CHAPTER 1

INTRODUCTION TO ACCOUNTING

Accounting – An Information System

Every individual or group in society must make economic decisions about

the future. One example is a manager of a company who has to determine which
product or products are not saleable. This information is necessary for the
manager who has to decide whether to stop selling them to customers. Others will
make investments only if a company is financially sound. National and local
governments need accounting information for tax purposes. Non-profit entities
such as churches, civic and charitable organizations need meaningful and easily
understood economic and accounting information for planning and proper
implementation of their programs. Because accountants are known for their
financial and analytical capabilities, they are often asked to analyze the available
financial data for clues that will serve as guides to the future.

External and Internal Users of Accounting Information

The users of financial information can be classified as either external or

internal decision makers.

External decision makers are people who lack direct access to the
information generated by the internal operations of a company. Examples are
present shareholders, potential investors, creditors, suppliers, rank-and-file
employees, customers, brokers, underwriters, labor unions, trade associations, and
the public. These external decision makers use accounting information in deciding
whether to invest in the business entity, extend it credit, or even to do business
with it.

The process of developing and reporting accounting information to external

decision makers is called financial accounting. The reports are called general-
purpose financial statements composed of the balance sheet, the income statement
and the statement of cash flows.

Internal decision makers are the managers of an entity. These managers are
responsible for planning the future of the business, implementing those plans,
controlling the daily operations of the business and reporting information to other
operating officers.

The process of developing and reporting financial information for internal

users is called management accounting. The reports are called special-purpose
reports.

Forms of Business Organization

Single or Sole Proprietorship - A business owned by one individual only. It is

the most basic form of business organization. It is the easiest form of business to
organize since there are only minimal legal requirements to follow. It is less
complicated to operate and decisions are made faster since only one owner decides
and all profits will go to one owner only.

Partnership - An association of two or more persons who bind themselves to

contribute money, property, or industry to a common fund, with the intention of
dividing the profits among themselves. Partnerships are governed by the Civil
Code of the Philippines. A partnership is easier to organize than a corporation.
Better decisions are made since there are two or more owners. It is also less
complicated to operate than a corporation.

Corporation - An artificial being created by operation of law, having the right of

succession and the powers and attributes expressly authorized by law or incident to
its existence. Corporation is the most complex form of business organization. The
owners of a corporation are shareholders. Certificates of stock are issued to
evidence ownership in a stock corporation.

Types of Business Operations

Service business - This is the simplest form of business. This business renders
services to customers or clients in exchange for a fee. Examples are operators of
public transport, beauty parlors, security agencies, janitorial services and
professionals who practice their professions like doctors, nurses, accountants,
lawyers, and engineers.

Merchandising business - This business buys goods or commodities from

suppliers and sells the same at a profit. Examples are sari-sari stores, groceries,
supermarkets, hardwares, drug stores, car dealers, real estate dealers and appliance
stores.

Manufacturing business - This business is quite similar to a merchandising

business in that both sell the goods at a profit. The difference is that a
manufacturing business actually produces the goods that it sells to its customers.

Accounting Defined

Accounting definition changes. The traditional definition of accounting is:

Accounting is the art of recording, classifying, and summarizing, in a

significant manner, and in terms of money, transactions and events which are in
part at least of a financial character, and interpreting the results thereof.

Other definition of accounting is:

Accounting is a service activity. Its function is to provide quantitative

information, primarily financial in nature, about economic entities, that is intended
to be useful in making economic decisions.

Specialized Accounting Fields

Public Accounting

Accountants and their staff who offer services on a fee basis are said to be
engaged in public accounting. In public accounting, an accountant may practice as
an individual or as a member of a public accounting firm. Certified Public
Accountants (CPAs) are public accountants who have met the required education,
experience and examination requirements for obtaining a CPA certificate.

Services rendered by CPAs in public practice are:

 Auditing involves the independent examination of financial

statements by CPAs for the purpose of expressing an opinion on the
fairness of the financial statements.

 Tax services include not only the preparation of tax returns, but also
include tax planning for various clients.
  Management advisory services or management consulting involves
providing services to clients on matters relating to the accounting
records, budgeting, cost accounting, marketing, organizational
planning, personnel and recruiting, production and many other
business areas.

Private Accounting

Accountants employed by a business firm or a not-for-profit organization are

said to be engaged in private accounting. They may be called controller or the
chief accountant in a business. They may also be employed as vice-presidents for
finance, cost accountant, internal auditors or even budget director.

Accounting Education

Accountants employed as instructors, professors, reviewers or researchers

are in the field of accounting education. Only Certified Public Accountants can
engage in this field of endeavor.

Government

Accountants employed in any governmental units are said to be in the field

of government accounting. They may be hired or employed as auditor, budget
officer or even consultant in government units like the Securities and Exchange
Commission, the Bureau of Internal Revenue, the Bureau of Customs, the
Department of Finance or the Department of Budget and Management.

Accounting Development

Accounting traces its roots to the Middle East region, where as early as 8500
BC, tradesmen use clay objects to represent commodities such as flocks of sheep,
jars of spices and oil, bolts of clothing and other goods. Some archeologists later
unearthed clay tablets marred with symbols and other writings and interpreted
them to mean records of goods sold and other statistics kept at that time. 1

The ancient civilizations of Babylon, Greece and Egypt also used clay
tablets ( in later years, papyri were used as the medium for record keeping ). These
records show wage payments, material requisitions and costs of labor, which only
shows that accounting has already been in use even during Biblical times. 1

In 1494, Friar Luca Pacioli wrote a book which contains discussions on the
double-entry bookkeeping system. The book was entitled Summa de Arithmetica,
Geometria, Proportioni et Proportionalita (Everything about Arithmetic, Geometry,
Proportions and Proportionlity) and it summarizes the existing mathematical
knowledge at the time. Friar Pacioli was considered the father of Double-Entry
Bookkeeping.1

In the mid-18th to the mid-19th centuries, the Industrial Revolution altered

the way goods are produced from the artisan/craftsman method to the assembly-
line method. Cost accounting, the specialized field of accounting which deals with
the assignment of costs to products, emerged during this period. 1

The corporate form of business organization was created to accommodate

the need for increasingly large amounts of funds which are required to finance the
expansion of business during the period. 1

FINANCIAL STATEMENTS

The principal financial statements of a proprietorship are the statement of

comprehensive income, the statement of changes in owner’s equity, the statement
of financial position, and the statement of cash flows.

Statement of Comprehensive Income – A summary of the revenue and expenses

for a specific period of time, such as a month or a year.

Statement of Changes in Owner’s Equity – A summary of the changes in the

owner’s equity that have occurred during a specific period of time, such as a month
or a year.

1
National Geographic Magazine; Wikipedia.com;Image of Luca Pacioli
Statement of Financial Position – A list of the assets, liabilities, and owner’s
equity as of a specific date, usually at the close of the last day of a month or a year.

Statement of Cash Flows – A summary of the cash receipts and cash payments
for a specific period of time, such as a month or a year.

Elements of the Financial Statements

Statement of Financial Position

Assets - An 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.

Liabilities - A 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.

Owner’s Equity - This is the residual interest in the assets of the

enterprise after deducting all its liabilities.

Statement of Comprehensive Income

Income - Refers to increases in economic benefits during the

accounting period in the form of inflows or enhancements
of assets or decreases of liabilities that result in increase
in equity, other than those relating to contributions from
equity participants.
Expenses - Refer to decreases in economic benefits during the
accounting period in the form of outflows or depletion of
assets or increases of liabilities that result in decrease in
equity, other than those relating to distributions to 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. Gain represents other items that meet the definition of income and may, or
may not, arise in the course of the ordinary activities of an enterprise.

The definition of expenses encompasses losses as well as those expenses that

arise in the course of the ordinary activities of the enterprise. Losses represent
other items that meet the definition of expenses and may, or may not, arise in the
course of the ordinary activities of the enterprise.

Examples of Elements of the Financial Statements

Statement of Financial Position

 Assets

Cash - Cash is any medium of exchange that the

bank will accept at face value. It includes
coins and currencies. Checks, money orders,
bank drafts, and bank deposits.
Accounts Receivable - These are claims against debtors or
customers arising from the provision of
services or delivery of goods on credit.

Notes Receivable - These are claims against debtors or

customers evidenced by a written promise to
pay called 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.

Prepaid Expenses - These are expenses paid for by the business

in advance. Examples are Prepaid Rent,
Prepaid Insurance and Prepaid Interest.

Property, Plant and Equipment

- These are tangible assets held by a business
for use in the production of goods or
services, or for rental to others, or for
administrative purposes and which are
expected to be used during more than one
accounting period. Examples are: Land,
Building, Equipment, Truck, Automobile,
Furniture and Fixtures.
 Liabilities

Accounts Payable - These are amounts due to creditors arising

from the purchase of merchandise or services
on account.

Notes Payable - These are amounts due to creditors

evidenced by a written promise to pay.

Accrued Liabilities - These are amounts owed to others for unpaid

expenses. Examples are Salaries Payable,
Taxes Payable, Interest Payable and Utilities
Payable.

Unearned Revenues - These are revenues collected by the business

in advance. When a business receives
payments before providing services to
customers, there is an obligation created on
the part of the business to provide services.
Once the business provides the services, the
advance collections from customers will
become earned and will be recorded as
income.

Mortgage Payable - These are long-term debts secured by certain

assets as collateral.

 Owner’s Equity

Capital - This is used to record the initial or original

investments of the owner. Any additional
investments are also recorded in the Capital
account. Net income increases Capital while
net loss decreases Capital. Examples are
Juan Cruz, Capital; Jose Santos, Capital
 Withdrawals - Another term is Drawing or Personal. This is
used to record any withdrawal of cash or
other assets of the business by the owner
intended for any personal or non-business
use. Examples are: Juan Cruz, Drawing;
Jose Santos, Drawing.

Statement of Comprehensive Income

 Income

Service Income, Fees Income - These are revenues earned by

rendering services to customers or
clients.

Sales - These are revenues earned by selling

merchandise to customers.

 Expenses

Rent Expense - This is used to record expense for

leased office spaces, building or
other assets.

Supplies Expense - This is used to record supplies used

by the business.

Depreciation Expense - This is used to record portion of the

cost of a tangible asset like building
allocated as expense during an
accounting period.
Interest Expense - This is used to record an expense
for using borrowed funds.

Uncollectible Accounts Expense- Other terms are Provision for

Doubtful Accounts, Bad Debts
Expense or Doubtful Accounts
Expense. This is used to record the
amount of receivables estimated to
be uncollectible and charged to
expense during an accounting
period.
 DISCUSSION QUESTIONS

1. Describe accounting as an information system.

2. Explain the two types of financial information users.

3. What is financial accounting?

4. What is management accounting?

5. What are the three forms of business organization? Explain each.

6. What are the types of business as to operation? Explain each.

7. Define accounting.

8. What are business transactions?

9. What are assets, liabilities and owner’s equity? Give examples of each.

10. What are income and expenses? Give examples of each.

11. What are the four financial statements? Explain each.

12. What are the specialized accounting fields? Explain each.

 EXERCISES

TRUE OR FALSE

Encircle T if the statement is true, F if the statement is false.

T F 1. A merchandising business is one which buys goods from

suppliers and sells them at a profit.

T F 2. Manufacturing businesses always earn more than

merchandising business.

T F 3. One of the advantages of a partnership over a single

proprietorship is the higher amount of capital that it can
accumulate during the formation stage.

T F 4. A sole proprietor is both the owner and manager of his

business.

T F 5. A partnership is always owned by two persons.

T F 6. All partnerships have an unlimited liability.

T F 7. Unlimited liability means that the personal properties of

general partners may be used in the settlement of the
liabilities of the partnership.

T F 8. The owners of a partnership are called stockholders.

T F 9. Stockholders have limited liability.

T F 10. A corporation may be formed to provide services to the

public.
 IDENTIFICATION

_________________ 1. A type of business that changes basic inputs

into products that are sold to individual
customers.

_________________ 2. A type of business that purchases products

from other businesses and sells them to
customers.

_________________ 3. A business owned by one individual.

_________________ 4. A business owned by two or more individuals.

_________________ 5. An artificial being created by operation of law

having the right of succession and the powers
and attributes expressly authorized by law or
incident to its existence.

_________________ 6. Resources controlled by a business.

_________________ 7. The rights of creditors that represent debts of

the business.

_________________ 8. The rights of the owners.

_________________ 9. Assets = Liabilities + Owner’s Equity.

_________________ 10. The liability created by purchase on account.

_________________ 11. Items such as supplies that will be used in the

business in the future.
_________________ 12. A claim against the customer.

_________________ 13. Long-term debt secured by certain assets as

collateral.

_________________ 14. Another term is Drawing or Personal.

_________________ 15. The process of developing and reporting

accounting information to external decision
makers.

_________________ 16. People who lack direct access to the

information generated by the internal
operations of a company.

_________________ 17. Process of developing and reporting financial

information for internal users.

_________________ 18. These are the internal decision makers.

_________________ 19. A service activity whose function is to provide

quantitative information, primarily financial in
nature, about economic entities, that is
intended to be useful in making economic
decisions.

_________________ 20. Reports prepared by financial accounting.

 CHAPTER 2
ANALYZING BUSINESS TRANSACTIONS

Generally Accepted Accounting Principles

Because it is important that all who will receive accounting reports be able
to interpret them, a set of practices were developed that will provide guidelines for
financial accounting. The term used to describe these practices is generally
accepted accounting principles (GAAP).

Generally accepted accounting principles encompass the conventions, rules,

and procedures necessary to define accepted accounting practice at a particular
time. These “principles” are not like the unchangeable laws of nature found in
chemistry or physics. They are developed by accountants and businesses to serve
the needs of decision makers, and they can be changed or altered as better methods
are developed or as circumstances change.

A few examples of these generally accepted accounting principles are:

1. Business Entity Concept

Under the business entity concept, the activities of a business are recorded
separately from the activities of the owner or owners. This concept is important
because it limits the economic data in the accounting system to data related directly
to the activities of the business. Thus, the accountant for a business with one
owner (a proprietorship) would record the activities of the business only, not the
personal activities, property, or debts of the owner.
2. Going Concern or Continuity Assumption

To prepare financial statements for an accounting period, the accountant

must make an assumption about the ability of the business to continue.
Specifically, the accountant assumes that unless there is evidence to the contrary,
the business entity will continue to operate for an indefinite period. This method
of dealing with the issue is called the going concern or continuity assumption. The
justification for all the techniques of income measurement rests on this assumption
of continuity.

3. Time Period Assumption

The operating results of any business cannot be known with certainty until
the company has completed its life span and ceased doing business. But financial
reports covering shorter time periods are needed because external decision makers
require timely accounting information to satisfy their analytical needs. Because of
this, businesses have imposed the time-period assumption, requiring that changes
in a business’s financial position be reported over a series of shorter time periods
like annually, semi-annually, quarterly or monthly. An annual accounting period is
the most common which can be a calendar year or a fiscal year. Example: January
1, 2016 to December 31, 2016 is a calendar year; July 1, 2016 to June 30, 2016 is
a fiscal year.

4. Unit-of-Measure Assumption

The unit-of-measure assumption specifies that accounting should measure

and report the results of a business’s economic activities in terms of a monetary
unit such as the Philippine peso. The assumption recognizes that the use of a
standard monetary unit throughout all financial statements is an effective means for
aggregating and communicating accounting information. It is a standard practice
to ignore changes in the purchasing power of a peso.
5. Accrual Basis

Under this basis, the effects of transactions and other events are recognized
when they occur (and not as cash or its equivalent is received or paid) and they are
recorded in the books of accounts or accounting records and reported in the
financial statements of the periods to which they relate.

In contrast, revenues and expenses may be accounted for on a cash received

and cash paid basis. This practice is known as the cash basis of accounting.
Under this method, revenues are reported as earned in the period in which cash is
received; expenses are reported in the period in which cash is paid.

Example: Atty. Zachary started to practice his profession. On January 5,

Atty. Zachary rendered legal services to XYZ Company and received P 10,000 as
payment from XYZ Company on January 15.

Under the accrual basis, Atty. Zachary will recognize income on January 5,
the date when he rendered his services to XYZ Company. Under the cash basis,
Atty. Zachary will recognize income on January 15, the date when he received the
cash from XYZ Company.

So, we can see from the example, that under the cash basis, revenue is
recorded on the date the cash is received while under the accrual basis, revenue is
recorded on the date the service is rendered.

BUSINESS TRANSACTIONS

A transaction is an economic event or condition that directly changes an

entity’s financial condition or directly affects its results of operations. It is an
exchange of values stated in terms of money between two parties. Business
entities may have hundreds or even thousands of transactions every day. These
transactions are the raw materials of accounting reports.

All business transactions can be stated in terms of changes in the elements of

the accounting equation.
The Accounting Equation

Business transactions are analyzed, recorded, classified and summarized to

be able to determine the financial position and the result of operation of a business.
Analysis of business transactions can be done through the accounting equation.

What is the basic accounting equation? This equation states that:

ASSETS = LIABILITIES + OWNER’S EQUITY

The two sides of the equation must always be equal or “in balance”.

Other ways of expressing the equation are:

OWNER’S EQUITY = ASSETS - LIABILITIES

LIABILITIES = ASSETS - OWNER’S EQUITY

Some Illustrative Transactions

Let us now examine the effect of some of the most common business
transactions on the accounting equation. Suppose that Juan Cruz finished law
school, passed the bar examination and immediately set up his own law practice in
June, 2021.

During the first month of operation, he completed the following transactions:

June 1 Began the law practice by investing P 200,000 in a bank

account established for the business.

Assets = Liabilities + Owner’s Equity

J. Cruz, Type of OE
Cash = Liabilities + Capital Transaction
P200,000 = P200,000 Owner’s Investment
=========== ===========
 June 5 Purchased a law library for P 90,000 cash.

Assets = Liabilities + Owner’s Equity

J. Cruz, Type of OE
Cash Law Library = Liabilities + Capital Transaction
Bal. P200,000 P200,000
- 90,000 + 90,000 ________
Bal. P110,000 P 90,000 P200,000
============= ============ ==============

June 10 Purchased office supplies for P 4,000 on credit.

Assets = Liabilities + Owner’s Equity

Cash Office Law Accounts J. Cruz,
Supplies Library = Payable Capital Type of OE Transaction
Bal P110,000 P 90,000 P200,000
+P 4,000 = +P 4,000
________________________ __________________ ______________________ _____________________ _________________________

Bal P110,000 P 4,000 P 90,000 P 4,000 P200,000

========== ======== ========= ======== ==========

June 15 Accepted P 50,000 in cash for completing a contract.

Assets = Liabilities + Owner’s Equity

Cash Office Law Accounts J. Cruz,
Supplies Library = Payable Capital Type of OE Transaction
Bal P110,000 P 4,000 P 90,000 P 4,000 P200,000
+ 50,000 + 50,000 Service Revenue
________________________ __________________ ______________________ _____________________ _________________________

Bal P160,000 P 4,000 P 90,000 P 4,000 P250,000

========== ======== ========= ======== ==========

June 18 Billed clients P150,000 for services rendered during the month

Assets = Liabilities + Owner’s Equity

Accounts Office Law Accounts J. Cruz, Type of OE
Cash Receivable Supplies Library Payable Capital Transaction
Bal P160,000 P 4,000 P90,000 P 4,000 P250,000
+P150,000 +150,000 Service Revenue
_______________________ __________________________ ____________________ ______________________ _____________________ _______________________

Bal P160,000 P150,000 P 4,000 P90,000 P 4,000 P400,000

========== =========== ======== ========= ========= ==========
 June 20 Paid P2,000 of the amount owed for office supplies.

Assets = Liabilities + Owner’s Equity

Accounts Office Law Accounts J. Cruz, Type of OE
Cash Receivable Supplies Library Payable Capital Transaction
Bal P160,000 P150,000 P 4,000 P90,000 P 4,000 P400,000
- 2,000 - 2,000
_______________________ __________________________ ____________________ ______________________ _____________________ _______________________

Bal P158,000 P150,000 P 4,000 P90,000 P 2,000 P400,000

========== =========== ======== ========= ========= ==========

June 25 Received P100,000 in cash from clients who had been

previously billed for services rendered.

Assets = Liabilities + Owner’s Equity

Accounts Office Law Accounts J. Cruz, Type of OE
Cash Receivable Supplies Library Payable Capital Transaction
Bal P158,000 P150,000 P 4,000 P90,000 P 2,000 P400,000
+100,000 -100,000
_______________________ __________________________ ____________________ ______________________ _____________________ _______________________

Bal P258,000 P 50,000 P 4,000 P90,000 P 2,000 P400,000

========== =========== ======== ========= ========= ==========

June 28 Paid rent expense for the month in the amount of P30,000.

Assets = Liabilities + Owner’s Equity

Accounts Office Law Accounts J. Cruz, Type of OE
Cash Receivable Supplies Library Payable Capital Transaction
Bal P258,000 P 50,000 P 4,000 P90,000 P 2,000 P400,000
- 30,000 - 30,000 Rent Expense
_______________________ __________________________ ____________________ ______________________ _____________________ _______________________

Bal P228,000 P 50,000 P 4,000 P90,000 P 2,000 P370,000

========== =========== ======== ========= ========= ==========

June 30 Received the following bills for the month of June:

Meralco-P5,000 PLDT-P4,000
These bills will be paid next month.

Assets = Liabilities + Owner’s Equity

Accounts Office Law Accounts J. Cruz, Type of OE
Cash Receivable Supplies Library Payable Capital Transaction
Bal P228,000 P 50,000 P 4,000 P90,000 P 2,000 P370,000
+ 9,000 - 9,000 Utilities Expense
_______________________ __________________________ ____________________ ______________________ _____________________ _______________________

Bal P228,000 P 50,000 P 4,000 P90,000 P11,000 P361,000

========== =========== ======== ========= ========= ==========
 June 30 Paid salary of secretary for the month, P12,000.

Assets = Liabilities + Owner’s Equity

Accounts Office Law Accounts J. Cruz, Type of OE
Cash Receivable Supplies Library Payable Capital Transaction
Bal P228,000 P 50,000 P 4,000 P90,000 P11,000 P361,000
- 12,000 - 12,000 Salary Expense
_______________________ __________________________ ____________________ ______________________ _____________________ _______________________

Bal P216,000 P 50,000 P 4,000 P90,000 P11,000 P349,000

========== =========== ======== ========= ========= ==========

June 30 Withdrew P40,000 from the practice for personal use.

Assets = Liabilities + Owner’s Equity

Accounts Office Law Accounts J. Cruz, Type of OE
Cash Receivable Supplies Library Payable Capital Transaction
Bal P216,000 P 50,000 P 4,000 P90,000 P11,000 P349,000
- 40,000 - 40,000 Owner’s Withdrawal
_______________________ __________________________ ____________________ ______________________ _____________________ _______________________

Bal P176,000 P 50,000 P 4,000 P90,000 P11,000 P309,000

========== =========== ======== ========= ========= ==========

The financial statements of Juan Cruz for the month of June are shown
below:

Juan Cruz
Statement of Comprehensive Income
For the Month Ended June 30, 2021

Service Income P 200,000

Less: Expenses
Rent Expense P 30,000
Salary Expense 12,000
Utilities Expense 9,000
__________________________________
51,000
_______________________________________

Net Income P 149,000

==================
 Juan Cruz
Statement of Changes in Owner’s Equity
For the Month Ended June 30, 2021

Capital, June 1, 2016 P 0

Add: Investment P 200,000
Net Income 149,000 349,000

Less Withdrawals 40,000

Capital, June 30, 2016 P 309,000
==================

Juan Cruz
Statement of Financial Position
June 30, 2021

ASSETS
Cash P 176,000
Accounts Receivable 50,000
Office Supplies 4,000
Law Library 90,000
_________________

Total Assets P 320,000

==============

LIABILITIES
Accounts Payable P 11,000

CAPITAL
Juan Cruz, Capital 309,000
_________________

Total Liabilities and Capital P 320,000

===============
 Juan Cruz
Statement of Cash Flows
For the Month Ended June 30, 2021

Cash flows from operating activities:

Cash received from customers P 150,000
Deduct cash payments for expenses and
payments to creditors 44,000
Net cash flow from operating activities P 106,000

Cash flows from investing activities:

Cash payments for acquisition of law
Library ( 90,000)

Cash flows from financing activities:

Cash received as owner’s investment P 200,000
Deduct cash withdrawal by owner 40,000
Net cash flow from financing activities 160,000

Net cash flow and June 30, 2016 Cash Balance P 176,000
===========

When analyzing business transactions using the accounting equation, the

following points should be considered:

1) Determine whose point of view the transactions are to be analyzed.

2) Determine the account titles affected by the transaction. At least two

account titles may be affected by every transaction.

3) Determine the effect of the transaction on the account titles. The

effect can either be an increase or a decrease.

4) Determine the amount of the transaction.

5) Always remember that using this method of analysis, the left side of
the equation should always equal the right side.
 DISCUSSION QUESTIONS

1. What are generally accepted accounting principles?

2. Give some examples of GAAP.

3. What is business entity concept? Explain.

4. What is going concern or continuity assumption? Explain.

5. What is time-period assumption? Explain.

6. What is unit-of-measure assumption? Explain.

7. What is accrual basis? How will you distinguish accrual basis from
cash basis?

8. What are business transactions?

9. What is the basic accounting equation?

10. What are the other ways of expressing the accounting equation?

11. What points must be considered when analyzing business transactions

using the accounting equation?

12. What two types of transactions increase the owner’s equity of a

proprietorship?

13. What two types of transactions decrease the owner’s equity of a

proprietorship?
 EXERCISES
Exercise 2-1

Ms. Joy Bautista operates her printing business. Summary of financial data for
June are presented in equation form as follows. Each line designated by a number
indicates the effect of a transaction on the accounting equation. Each increase and
decrease in owner’s equity, except transaction (5), affects net income.

Office
Cash + Supplies + Equipment = Liabilities + Owner’s Equity
Bal. 3,000 375 15,000 3,750 14,625
1 + 7,500 + 7,500
2 - 1,000 + 1,000
3 - 5,625 - 5,625
4 + 250 + 250
5 - 750 - 750
6 - 2,650 - 2,650
7 - 400 - 400
_________________ _______________ _________________ _______________ _____________________

Bal 475 225 16,000 1,350 15,350

============ =========== ========== ======== ==========

a. What is the amount of net decrease in cash during the month? ____________

b. What is the amount of net increase in Owner’s Equity during

the month? ____________

c. What is the amount of the net income for the month? _______________

Exercise 2-2

Use the accounting equation to answer each question below. Show any
calculations you make.

1. The assets of Alaska Company are P650,000, and the owner’s equity is
P360,000. What is the amount of the liabilities? ____________

2. The liabilities and owner’s equity of Cleveland Company are P95,000 and
P32,000, respectively. What is the amount of the assets? _____________
3. The liabilities of Lakers Company equal to one-third of the total assets,
and owner’s equity is P240,000. What is the amount of the liabilities?
What is the amount of the assets? _________________

4. At the beginning of the year, Miami Company’s assets were P110,000,

and its owner’s equity was P50,000. During the year, assets increased
P30,000, and liabilities decreased P5,000. What was the owner’s equity
at the end of the year? _____________

Exercise 2-3

Identify the following transactions by the type of owner’s equity transaction by

marking each as either an owner’s equity investment ( I ), owner’s withdrawal (W),
revenue ( R ), expense ( E ), or not an owner’s equity transaction ( NOE ).

______ a. Received cash for providing a service.

______ b. Paid cash to employee for services performed.

______ c. Paid cash to purchase equipment.

______ d. Took assets out of business for personal use.

______ e. Performed a service and received a promise for payment.

______ f. Received cash from a customer previously billed for a

service.

______ g. Paid service station for gasoline.

______ h. Transferred assets to the business from a personal account.

Exercise 2-4

Identify each of the following transactions as to:

A. Increase in one asset, decrease in another asset

B. Increase in an asset, increase in liability
C. Increase in an asset, increase in capital
D. Decrease in an asset, decrease in liability
E. Decrease in an asset, decrease in capital
F. Increase in liability, decrease in capital

During the month of August, West Company had the following transactions:

_______ a. Paid salaries for August, P 18,000.

_______ b. Purchased equipment on credit, P 30,000.

_______ c. Purchased supplies with cash, P 1,000.

_______ d. Additional investment by owner, P 40,000.

_______ e. Received payment for services performed, P 6,000.

_______ f. Paid for part of equipment previously purchased on credit,

P 10,000.

_______ g. Billed customers for services performed, P 16,000.

_______ h. Withdrew cash, P 15,000.

_______ i. Received payment from customers billed previously,

P 3,000.

_______ j. Received utility bill, P 700.

Exercise 2-5

The total assets and liabilities at the beginning and end of the year for Max
Company are listed below:

Assets Liabilities
Beginning of the year P 220,000 P 90,000
End of the year 400,000 240,000

Determine Max Company’s net income for the year under each of the following
alternatives:

1. The owner made no investments in the business or withdrawals from

the business during the year. _________

2. The owner made no investments in the business, but the owner

withdrew P 44,000 during the year. __________

3. The owner made an investment of P26,000, but made no withdrawals

during the year. __________

4. The owner made an investment of P20,000, and withdrew P44,000

during the year. _________

Exercise 2-6

Mel Jason is the owner and operator of MJ Laundry. At the end of its accounting
period, December 31, 2020, MJ Laundry has assets of P 162,500 and liabilities of
P 71,000. Using the accounting equation and considering each case independently,
determine the following amounts:

a. Mel Jason, Capital as of December 31, 2020. __________

b. Mel Jason, Capital as of December 31, 2021, assuming that assets

increased by P 42,000 and liabilities increased by P 18,500 during
2021. _________
 c. Mel Jason, Capital as of December 31, 2021, assuming that assets
decreased by P4,000 and liabilities increased by P8,500 during
2021. __________

d. Mel Jason, Capital as of December 31, 2021, assuming that assets

increased by P37,500 and liabilities decreased by P8,750 during
2021. __________

e. Net income ( or net loss ) during 2021, assuming that as of

December 31, 2021, assets were P 212,500, liabilities were P 52,500
and there were no additional investments or withdrawals. ________

Exercise 2-7

The following selected transactions were completed by Mayday’s Catering Service

during September of 2021.

1. Received cash for providing catering services, P 24,300.

3. Received cash from owner as an investment, P 150,000.
9. Paid advertising expense. P 5,000.
11. Billed customers for catering services on account, P 15,000.
15. Bought supplies on account, P 12,000.
19. Paid rent for the month, P 7,000.
22. Received cash from customers on account, P 7,500.
25. Paid creditors on account, P 8,000.
28. Bought equipment for cash, P 20,000.
30. The owner withdrew P 15,000 for personal use.
Required:
1) Using the accounting equation, analyze the above transactions of
Mayday’s Catering Service.

Assets = Liabilities + Owner’s Equity

Accounts Office Accounts J. Abad, Type of OE
Date Cash Receivable Supplies Equipment = Payable + Capital Transaction

2) Prepare the Statement of Comprehensive Income for the month ended

September 30, 2021.

3) Prepare Statement of Owner’s Equity for the month ended September

30, 2021.

4) Prepare a Statement of Financial Position as of September 30, 2021.

5) Prepare statement of cash flows for the month ended September 30,
2021.