3 The Accounting Equation
3 The Accounting Equation
3 The Accounting Equation
Account Title
Left side or Debit side Right Side or Credit Side
The Accounting Equation
Income
Debit Credit
(-) (+)
Decrease Increase
Normal Balance
Accounting Events and Transaction
Assets should be classified only into two: current assets and non-current assets.
Per revised Philippine Accounting Standard (PAS) No. 1, an entity shall classify
assets as current when:
A. it expects to realize the asset, or it intends to sell or consume it, in its normal
operating cycle
B. it holds the assets primarily for the purpose of trading
C. it expects to realize the asset within twelve months after the reporting period; or
D. the asset is cash or a cash equivalent (as defined as PAS No. 7) unless the asset is
restricted from being exchanged or used to settle liability for at least twelve months
after the reporting period.
Operating Cycle
Operating cycle is the time between the acquisition of assets for processing
and their realization in cash or cash equivalent.
When the entity’s normal operating cycle is not clearly identifiable, it is
assumed to be twelve months
Current Assets
Cash – is any medium of exchange that a bank will accept for deposit at face
value. It includes coins, currency, checks, money orders, bank deposits and
drafts.
Cash Equivalent – per PAS No. 7, these are short-term highly liquid
investments that are readily convertible to known amounts of cash and which
are subject to all insignificant risk of change in value.
Notes 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
promissory notes.
Current Assets
Inventories – Per PAS No. 2, 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 process or in
the rendering of services.
Prepaid expenses – These are expenses paid for by the business in advance. It
is an asset because the business avoids having to pay cash in the future for a
specific expense. These includes insurance and rent. These prepaid items
represent future economic benefits – assets – until the time these start to
contribute to the earning process; these, then, become expenses.
Non-current assets
Property, Plant and Equipment – per PAS No. 16, these are tangible assets that
are held by an enterprise for use in the production or supply of goods or services,
or for rental to others, or for administrative purposes and which are expected to
be used during more than one period. Included are such items as land, building,
machinery and equipment, furniture and fixtures, motor vehicles and
equipment.
Accumulated Depreciation – it is contra account that contains the sum of the
periodic depreciation charges. The balance in this account is deducted from the
cost of the related asset to obtain book value.
Intangible Assets – Per PAS No. 38, these are identifiable, nonmonetary assets,
without physical substance held for use in the production or supply of goods or
services, for rental to others, or for administrative purposes. These includes
goodwill, patents, copyrights, licenses, franchises, trademarks, brand names,
secret processes, subscription lists, and non-competition agreements.
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 assets 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 (from the Latin capitalis, meaning “property”). 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 and other assets that the owner may withdraw from
the business ultimately reduce it. This account title bears the name of the
owner. (example: Castino, Capital)
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. (example: Castino, Withdrawal)
Income Summary – It is a temporary account used at the end of the
accounting period to close income and expenses. This account shows the
profit or loss for the period before closing to the capital account.
Income
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 and Wages Expense. Includes all payments as a result of an employer-
employee relationship such as salaries and wages, 13 th month pay, cost of
living allowances and other related benefits
Telecommunications, electricity, fuel and water expenses – Expenses related
to use of telecommunication facilities, consumption of electricity, fuel and
water
Rent expense – Expenses for space, equipment and other asset rentals
Supplies expense – Expense of using supplies (e.g. office supplies) in the
conduct of daily business.
Expenses
Business transaction
Is the occurrence of an event or a condition that affects financial position and can
be reliably recorded
Financial Transaction worksheet
The financial transactions will be analyzed by means of a financial transaction
worksheet which is a form used to analyze increases and decreases in the assets,
liabilities or owner’s equity of a business entity.
Distinction between Revenues and
Receipts
Transaction Amount Cash Receipts Sales Revenue
(This Year) (This Year)
1. Cash sales made 200,000 200,000 200,000
this year
2. Credit sales 300,000 300,000 -
made last year;
cash received this
year
3. Credit sales 400,000 400,000 400,000
made this year;
cash received this
year
4. Credit sales 100,000 - 100,000
made this year;
cash to be
received next year