Learning Objectives: After studying this chapter, you should be able to: L YO PRN s 10. 11. 12. ACCOUNTING FUNDAMENTALS The Accounting Equation and the Double-Entry System Distinguish between accounting event and transaction. Explain how an accounting information system helps the decision makers. Define the elements of financial statements. Describe the nature of the typical account titles used in recording transactions. Understand what is meant by the accounting equation and prove the validity of the "mirror image" concept. Describe the account (the simple T-Account) and its uses. Understand what i$ meant by the double-entry system. Explain how the double-entry system follows the rules of the accounting equation. Define debits and credits. Summarize the rules of debit and credit as applied to balance sheet and income statement accounts. 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. Distinguish between revenue and receipts. The starting point in the accounting process is an analysis of the transactions of a business. A business transaction is any financial event, that changes the resources of a firm. For example, purchases, sales, payments and receipt of cash are all business transactions. The accountant must look at the effects of each business transaction to decide what information to record and where to record it. accounting begins with an investigation Thus, the study of into, how the accountant analyzes business transactions.ACCOUNTING EVENTS AND TRANSACTIONS nges in an enterpri An accounting event is an economic occurrence that ee a ee me assets, liabilities, and/or equity. Events may be ces setae ceeraree equipment for the Production of goods or services. It Such as the purchase of raw materials from a supplier olves the transfer of something of ‘ons include acquiring assets from sing or selling goods and services, A transaction is @ particular kind of event that inv’ value between two entities, Examples of transacti owner(s), borrowing funds from creditors, and purcha: ACCOUNTING INFORMATION SYSTEM Every business organization must have an accounting information system which wiy Benerate reliable financial information needed by the decision-makers in a timely Tanner. The design and operation of a system must consider the anticipated users of the information and the types of decisions they are expected to make. The design of the system to meet the entity's information requirement depends on the fitm’s size, nature of operations, volume of transaction data, organizational structure, form of business and extent of government regulation. These will influence the way in. which information is accumulated and reported in the financial statements. An accounting information system is the combination of personnel, records and Procedures that a business uses to meet its need for financial information. Most firms have an accounting manual that specifies the policies and procedures to be followed in accumulating information within the accounting information syste details what events are to be recorded in the accounts, and wh information is to be classified and accumulated. An e system should achieve the following objectives: m. This ‘manual en and how the fective accounting information * To process the information effi ciently at the least Cost (cost-benefit principle). * To protect entity's assets, to ensure that dat: ms a are reliable, inimi wastes and the possibility of theft or fraud (control principle) to minimize * To be in harmony with the entity's organizatio, nal (compatibility principle). and human factors * To be able to accommodate growth in the volume organizational changes (flexibility principle), Of transactions and for 62The Accounting Process Economic Activities Accounting, Information Actions (decisions) Decision Makers The above diagram illustrates how economic activities flow into the accounting process, which produces accounting information. This information is then used by decision makers in making economic decisions and taking specific actions; thus, resulting in economic activities. The cycle goes on. ELEMENTS OF FINANCIAL STATEMENTS, Financial Position At regular intervals the business will review the status of the firm’s assets, liabilities, and ‘owner’s equity in'a formal report called a balance sheet, which is prepared to show the firm’s financial position on a given date. 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. In simple terms, assets are valuable resources owned by the entity. Assets include cash, cash equivalents, notes receivable, accounts receivable, inventories, prepaid expenses, property, plant and equipment, investments, intangible assets and other assets. 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. A plain definition would be—liabilities are obligations of the entity to outside parties who have furnished resources. Liabilities include notes payable, accounts payable, accrued liabilities, unearned revenues, mortgage payable, bonds payable and other debts of the enterprise. 1 63er deducting af ; Equi i : erprise afte ‘uity is the residual interest in the assets of the ente'? he form of busines lit i" tl liabilities. Equity may pertain to any ofthe following depending O° Organization: a it because thy \na sole proprietorship, there is only one owner’s equity accoun ere is only one owner, Ia partnership, an owner's equity account exists for each partner. In a corporation, owners’ equity, or shareholders’ oF stockholders equity, Consists of share capital or capital stock, retained earnings and reserves representing appropriations of retained earnings among others. Performance If there is an excess of revenue over expenses, the excess represents a profit. Making a Profit is the reason that people risk their money by investing it in a business. A firm’s accounting records show not. only increases and decreases in assets, liabilities, ang owner's equity but the detailed results of all transactions involving revenue: ang expenses. Income is increases in economic benefits during the accounting period in the form of inflows or enhancements of assets or decreases of liabilities that result in increases in equity, other than those relating to contributions from 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. Gains represent other items that meet the definition of income and may, or may not, arise in the course of the ordinary activities of an enterprise. Gains represent increases in economic benefits and as such are no different in nature from revenue. Hence, they are not regarded as constituting a separate element. Expenses are decreases in economic benefits during the accounting period in the form of outflows or depletions of assets or incurrences of liabilities that result in decreases in equity, other than those relating to distributions to equity participants The definition of expenses encompasses losses as well as those expenses that arise in the course of the ordinary activities of the enterprise. There are various classes of expenses but they are generally classified as Cost of services rendered or cost of goods sold, distribution costs or selling expenses, administrative expenses or other operating expenses: Losses represent other items that meet the definition of expense and may or may rot, arise in the course of the ordinary acti es of an enterprise. Losses represent 64decreases in economic benefits and as such are no different in nature from other expenses. Hence, they are not regarde d as a separate element. TYPICAL ACCOUNT TITLES USED BALANCE SHEET Accountants use’ special accountin, interests. F assets and financial int ig terms when they refer to property and financial or example, they refer to property that a business owns as the business's to the debts or obligations of the business as its liabilities. The owner's terest is called owner's equity; sometimes it is called proprietorship or net worth. Owner’s equity is the preferred term and is the term used throughout this book. 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; cc. 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. 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. Current Assets Cash. Cash is any medium of exchange that a bank will accept for deposit at face value. Itincludes coins, currency, checks, money orders, bank deposits and drafts. Cash Equivalents. These are short-term, highly liquid investments 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. 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. 65eh " Thesé are assets which are (a) held for sale efor ores “ n the process of production for such sale; oF (C) a of services * consumed in the production process or in the ren . Prepaid Expenses, asset because the expense. These economic benefit: Process; th Inventories, business; (b) Supplies to by ese ate expenses paid for byte busines in ENE tis 9g © business avoids having to pay cash in the tite ielude insurance and rent. These prepaid items represent futurg S—assets unt the time these start to contribute to the earning ese, then, become expenses, Non-current Assets Property, Plant and Equipment. These are tangible assets that are held by an CIR Drse for Use in the production or supply of goods or services, or for rent i others, or for administrative Purposes and which are expected to be used during more than one period. Included are such items xe land, building, machinery and equipment, furniture and fixtures, motor vehicles ana equipment. Accumulated Depreciation, depreciation charges. The related asset—equipment o 'tis a contra account that contains the sum of the periodic balance in this account’is deducted from the cost of the buildings—to obtain book value. Intangible Assets. These are identifiable, substance held for use in the production or s others, or for administrative purpdses. Thes: licenses, franchises, trademarks, Non-competition agreements. nonmonetary assets without physical supply of goods or services, for rental to e include goodwill, patents, copyrights, brand names, secret processes, subscription lists and Liabilities An entity shall classify a liability as current when: a. it expects to settle the liability in its normal of b. it holds the liability primarily for the purpose c. the liability is due to be settled within twel reporting period; or d. the entity does not have an unconditional ri liability for at least twelve months after the e perating cycle; of trading; 'Ve months after the end of the Isht to defer settlement of the 'nd of the reporting period ‘An entity shall classify all other liabilities as non-current, Current Liabilities Accounts Payable. This account represents the reverse +, receivable. By accepting the goods or services, the buyer a near future. lationship of the accounts '8rEes to pay for them in theNotes Payable. A note payable is like a note receivable but in a reverse sense. In the case of a note payable, the business entity is the maker of the note; that is, the business entity is the party who promises to pay the other party a specified amount of money on a specified future date. 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. 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. 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 are recorded in the drawing or withdrawal account rather than directly reducing the owner's equity account. Income Summary. Itis 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. 67NT income sTATEME! including claims to mone In s (inclu 7 come other or services or from the use les of B00" crease in istomer Or Client; fo, ices for a CU’ Service Income. Revenues earned by perforin ces bya laundry shop. it ices by a CPA firm, laun example, accounting services ya i ee example, sale of builtin or Revenue, or income, is the inflow of ipa 7 Such as sale made on credit) that results fro! anin of money or property. The result of revenue is ssets. handi Sales. Revenues earned as a result of sale of merc! materials by a construction supplies firm. Expenses sets, or the incurring of a An expense involves the outflow of money, the use of oe en anid services tsedin liability. Expenses include the costs of any materials, labor, supplies, 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" month pay, cost of living allowances and other related benefits, 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 pai id on insuran vehicle, health, life, fire, typhoon or flood) whi ice covera fe (e.g. on motor ch has expire Be (eg Depreciation Expense. The portion of the cost of at angible equipment) allocated or charged as expense during an asset ac (e.g. buildings and counting Period, Uncollectible Accounts Expense. The amount of FeCeivables acy: of collection and charged as expense during an accounting perio ted to be doubtful iod, Interest Expense. An expense related to use of borrowed fund. s, 62THE ACCOUNTING EQUATION Financial statements tell us how a business is performing. They are the final products of the accounting Process. But how do we arrive at the items and amounts that make UP the financial statements? The most basic tool of accounting is the accounting equation This equation presents the resources controlled by the enterprise, the present obligations of the enterprise and the residual interest in the assets. It states that assets must always equal liabilities and owner's equity. The basic accounting model is: Assets = Liabilities + Owner's Equity Note that the assets are on the left side of the equation opposite the liabilities and ‘owner's equity. This explains why increases and decreases in assets are recorded in the opposite manner (“mirror image”) as liabilities and owner's equity are recorded. The equation also explains why liabilities and owner's equity follow the same rules of debit and credit. The logic of debiting and crediting is related to the accounting equation. Transactions may require additions to both sides (eft and right sides), subtractions from both sides (left and right sides), or an addition and subtraction on the same side (left or right side), but in all cases the equality must be maintained. oe Owner's Assets Liabilities Equity 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. : 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 69and decreases in the increases lyze inet transaction worksheet which is a form used a ass el . assets, liabilities or owner's equity of a busine not provides 9 Wide Tange t ad ess is Owned by Dy Mlustration. San Mateo Accounting Services '5 prietorship busin Caballes, MBA. Thy bookkeeping and accounting services. This sole PIOPT™ py Glaiza ie Reynaldo San Mateo, is also a CPA. The office i public access. firm is located in a large office complex that has a firm harge accountin, its clients to ¢ ting Fe nonthly basis for the services Son ino prefer May Pay in cash 1s To simplify record keeping and billing, San Mateo ! services that are provided by the firm. He bills client they have received during the period. Custome! immediately after services are provided. it is created by a financial When a specific asset, liability or owner's equity richest using the appropriate transaction, it is listed in the financial transaction sera in’ parentheses During accounts. Note that the date of the transaction is enclo: ial transactions took place, October 2016, the first month of operations, various financi These transactions are described and analyzed as follows: initial Transactions Starting a Business Oct. 1 Reynaldo San Mateo obtained the funds to start the business by withdrawing P800,000 from his personal savings. He deposited the money in a new bank account that he opened in the name of the firm, San Mateo Accounting Services. San Mateo Accounting Services Financial Transaction Worksheet Month of October 2016 Assets * Uabilities + Owner's Equity Cash & San Mateo, Capital (a) __Pat 2 m4 P800,000 The financial transaction is analyzed as follows: . on ent separate and distinct from San Mateo's Personal financial affairs is * Aneconomic resource—cash of PR source of this asset is the contrib owner's equity. The owner's equi on rane in the business entity. The e , : ty account is San Mates ei Which represents + The dual nature of the transactio *. Lao + FHL + COOH. = 50,000 —— = This transaction is a payment on account. The effect ant "accounts payable, The decrease in the asset—cash and a decrease in: the liability . i se the Payment of cash on account has no effect on the asset—supplies becau: Payment does not increase or decrease the supplies available to the business. Effects of Revenue and Expenses Shortly after San Mateo opened his business on October 1, 2016, some of the tenants in the office complex where the business is located became San Mateo’s first clients. San Mateo 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, Selling Services on Credit Oct.13 San Mateo Accounting Services earned P70,000 ¢ of revenue from charge account clients. These clients are allowed 30 days to Pay. A Cash + Accounts + Supplies +’ Equipment os : oe oe Payable Capital Bal. 740,000 20,000 P100,000 (83) POO 60,000 00.0 Bal. __P740,000. + P70,000_ + __P20,000 + Fogg | os ~ Sesion | LeRaGo. + Fara SS * 2930,000 72The entity has performed services to clients so income should already be recognized. San Mateo is entitled to receive payment for these but the clients did not pay immediately. Performing the services creates an economic resource, the clients’ promise to pay the amount which is called accounts receivable. This transaction resulted to an increase in an asset—accounts receivable and an increase in owner's equity of P70,000. Employees’ Salaries Oct. 18 San Mateo Accounting Services hired an accounting staff on Oct. 1 to help in the business. The firm paid P25,000 in salaries for this employee and Glaiza Caballes. A = t +. © Cash + Accounts + Supplies + Equipment = Accounts + San Mateo, Receivable Payable Capital Bal. P740,000 70,000 20,000 100,000 60,000 870,000 (18) __ (25,000) (25,000) Bal. __P715,000_ + _P70,000_ +__P20,000 + P100,000_ = __P60,000_ + ___P845,000 This transaction resulted to a reduction in owner's equity as well as a reduction in cash. By providing their services to San Mateo for half-month, the employees have created for __ the business an expense—salaries expense. Collecting Receivables Oct:23 San Mateo Accounting Services received P30,000 from clients who had previously bought services on account. This cash was applied to. their accounts. A = L + OE Cash + Accounts + Supplies + Equipment = Accounts + San Mateo, Receivable Payable Capital Bal, P715,000 70,000 20,000 100,000 = — P60,000 845,000 (23) ___ 30,000 (30,000) . bet —p7a5;000” + —P40,000_ + 20,000, + 100,000 760,500_ + __P845,000 P905,000_ = __P905,000 Last Oct. 13, San Mateo billed clients for services already rendered. On Oct 23, the entity was able to collect P30,000 from them. The asset—cash is increased by P30,000. The business should not record service income on May 20 since it has already recorded the income last May 17. Total assets are unchanged. The business merely reduced one asset—-accounts receivable and increased another—cash. BSelling Services for Cash 00 in revenue from | of P210,0 Oct.27 San Mateo Accounting Services earned a total ices. . eeping servi clients who paid cash for accounting and bookkeeP! 2 L + OE A = Accounts + San Mateo, (ash + Accounts + supplies + Equipment Payable Capital Receivable 60,000 P B45, Bal. 745,000 P40,000 20,000 100,000 aw (27) _ 210,000 — Bal. _P955,000_ + P40,000_ + P20,000 + __P100,000 P4,115,000 210,00 760,000 + —PI,055.oq5~ 1,115,000 Ze entity earned service income by rendering accounting and bookkeeping Services to Its clients. San Mateo rendered his professional services and collected revenues in cash, The effect on the accounting equation is an increase in the asset—cash and an increase in owner's equity. Income increases owner's equity. This transaction caused the business to grow, as shown by the increase in total assets from P905,000 to P1,115,000. Utilities Expense ss Oct. 30 San Mateo Accounting Services received a P35,000 bill for the utilities that it had used during the month. A check was issued to pay the bill immediately, A a L + OF Cash + “Accounts + Supplies. + Equipment = ‘Accounts + San Mateo, Receivable Payable Capital Bal. P955,000 40,000 20,000 P100,000. = 60,000 1,055,000 (30) (35,000) * (35,000) Bal. __P920,000_ + P40,000_ + __P20,000_ + _P100,0007 = P60,000_ + P1,020,000 1,080,000 = 080,000" = FF 080,000 Expenses are recorded when they are incurred, Expenses can be Paid in cash when they occur, or they can be paid later. The payment for Utilities is an ex, October. It represented an outflow of resources and a reducti Expenses have the opposite effect of income; they cause th ‘shown by the smaller amount of total assets of P1,080,000, Pense for the month of tion of owner's equity. e business to shrink a Rent Expense Oct. 31. San Mateo Accounting Services issued a check as paymey = nt for October. The lease contract San Mateo signeq specified for suis nai ee P45,000. monthly 1 74A cash + = eet : ‘Accounts + Supplies + Equipment = Accounts + Receivable Payable Bal. _P920,000 , P. Pasi "40,000 20,000 100,000 60,000 Bal. __P875,000_ + —p200007 + ~p100,0007 = ~P60,000- + 920,000. + __P100,000 P60,000_ + P1,035,000_ *_ Pi,035,000 The rent ext Gayinent Bea of ss 009) is an expense for October. The treatment is similar to the . Thus, as in the previo the total assets to diminish. previous transaction, the payment for rent caused Effect of Owner's Withdrawals The owner of the business and the business are separate economic entities. If the owner's personal transactions are mixed up with those of the business, it will be very difficult to measure the performance of the firm. Oct. 31 Reynaldo San Mateo withdrew P150,000 in cash from the business to pay for personal expenses. A L + OE Cash + Accounts + Supplies + Equipment = Accounts + San Mateo, Receivable Payable Capital Bal. P875,000 40,000 20,000 00,000 = 60,000 975,000 (31) (150,000) (150,000) Bal. P725,000_ + 40,000 + 20,000 + 100,000 60,000. + 825,000 7885,000 = 885,000 On Oct. 1, San Mateo invested P800,000; both cash and owner's equity increased. That transaction was an investment by the owner and not an income-generating activity. San Mateo simply transferred funds from his personal account to the business. exactly the opposite. Withdrawals are not a business expense but 2 the business. Withdrawal of cash or other assets for the owner of the entity receives advance distribution withdrawal transaction resulted to a reduction in both Acash withdrawal is decrease of the owner’s equity in personal use is the way by which of the profits. The P150,000 cash cash and owner's equity. . THE ACCOUNT . a tool for analyzing the effects of business transactions. It d every transaction in the equation format if a ‘ad, separate written records called accounts are device of accounting. A separate account is The accounting equation is would be awkward, though, to recor business had many transactions. Instes kept. The account is the basic summary 5in maintained for each element that appear a equity) and in the income statement (inco vt defined as a detailed record of the increase5, ‘ ents. ‘ed, an that appears in an entity's financial statem ‘summarized, ifie information can be analyzed, recorded, classi Use of T-Accounts ~ The simplest form of the account is known as the a the letter "T". The account has three parts as sho eet (assets, liabilities ang sl fs). Thus, an account may be nd expen balance of each elemeny jecreases ®| kept so that financiay are counts ond reported balance di, count because of its similarity to "T" act below: Account Title Left side or | Ri Debit side ight side or Credit side 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 /east two accounts. The total debits for a transaction must always equal the total credits, An account is debited when an antount is ent credited when an amount is entered on the credit are Dr. and Cr., respectively. The account type determines how increases or assets’are recorded as debits'(on the left side are recorded as credits (on the right side), ‘ered on the left side of the account and right side. The abbreviations for debit and costes initare recorded. Increasesin of the a © account) while decreases in assets 0 inversely, incre in liabilitie owner's equity are recorded by credits and decreas, ases in liabilities and The rules of debit and credit for income and ._ Felationship of these accounts to owner’s equit expense decreases owner's equity. Hence, increas, and decreases as debits. Increases in expenses are credits. These are the rules of debit and credit. 1h, 76 eS are entered as debits. expense acc, ‘Ounts a he ity. Income incr re based on tl es in incomes Owner's equity and Tecorded ag ae recorded as credits following « celts and decreases as '8 Summarizes the rules:. Balance Sheet Accounts Assets Liabilities and Owner's Equity Debit Credit Debit Credit mu! 0 | | 0) «) { Increases Decreases Decreases Increases ‘Normal Balance Normal Balance Income Statement Accounts Debit for decreases in owner's equity Credit for increases in owner's equity Expenses Income Debit Credit Debit Credit (+) 0 | | a t Increases Decreases Decreases Increases Normal Balance Normal Balance 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 accounts normally have debit balances; liability, owner's equity and income accounts normally have credit balances. This result occurs because increases in an account are usually greater than or equal to decreases. Increases Recorded by Normal Balance Tccount Category Debit Credit Debit Credit Assets a v Liabilities a te v ‘Owner's Equity: ‘Owner's Capital fv v Withdrawals A v _ ; 7 +—] Income 3 v Expenses 7 : I Ilustration. Using T-accounts, the rules of debit and credit wil Mateo Accounting Services illustration. Before being recorded analyzed to determine which accounts must be increased or dg been*determined, the rules of debit and credit are applied increases and decreases to the accounts. to effect the a I be applied 4 a transactio, creased, 0 the San must be 7iness by withdrawing Papp, ea sney in 2 NeW Bank acg, the ting Services ‘Accoun : n Mateo thi Oct.2 San Mateo obtained the funds to start ted from his personal savings. He deposi es that he opened in the name of the firm, Assets (Increase) = Cunt ‘owner's Equity (Increase) san Mateo, Capital Cash Credit Debit (+) « 10-1 800,000 10-1 800,000 1's equity. According to thy This transaction increased both the asset—cash and ee s debit while an increase in rules of debit and credit, an increase in asset is rears debit cash and to credit San Owner's equity is recorded as credit; thus, the entry is to ide of the amounts for Mateo, Capital. The transaction dates are placed on the left si r reference. Oct. 3 Caballes bought a computer, a copy machine, a fax machine, calculators and other necessary equipment from M. Medina, Inc., at a cost of 100,000. 1, Medina, inc., agreed to allow 60 days for the firm to pay the bill. Assets (Increase) = Liabilities (Increase) Equipment Accounts Payable Debit Credit Debit Credit (+) ) () (+) 10-3 100,000 10-3 100,000 The asset—equipment is increase d by a debit of P100,00 accounts payable is increased bya Credit for the same am 10 while the liability account— lount, Oct.5 — Caballes placed an order for check with its order, Assets (Decrease) Cash Debit" Credit (+) () 10-1 800,000} 10-5. 20,000 78This transaction increased th are increased by debits and credited for P20,000. '@ asset—supplies and decreased the asset—cash. Assets decreased by credits; thus, supplies is debited and cash is Oct.9 — Caballes decided to Pay P40,000 to M. Medina, Inc., to reduce the firm’s debt to that business, Assets (Decrease) = Uabilities (Decrease) Cash Accounts Payable a Credit Debit Credit O oO (+ 10-1 800,000} 10-5 20,000 109 40,000 10-3 100,000 10-9 40,000 Assets are decreased by credits while liabilities are decreased by-debits. The transaction is recorded by debiting accounts payable and crediting cash for P40,000 each. Oct. 13 San Mateo Accounting Services earned P70,000 of revenue from charge account clients. These clients are allowed 30 days to pay. Assets (Increase) = Owner's Equity (Increase) Accounts Receivable Fees Revenues Debit Credit Debit Credit ) o oO. ) 10-13 70,000 10-13 70,000 Assets are increased by debits, income are increased by credits. Increases in income increase owner's equity. A debit of P70,000 to accounts receivable and a credit of P70,000 to the income account—fees revenues is needed. Oct.18 San Mateo Accounting Services hired an accounting staff on Oct. 1 to help in the business. The firm paid P25,000 in salaries for this employee and Glaiza Caballes. Assets (Decrease) = ‘Owner's Equity (Decrease) Cash Salaries Expense it i Debit Credit it Credit al 0 «) Oo 10-1 800,000] 10-5 20,000 10-18 25,000 10-9 40,000 10-18 25,000 79py credits. Hence, salaries re det ame amount. Increases j, Expenses are incr ike eased by debits and assets @ the si expense is debited for P25,000 and cash credited for salaries expense decrease owner's equity ; 00 from clients who hag p30, i Oct. 23 san Mateo Accounting Services received T=", was applied to thei Previously bought services on account accounts. Assets (Decrease) Assets (Increase) - ‘accounts Receivable Sash Credit Debit Credit (+) ) 10-1 800,000 | 10-5 20,000 10-23 30,000 | 10-9 40,000 10-18 25,000 Collections on account reduced the asset—accounts rebdivable but inet asset—cash. Assets are increased by debits and decreased by credits; thus, a debit to cash for P30,000 and a credit to accounts receivable for P30,000 is made. Oct. 27 San Mateo Accounting Services earned a total of P210,000 in revenue from clients who paid cash for accounting and bookkeeping services. ‘Owner's Equity (Increase) Assets (Increase) = Cash Fees Revenues Debit Credit Debit Credit () oO 0 (+) 10-1. 800,000 } 10-5 20,000 . 10-13 70,000 10-23 30,000] 10-9 40,000 10-27 210,000 10-27 210,000 | 10-18 25,000 The transaction increased the. asset—cash and increased the income account—fees revenues. Assets are increased by debits, income are increased by credits; hence, 2 debit of P210,000 to cash and a credit of P210,000 to fees revenues is made. Increases in income increase owner's equity. - Oct. 30, San Mateo Accounting Services received a P35,000 bill for the utilities that it had used during the month. A check was issued to pay the bill immediately. Assets (Decrease) = Ouners uty (Decrease) Cash Utilities Expense Debit Credit Debit ~ (+) O 4) ona 10-1 800,000 | 10-5 20,000 1030 35,000 8010-23 30,000 | 10-9 40,000 10-27 210,000 | 10-18 25,000 10-30 35,000 Expenses are increased by debits and assets are decreased by credits; therefore, utilities expense is debited and cash credited for P35,000. Increases in expenses decrease owner's equity. Oct. 31 San Mateo Accounting Services issued a check as payment for office rent for October. The lease contract San Mateo signed specified a monthly rent of 45,000. Assets (Decrease) = ‘Owner's Equity (Decrease) Cash Rent Expense Debit Credit Debit Credit (+) © ) Q 10-1 800,000 | 10-5 20,000 10-31 45,000 10-23 30,000 | 10-9 40,000 10-27 210,000 | 10-18 25,000 10-30 35,000 10-31 45,000 As in utilities expense, the payment for office rent for October requires a debit to an expense account and a credit to an asset account. Thus, rent expense is debited and cash credited for P45,000. Owner's equity decreases when expenses increase. Oct. 31 Reynaldo San Mateo withdrew P150,000 in cash from the business to pay for personal expenses. Assets (Decrease) ‘Owner's Equity (Decrease) Cash . ‘San Mateo, Withdrawals Debit Credit Debit Credit (+) oO (4) oO 10-1. 800,000 | 10-5 20,000 10-31. 150,000 10-23 30,000 | 10-9 40,000 10-27 210,000 | 10-18 * 25,000 10-30 35,000 10-31 45,000 10-31 150,000 Withdrawals are reductions of owner's equity but are not expenses of the business entity. A withdrawal is a personal transaction of the owner that Is exactly the opposite of an investment. This transaction increased the withdrawals account but reduced cash. Debits record increases in the withdrawals account and credits record decreases in asset 817 P150,000 each i, h fo dit to cas! accounts; thus, a debit to withdrawals and 2 <1 necessary, : S DISTINCTION BETWEEN REVENUES AND RECEIPT: : venues and receipts ag 7 en Fel . tion betwe' types of sales transactions At this point, it will be useful to learn the distinc . ws various 5 for “this year”: illustrated in the following table, The. table sho les revenue’ and classifies the effect of each on cash receipts and Sal This Year Sales sh Transaction Amount newts Revenue 200,000 1. Cash sales made this year. 200,000 CEO 0 2. Credit sales made last year; 300,000 300, cash received this year. 400,000 3. Credit sales made this year; 400,000 400,000 cash received this year. 100 4. Credit sales made this year; 100,000 One cash to be received next year. —_ Total _-P900,000_P700,000 EFFECTS OF TRANSACTIONS It will be beneficial in the long-term to be able to understand a classification approach that emphasizes the effects of accounting events rather than the recording procedures involved. 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 nine types of effects of transactions are as follows: 1. Increase in Asset = Increase in Liability 2. Increase in Asset = Increase in Owner’s Equity Increase in one Asset = Decrease in another Asset Decrease in Asset = Decrease in Liability Decrease in Asset = Decrease in Owner's Equity Increase in Liability = Decrease in Owner's Equity Increase in Owner's Equity = Decrease in Liability Increase in one Liability = Decrease in another Liability Increase in one Owner's Equity = Decrease in another Owner's Equity PEN an Ew