet

the definition of income and do not arise
in the course of the ordinary regular
activities of an entity.
 For example, gains include gain from
disposal of noncurrent assets, unrealized
gain on trading securities and gain from
expropriation.
Revenue from sale of goods

 PAS 18 provides the following conditions for the

recognition of revenue from sale of goods:
 The entity has transferred to the
buyer the significant risks and rewards
of ownership of the goods.
 The entity retains neither continuing
managerial involvement nor effective
control over the goods sold.
Revenue from sale of goods

 Theamount of revenue can be

measured reliably.
 It is probable that economic benefits
associated with the transaction will
flow to the entity.
 The costs incurred or to be incurred in
respect of the transaction can be
measured reliably.
Revenue from rendering of
services
 PAS 18 provides the following conditions for the
recognition of revenue from rendering of services:
 The amount of revenue can be measured reliably.
 It is probable that the economic benefits associated with
the transaction will flow to the entity.
Revenue from rendering of
services
 The stage of completion of the transaction at the end of
reporting period can be measured reliably.
 The costs incurred for the transaction and the cost to
complete can be measured reliably.
Revenue from interest,
royalties and dividends
 Interest revenue shall be recognized on a time
proportion basis that takes into account the effective
yield on the asset.
 Royalties shall be recognized on an accrual basis in
accordance with the substance of the relevant
agreement.
Revenue from interest,
royalties and dividends
 Dividends shall be recognized as revenue when the
shareholder’s right to receive payments is established,
meaning, when the dividend is declared.
Expense recognition principle

a. It is probable that a decrease in future economic

benefits has occurred as a result of a decrease in an
asset or an increase in a liability.
b. The decrease in economic benefits can be measured
reliably.
Definition of expenses

 The definition of encompasses losses as well as those

expenses that arise in the course of the ordinary regular
activities of the entity.
 Expenses that arise in the ordinary regular activities of
the entity include, for example, cost of sales, wages
and depreciation.
Definition of expenses

 Losses represent other items that meet

the definition of expenses and do not
arise in the course of the ordinary
regular activities of the entity.
 Examples include losses resulting from
disasters such as fire, flood, tsunami
and hurricane as well as those arising
from disposal of noncurrent assets.
Matching Principle

 Those costs and expenses incurred in

earning a revenue shall be reported
in the same period.
 There shall be simultaneous or
combined recognition of revenue and
expenses that result directly from
the same transactions and events.
 “There is no gain if there is no pain.”
Cause and effect association

 The expense is recognized when the revenue is already

recognized.
 “Strict matching concept”
 Examples include cost of merchandise inventory,
doubtful accounts, warranty expense and sales
commissions.
Systematic and rational
allocation
 Some costs are expensed by simply
allocating them over the periods
benefited.
 When economic benefits are expected
to arise over several accounting periods
and the association with income can
only be broad or indirectly determined,
expenses are recognized on the basis of
systematic and allocation procedures.
Systematic and rational
allocation
 Concrete examples include depreciation of PPE,
amortization of intangibles and allocation of prepaid
rent and insurance.
Immediate recognition

 The cost incurred is expensed outright

because of uncertainty of future
economic benefits or difficulty of reliably
associating certain costs with future
revenues.
 Examples include officers’ salaries and
most administrative expenses, and
advertising expenses.
The Account

 Basic summary device of accounting

 A separate account is maintained for each
element that appears in the statement of
financial position (assets, liabilities and
equity) and in the income statement
(income and expenses)
The Account

 Detailed record of the increases,

decreases and balance of each element
that appears in an entity’s financial
statements
“T” account

 The simplest form of the account

 Has three parts: accounts title, left side
or debit side and right side or credit side
The Accounting Equation

 Most basic tool of accounting

 Presents the resources controlled by the
enterprise, the present obligations and
the residual interests in the assets
 States that assets must always equal
liabilities and owner’s equity
 The Accounting Equation

Assets = Liabilities + Owner’s Equity

Debits and Credits –
The Double-Entry System
 The dual effects of a business transaction
is recorded.
 A debit side entry must have a
corresponding credit side transaction.
 For every transaction, there must be one
or more accounts debited and one or
more accounts credited.
Debits and Credits –
The Double-Entry System
 Each transaction affects at least two
accounts.
 The total debits for a transaction must
always equal the total credits.
Normal Balance of an Account
Increases Recorded Normal Balance
by
Account Category Debit Credit Debit Credit
Assets a a
Liabilities a a
Owner’s Equity
Owner’s Capital a a
Withdrawals a a
Income a a
Expenses a a
Types and Effects of
Transactions
 Although business entities engage in numerous
activities, all transactions can be classified into one of
four types, namely:
 Source of Assets (SA)
 Exchange of Assets (EA)
 Use of Assets (UA)
 Exchange of Claims (EC)
Types and Effects of
Transactions
 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.
Types and Effects of
Transactions
 Use of Assets (UA). An asset account
decreases and a corresponding claims
(liabilities or equity) account decreases.
 Exchange of Claims (EC). One claims
account increases and another claim
account decreases.
Types and Effects of
Transactions
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)
Types and Effects of
Transactions
5. Decrease in Assets = Decrease in
Owner’s Equity (UA)
6. Increase in Liabilities = Decrease
in Owner’s Equity (EC)
7. Decrease in Liabilities = Increase
in Owner’s Equity (EC)
8. Increase in One Liability =
Decrease in another Liability (EC)
Types and Effects of
Transactions
9. Increase in one Owner’s Equity =
Decrease in one Owner’s Equity
(EC)
Typical Account Titles Used
 Assets should only be classified into two:
current and non-current. Per revised
Philippine Accounting Standards (PAS) 1,
an entity shall classify assets as current
when:
a. It expects to realize the asset, or
intends to sell or consume it, in its
normal operating cycle;
Typical Account Titles Used
b. It holds the asset primarily for the
purpose of trading;
c. It expects to realize the asset within
twelve months after the reporting
period; pr
d. The asset is cash or a cash equivalent
(as defined in PAS 7) unless the asset
is restricted from being exchanged or
used to settle a liability for at least
twelve months after the reporting
period.
Typical Account Titles Used
 Assets
 Current Assets:
Cash and Cash Equivalents
Notes Receivable
Accounts Receivable
Inventories

Prepaid Expenses
Typical Account Titles Used
 Assets
 Non-Current Assets:
Property, Plant and Equipment
Accumulated Depreciation
Intangible Assets
Typical Account Titles Used
 Per revised PAS 1, an entity shall classify a
liability as current when:
a. It expects to settle a 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
reporting period; or
Typical Account Titles Used

d. The entity does not have an

unconditional right to defer
settlement of the liability for at least
twelve months after the reporting
period.
Typical Account Titles Used
 Current Liabilities
 Accounts Payable
 Notes Payable
 Accrued Liabilities
 Unearned Revenues
 Current Portion of Long Term Debt
Typical Account Titles Used

 Non-Current Liabilities
 Mortgage Payable
 Bonds Payable
Typical Account Titles Used

 Owner’s Equity
 Capital

 Withdrawals

 Income Summary
Typical Account Titles Used

 Income
 Service Income
 Sales
Typical Account Titles Used
 Expenses
 Cost of Sales
 Salaries or Wages Expense
 Rent Expense
 Telecommunications, Electricity, Fuel and
Water Expenses
 Supplies Expense
 Insurance Expense
Typical Account Titles Used

 Expenses
 Depreciation Expense
 Uncollectible Accounts Expense
 Interest Expense
CHART OF ACCOUNTS
A chart of accounts is an accounting tool that contains a list of all accounts used by
a business. Different companies use different account titles. The specific accounts
used by a company is detailed in its chart of accounts.
 Purpose of the Chart of Accounts
A chart of accounts contains all the accounts used by a business. It is a useful tool to
the accountant or bookkeeper in knowing what account titles to use in recording
transactions. Account titles used by companies vary and may depend upon the
industry of the business, the type of ownership, preferences, and other factors. The
use of a consistent set of accounts is needed for an effective and efficient
accounting system.
 Coding System
The accounts in the chart of accounts are grouped and each is given a code or
account number. The account number serves as a unique identifier or an "ID" for
each account.
A systematic coding or numbering system is often used. For example: asset accounts
start from account #001 to 199, liability accounts start from 200 to 299, capital
accounts use 300 to 399, revenue accounts from 400 to 499, and expense accounts
from 500 to 599.
Large businesses also use account numbers or codes that contain vital information.
For example, 501S may be assigned for salary expenses incurred by the selling
department, and 501A for salary expenses of the administrative office.
CHART OF ACCOUNTS EXAMPLE
CHART OF ACCOUNTS EXAMPLE
Rules of Debit and Credit

 Asset accounts normally have ______

balances. An increase in an asset is
recorded as a ________ while a
decrease in asset is recorded as a
________.
 Liability
accounts normally have ______
balances. An increase in a liability is
recorded by a ________ while a
decrease is entered as a ________.
Rules of Debit and Credit

 Theowner’s capital account has

a ______ balance. This account
increases on the ______ side and
decreases on the ______ side.
 Income accounts normally have
______ balances. These accounts
increase on the _____ side and
decrease on the _____ side.
Rules of Debit and Credit

 Expense accounts normally have

______ balances. These
accounts increase on the _____
side and decrease on the _____
side.
Accounting Events

 Which of the following events would be

recognized in the accounting records of
Rogelio Ceradoy Company?
a. Ceradoy Company offers to purchase a
piece of land for P1,400,000. There is a
high likelihood that the offer will be
accepted.
b. Ceradoy Company receives notice that
its rental for an office space will
increase from P50,000 to P60,000 per
month effective April 1.
Accounting Events

c. Ceradoy Company receives its

electricity bill for the month of April.
The bill is due May 9.
d. Ceradoy Company places an order for
an office equipment costing
P108,000.
e. The office equipment ordered in
letter d is delivered. Payment is not
due until September
Elements of Financial
Statements
Assets Liabilities Equity
a 760,000 360,000 ?
.
b 860,000 ? 592,000
.
c ? 108,000 760,000
.
d 636,600 376,240 ?
.
e ? 800,000 (100,000)
.
Elements of Financial
Statements
 Use the accounting equation to answer each of
the questions below.
1. At the beginning of the year, the assets of
Cleofe Arib Services were P360,000 and its
owner’s equity was P200,000. During the
year, assets increased by P120,000 and
liabilities increased by P20,000. What was
the owner’s equity at the end of the year?
Elements of Financial
Statements
2. At the beginning of the year, Cora Gabayan
Calling Station had liabilities of P100,000 and
owner’s equity of P96,000. If assets increased
by P40,000 and liabilities decreased by
P30,000, what was the owner’s equity at the
end of the year?
3. The liabilities of Lenore Loqueloque Company
equal one-third of the total assets and the
owner’s equity is P240,000. What is the
amount of liabilities?
 Elements of Financial
Statements
Income Expenses Profit (Loss)
a. 840,000 ? 360,000
b. 2,400,000 ? 540,000
c. 1,300,000 860,000 ?
d. ? 2,000,000 720,000
e. ? 1,800,000 (400,000)
Transaction Effects on the
Basic Accounting Model
 The following are the transactions of Virginia Yacapin
services:
a. Received cash as additional investment.
b. Purchased supplies on account.
c. Charged customers for services made on account.
d. Rendered services to cash customers.
Transaction Effects on the
Basic Accounting Model
e. Paid cash for rent on building.
f. Collected in account receivable in full.
g. Paid cash for supplies.
h. Returned supplies purchased on account.
i. Paid cash to settle accounts.
j. Paid cash to owner for personal use.
Transaction Effects on the
Basic Accounting Model
Required: For each transaction, indicate whether
assets, liabilities or owner’s equity increased (+),
decreased (-) or did not change (0) by placing the
appropriate sign in the appropriate column.
Classification of Events

 Indicate whether each of the below transactions is a

source of asset (SA), use of assets (UA), exchange of
assets (EA), or exchange of claims (EC) transaction.
a. Received cash investment from the owner.
b. Paid cash on accounts payable.
c. Collected cash from accounts receivable.
Classification of Events

d. Made cash distribution to owner.

e. Paid cash for rent expense.
f. Invested cash in time deposit.
g. Purchased land with cash.
h. Performed services for clients on account.
i. Incurred operating expenses on account.
j. Performed services for cash.
Recording Transactions in a
Financial Transaction Worksheet

 On December 1, 2015, Ludivinia Victorino opened a

videotape rental store, Cavite Video, by investing
P250,000 cash from her personal savings account.
During the month of December, the following
transactions took place:
Recording Transactions in a
Financial Transaction Worksheet
Dec 1 Acquired supplies on account, P67,000.
4 Acquired videotapes costing P235,000 on
account.
5 Paid P8,500 to creditors.
8 Received P78,000 cash from ACA Video for
rental fees.
11 Billed Video City for video rentals,
P105,000.
16 Paid salaries, P15,000.
Recording Transactions in a
Financial Transaction Worksheet

17 Collected P77,000 from Video

City.
23 Victorino withdrew P47,000 from
the business.
24 Paid rent for the month, P41,500.

30 Paid utilities bill for the month,

P17,500.
Recording Transactions in a
Financial Transaction Worksheet

 Required: Record the transactions for the month of

December 2015 using a financial transaction worksheet.
Use the following accounts: Cash, Accounts Receivable,
Supplies, Videotapes, Accounts Payable and Victorino,
Capital.
Recording Transactions in
T-Accounts
 Evelyn Tria is an experienced events planner. The
transactions and accounts for the business are as
follows:
a. Invested P100,000 in cash to start her own business.
b. Paid P5,000 for one month’s rent.
c. Bought office furniture for P15,000 in cash.
Recording Transactions in
T-Accounts
d. Received delivery of laptop computer
amounting to P100,000. Paid 50% down,
balance due in 30 days.
e. Performed services for P12,000 in cash.
f. Performed services for P10,800 on credit.
g. Acquired a fax machine for P7,500; paid
P3,000 in cash, balance due in 10 days.
h. Received P5,400 from clients on account.
i. Paid P10,000 for salaries.
Recording Transactions in
T-Accounts
j. Settled in full the P4,500 balance for the fax machine.
k. Received P7,000 in cash for services performed.
l. Performed services for P12,000 on credit.
m. Paid P1,350 for the monthly telephone bill.
n. Paid P2,400 for electric and water bills.
o. Collected P2,000 from clients on account.
p. Tria withdrew P7,000 in cash for personal expenses.
Recording Transactions in
T-Accounts
Required: With the aid of T-accounts, record the
transactions listed above. Use the following
accounts: Cash, Accounts Receivable, Office
Furniture, Office Equipment, Accounts
Payable, Tria, Capital, Tria, Withdrawals,
Consulting Revenues, Salaries Expense, Rent
Expense, Utilities Expense and Miscellaneous
Expense.
Recording Transactions in a
Financial Transaction Worksheet

Laarni Pascua, a veteran photographer,

opened a studio for her professional
practice on July 1. Transactions
completed during the month follow:
a. Deposited P146,200 in a bank account
in the name of the business, Pascua
PhotoProfiles.
Recording Transactions in a
Financial Transaction Worksheet

b. Boughtnew photography equipment in

account from Canon Equipment, P71,210.
c. Invested personal photography
equipment into the business,P51,620.
d. Paid office rent for the month, P5,500.
e. Bought photography supplies for cash,
P7,960.
Recording Transactions in a
Financial Transaction Worksheet

f. Paid
premium for insurance cover on
photography equipment, P1,240.
g. Received P8,960 as professional fees
for services rendered.
h. Paid salary of part-time assistant.
i. Received and paid bill for telephone
service, P640.
Recording Transactions in a
Financial Transaction Worksheet

Paid Canon Equipment part of the

j.
amount owed on the purchase of
photography equipment, P4,200.
k. Received P15,480 as professional fees
for services rendered.
l. Paid for minor repairs to photography
equipment, P760.
Recording Transactions in a
Financial Transaction Worksheet

m.Pascua withdrew cash for personal use,

P9,600.
Required: Record the transactions for the
month of July 2015 using a financial
transaction worksheet. If the owner’s
equity account is affected by a
transaction, identify it as revenue,
expense, investment or withdrawal.
Transaction Analysis

a. Received P260,000 cash from clients for services

rendered.
b. Paid P480,000 of salaries to employees.
c. Collected P120,000 from clients on account.
d. The owner, G. Curaming, withdrew P80,000 cash
for personal use.
Transaction Analysis

e. Purchased P140,000 of supplies on account.

f. Billed clients P180,000 for services rendered.
g. Paid P100,000 to suppliers on account.
Transaction Analysis

For each of the transactions for G. Curaming

Company, a sole proprietorship, answer the
following questions:
a. What are the two accounts affected by the
transaction?
b. What type of account is affected – asset,
liability, owner’s capital, owner’s withdrawal,
income or expense account?
Transaction Analysis

c. Should the account be increased or decreased?

d. Should the account be debited or credited?