LESSON 1.1.

Introduction to Accounting

Accounting: An Overview
Accounting is the art of analyzing financial transactions and economic events,
5 recording them, classifying them into accounts, summarizing them, reporting, and
interpreting the results (Frias, 2016).
According to Cabrera (2015), accounting’s function is “to provide quantitative
information primarily financial in nature about economic entities that is intended to be
useful in making economic decisions.”
10 Accounting is a service activity and is systematic in nature. It follows a specific
process.
The Accounting Process
From the given definition of accounting, the accounting process can be determined.
The first step is analyzing. An accountant must look at the transactions entered
15 into, economic event that have taken place, and determine the effects on the business.
Generally, business transactions are supported by documentary pieces of evidence or
proofs. Example of these documents are official receipts, sales invoice, purchase order,
and others.
The second step in the accounting process is recording. Recording involves writing
20 the effects of the transactions and events which have been analyzed. Recording may be
done manually or be encoded with the use of computers or data-processing machines. It
involves inputting of information in the accounting books called journals.
After recording, the transactions must be classified. Classifying is the sorting or
grouping of similar transactions and events into specific account titles. This process
25 involves transferring the journalized transactions into books called ledgers.
The fourth step is summarizing. Summarizing is the process that involves grouping
together the various accounts referred to in the classifying process. This is where the
accounts are grouped into assets, liabilities, owner’s equity, revenue, cost and expenses.
The summaries are taken from the accounts in the general ledger.
30 The next step is to report. Reporting involves the preparation of financial
summaries called financial statements. These are written or documentary media where
the (1) results of the operation (income statement), (2) financial position (balance
sheet), and (3) cash flows (cash flows statement) are communicated to the users of
information.
35 The accounting process does not stop at reporting. The reports generated must be
interpreted. Interpreting directs attention to the significance of various matters and
 relationships. This step involves the computation of relationship of figures from the
financial reports and schedules. It is a combination of figures and narrations based on
the figures presented. The relationships may be in percent or in ratios, may be within
the financial report, or may be one report in relation to another report.
5

History of Accounting: The Double Entry System

The first description of double entry system appeared more than 500 years ago in a
mathematics book written by Fra Luca Pacioli.
Double entry means value received and value parted with. It means that for every
10 transaction or economic event, there are at least two effects in the accounting equation.
An increase or decrease in any asset, liability, owner’s equity, revenue, or expense is
always accompanied by an offsetting change within the basic accounting elements.
Double entry accounting is a processing system that involves entering the two
effects of every transaction. The method is orderly, simple, and flexible.
15 When records are not balanced, something must be wrong. This gives a warning to
the accountant to review the records, find the error, and make the necessary correction.
However, “in balance” does not necessarily mean “free from error.”

LESSON 2.1. Users of Accounting Information

20

Accounting Information: An Overview

Financial statements are prepared by entities whether for profit or nonprofit. These
entities may be sole proprietorships, partnerships, or corporations. The management is
primarily responsible for the preparation and presentation of financial statements.
25 The financial statement and business records may be used by different parties as
basis in making business decisions. To further understand why it is important to keep
business records, we must first know the different users of accounting information.
External Users vs. Internal Users
The external users of accounting information are those people who are outside the
30 business entity or organization while the internal users are those within the business
organization. External users include potential investors, lenders, suppliers, customers,
the government, and the public. On the other hand, internal users include current
investors or owners, employees, and the management (Cabrera, 2015).

35
 External Users
Potential investors use accounting information to determine whether or not to
invest in equity ownership in the business. They generally assess the company’s ability
to pay dividends or returns to investors. Lenders seek to determine the ability of
5 borrowers to be on time in paying the loans granted to them by the creditors. On the
other hand, suppliers use accounting information to determine the ability of the
customer (the company) to pay debts as they fall due, and the ability of the customer to
remain as a continuing buyer. Customers determine the ability of the enterprise to be a
continuing source of supply and the ability of the company to exist over a long period of
10 time. Government agencies seek to determine the capacity of the enterprise to pay
taxes and its tax compliance. They use accounting information to provide the bases for
monitoring and regulating the activities of enterprises and individuals. The public seeks
to determine the activities of the enterprise and contribution to the economy in the
form of (a) number of employees, (b) ownership of assets, (c) prices of their products,
15 (d) patronage of local suppliers, and (e) patronage by the customers (Cabrera, 2015).

Internal Users
Current investors or owners seek to determine whether to buy more, hold, or sell
their investments in equity ownership in the business by assessing the ability of the
20 company to pay dividends or returns to its investors. Employees seek to determine
stability and profitability of employers (the company) and the stability of the employer
to pay salaries and fringe benefits. The management uses accounting information to
determine the activities of the enterprise for planning, organizing, leading, and
controlling (Cabrera, 2015).
25

LESSON 3.1. Accounting Concepts and Principles

There are eight (8) basic accounting concepts and principles. These are the Entity
Concept, Exchange Price or Cost Concept, Going Concern Concept, Accrual Concept,
Objectivity Concept, Disclosure Concept, Reporting Period or Periodicity Concept, and
30 Unit of Measure.
The Entity Concept explains that the business is a separate entity or being from its
owner(s).
The Exchange Price or Cost Concept states that “all acquisition of items should be
recorded and retained in books at cost.” It requires the numbers on the financial
35 statement be based on actual expenses from business transactions incurred during the
period.
 On the other hand, the Going Concern assumes that during and beyond the next
fiscal period a company will complete its current plans, use its existing assets and
continue to meet its financial obligations. It assumes that the entity will remain in
business for the foreseeable future.
5 The Accrual Concept requires recording revenues when they are earned and not
when they are received in cash, and recording expenses when they are incurred and not
when they are paid.
The Objectivity Concept requires that the financial statements of an organization
must be based on solid evidence.
10 The Disclosure Concept requires the management to report all relevant information
about the company’s operations to creditors and investors in the financial statements
and footnotes.
The Reporting Period or Periodicity Concept assumes that a company’s complex
and ongoing activities can be divided up and reported in annual, quarterly, and monthly
15 financial statements.

It is a standard convention in accounting under which all transactions must be

consistently recorded using the same currency. This is according to the Unit of
Measure concept (Cabrera, 2015; Frias, 2016).
20

LESSON 4.1: THE ACCOUNTING EQUATION AND THE TYPES OF MAJOR ACCOUNTS
The Accounting Equation
The basic accounting equation is as follows:
Assets = Liabilities + Equity
25 Since equity can be computed by adding the capital account and income and then
deducting the expenses, the accounting equation can also be written as
Assets = Liabilities + Capital + Income - Expenses

Assets
30 Assets are resources controlled by the entity as a result of past events from which
future economic benefits are expected to flow to the entity.
There are different key terms for assets which we must understand. Amortization is
defined as the decrease in value of intangible assets. Depreciation, on the other hand, is
the decrease in value of tangible assets while appreciation is the increase in value of
35 tangible assets.
Assets can be classified as current or non-current. Current assets can easily be
 liquidated and are as good as cash. Non-current assets will take time and effort to be
liquidated. They are also called fixed assets.
There are different accounts which can be classified as current assets. First is
cash. Cash includes cash on hand and cash in bank. It must be expressed in a single
5 currency.
Accounts receivable is a right to collect payment; it is an oral promise from the
customer. Evidences include invoice and acknowledgement receipt. On the other
hand, notes receivable is a customer’s written promise to pay. It has a date of payment
and/or interest.
10 Supplies are used for operations and thus decrease upon use. Prepaid expenses are
payments made in advance for goods and services which are expected to be provided or
used up in the future. Examples are prepaid rent and prepaid cellphone load.
Inventory is not applicable for consignment businesses. It is only applicable for a
manufacturing business. The different types of inventory are: raw materials (ex.
15 ingredients), work-in-progress (unfinished products), and finished goods (products ready
for selling).
For the non-current assets, we have the following: land, building, equipment,
furniture and fixtures, patent, and other assets.
Land is not applicable for renting or leasing. It is appreciated (value goes up through
20 time). Building, on the other hand, is depreciated (decreases in value) due to lapse of
time, wear and tear, and obsolescence. Buildings usually have a lifespan of 20 years.
Equipment are also depreciated due to lapse of time, wear and tear, and
obsolescence. When buying equipment, it is important to look for materiality value.
Furniture are movable properties while fixtures are “fixed” or not movable. They
25 are also subject for depreciation.
Patent is considered as an intangible asset and includes intellectual property rights
(e.g. formula, designs).
There also other assets which are depreciated due to lapse of time, wear and tear, and
obsolescence. Cars have a lifespan of 5 years while gadgets have a lifespan of 3 years
30 only.
Liabilities
Liabilities are present obligations of the entity arising from past events, the
settlement of which is expected to result in an outflow from the entity of resources
embodying economic activities. These are normally settled by paying cash or rendering
35 service.
Liabilities can also be classified as current or non-current. Current liabilities are
 payable within a year while non-current liabilities have long-term (more than 1 year)
payment arrangements with the creditor. Current liabilities include accounts payable,
notes payable, salaries payable, accrued expense, and unearned income. On the other
hand, non-current liabilities include loans or mortgage payable and notes payable (if the
5 note is payable for more than a year).
Accounts payable usually has credit terms and is normally obtained from suppliers.
It is the opposite of accounts receivable. On the other hand, notes payable involves a
written promissory note from the entity.
Salaries payable are acquired due to cut off.
10 Accrued expense is an accounting expense recognized in the books before it is paid
for. It is typically periodic and is the opposite of prepaid expenses. It is also known as
accrued liabilities. Examples include regular rent and postpaid plans for mobile phones
and the Internet.
Unearned income is the liability account that reports the amounts received in
15 advance from customers for goods and/or services. It decreases when the goods and
services are provided and in turn, the revenue increases.
Loans or mortgage payable involve notes from the bank and usually involve
collateral.
Equity
20 Equity is the residual interest in the assets of the entity after deducting all its
liabilities. There are different terms used for equity depending on the form of the
business. For sole proprietorship, we use the term owner’s equity; for partnership,
partners’ equity; for corporation, shareholders’ equity.
There are different factors affecting equity. These are investment, withdrawal,
25 income, and expenses.
Investment is defined as the owner’s personal assets given to the
business. Withdrawal, on the other hand, accounts for the business asset taken by the
owner.
Revenue or income is defined as the inflow of cash or other assets coming from
30 customers for goods sold or services rendered to them. There are different terms used
for income depending on the type of business operation. For service business, we use
the term revenue while for merchandising and manufacturing we use the term sales.
Expenses are assets consumed or services of other business or persons used up in
order to earn revenue. For assets consumed, examples are supplies expense, cost of
35 goods sold, and depreciation expense. For services used up, examples include utilities
expense, salaries expense, and rent expense.
5

LESSON 5.1: BOOKS OF ACCOUNTS

10 Books of Accounts are a set of books used by accountants to record transactions
and events that are financial in nature. Transactions are exchanges which involve value
received and value parted with.
The books of accounts have money columns where corresponding amounts per
account title are written. A dash (-) in the centavo column represents “00”.
15 There are two major types of book of accounts: the journal and the ledger.
Journal
The general journal is called the book of original entry. It is where transactions are
initially recorded. A pre-printed general journal book has 100 pages with 37 lines per
page. Journal entries are written using the following format:
20 1. On the first line of the date column of a journal page, write the year, followed by
month, and the day of the month.
2. On the same line as the month and date, write the account or accounts to be debited.
3. Leave about two spaces as indention and then write the account or accounts to be
credited.
25 4. Write the peso amount or amounts on the debit column in line with the account or
accounts debited.
5. In the same way, write the amount or amounts credited.
6. Next to the line of the credit entries, leave about four spaces for indention and write
a brief explanation about the transaction.
30 7. On the posting reference column, write the page of the general ledger account where
the journal entry is posted.
A two-column journal can be used for all journal entries. However, the number or
volume of entries may make it inconvenient to record all transactions in the two-column
journal. In addition, the volume of transactions may call for division of work in the
35 recording process. The use of only one journal does not lend to itself to the sharing of
the tasks in bookkeeping.
 When special journals are in use, the recording may be distributed to bookkeepers
or computer encoders who will work on similar documents in batches.
Even when only one bookkeeper or encoder is tasked to do all the recording with
the use of special journals, he is able to maximize the use of time, concentrating on
5 similar transactions in one processing. Common special journals include:
1. Sales Journal or Sales Book
2. Purchases Journal or Purchases Book
3. Cash Receipts Journal or Cash Receipts Book
4. Cash Disbursement Journal or Cash Disbursement Book
10 Ledger
The general ledger is also called the book of final entry. The process of transferring
transactions from the general journal to the general ledger is called posting. A pre-
printed general ledger has 100 pages with 37 lines per page. Entries in the general
ledger follow this format:
15 1. Write the account title and the page (refer to the Chart of Accounts).
2. Write the column headings: Date, Particulars, Folio or Posting Reference, Debit, and
Credit. The left side of the ledger will be for debit while the right side will be for credit.
3. Similar to the general journal, write the year on the first line.
4. Write the month and day of the transaction.
20 5. Write the corresponding description.
6. On the folio or PR column, write the general journal page in which the transaction
posted can be seen.

Subsidiary ledgers are records of the increase (pluses), decreases (minuses), and

25 balances of certain general ledger accounts like:
1. Accounts Receivable – for customers (debtors) account)
2. Accounts Payable – for suppliers (creditors) account
Customer’s accounts and creditor’s accounts are to be updated daily to facilitate
collections and payment respectively.
30 For the Accounts Receivable Subsidiary Ledger, set up a ledger page for each
customer. Write the customer’s name and address. Assign a page number or reference.
Label the column with these headings:
 Date – for date of supporting documents
 Sales Invoice Number – for the sale on account (debit)
35  Official Receipt Number – for cash collection (credit)
 Debit Amount – for increase
  Credit Amount – for decrease
 Balance – net of increase and decrease
For the Accounts Payable Subsidiary Ledger, set up a ledger page for each creditor.
Write the customer’s name and address. Assign a page number or reference. Label the
5 column with these headings:
 Date – for date of supporting documents
 Purchase Invoice Number – for purchase on account
 Check/Cash Voucher Number – for payment
 Credit Amount – for increase
10  Debit Amount – for decrease
 Balance – net of increase and decrease

LESSON 6.1: ANALYSIS OF BUSINESS TRANSACTIONS

Business Transactions
15 Are economic events which affect the financial position of a business. These involve
an exchange of values (ex. Cash paid to acquire a motor vehicle).
A business transaction may also be an economic event like (1) the loss of accounts
receivable due to bad debts (2) loss due calamities like flood, earthquake, theft or it may
be (3) the depreciation from use of equipment
20 Business transactions are recorded in terms of money. Money or monetary unit is
common to all business transactions. It is a practical unit of measure.
Analysis of Transactions is the process of studying a transaction to determine its
economic effect (in terms of money) on the entity’s accounting equation. The economic
effect may be an increase or decrease in the assets, liabilities, and owner’s equity. After
25 every analysis, the equality in accounting equation is maintained because for every
transaction there is an increase and a compensating decrease.
Normal Balances
Are used as basis for the analysis of the effect of a business transaction to the major
accounts. If there is an increase in the account follow the normal balance. If there is a
30 decrease in the account , take the reverse of the normal balance. Here are the normal
balances for each major account.
1. Assets- Debit
2. Liabilities- Credit
3. Owner’s Equity- Credit
35 4. Withdrawal- Debit
5. Revenue/income- Credit
 6. Expenses- Debit
Rules of Debits
1. Debit an asset account for increase in asset
2. Debit liability account for decrease in liability.
5 3. Debit owner’s equity account for decrease in owner’s equity (withdrawal).
4. Debit income for decrease in income.
5. Debit expenses account for increase in expense.
Rules of Credits
1. Credit an asset account for decrease in asset.
10 2. Credit liability account for increase in liability.
3. Credit owner’s equity account for increase in owner’s equity (additional investment).
4. Credit income for increase in income.
5. Credit expense account for decrease in expense.
Case Analysis: ML Machine Shop
15 Below are six business transactions for ML Machine Shop
1. Owner Mary Ligon invested P200,000 in ML Machine Shop.
2. The business borrowed P100,000 from Asia Bank.
3. The business bought office equipment and paid P40,000 cash.
4. The business bought P50,000 furniture on credit.
20 5. Customer Leslie Joe paid P100,000 for car painting service.
6. The machine shop promised to pay P40,000 rent for the shop space rented from
owners of lot and building.
In the first transaction, the business received cash of P200,000 from Mary Ligon.
Thus, there is an increase in Assets. We follow the normal balance and debit cash. There
25 is also an increase in the owner’s equity as Mary Ligon invested in the business.
Following the normal balances, we credit Mary Ligon Capital (investment account).
For the second transaction, the business obtained money by getting a loan from the
bank. There is an increase in asset (debit cash) and an increase in liability (credit Loans
Payable).
30 The third transaction involved payment using cash. There is an increase in the asset
as the business purchased Office Equipment (debit office equipment) and a
corresponding decrease in the asset Cash (credit cash) thus, the net change for the
assets is zero.
The fourth transaction involves a purchase through credit. There is an increase in
35 Asset (debit Furniture and Fixtures) and an increase in liability (credit Accounts Payable)
For the fifth transaction, the customer paid cash for the services rendered. Thus,
 the business earned revenue. Therefore, we must record an increase in Assets (debit
Cash) and an increase in Owner’s Equity (credit Revenue)
In the last transaction, ML Machine Shop had a liability for the rent. Rent is
considered an accrued expense and can be accounted as Rent Payable. There is an
5 increase in Liabilities (credit Rent Payable) and a decrease in Owner’s Equity (debit Rent
Expense)
Table 6.1: Analysis of Business Transactions for ML Machine Shop
Transactions Assets Liabilities Owner’s Equity
1 Increase of P200,000 0 Increase of P200,000
(debit cash) (credit Mary Ligon
Capital)
2 Increase of P100,000 Increase of P100,000 0
(debit cash) (credit Loans Payable)
3 Increase of P40,000 0 0
(debit Office Equipment)
Decrease of P40,000
(credit cash)
4 Increase of P50,000 Increase of P50,000 0
(debit Furniture and (credit Accounts Payable)
Fixture)
5 Increase of P100,000 0 Increase of P100,000
(debit cash) (credit Revenue)
6 0 Increase of P40,000 Decrease of P40,000
(credit Rent Payable) (debit Rent Expense)

10

15

20
5

10

15

20