Basic Structure of Accounting Principle ( Accounting)

BASIC STRUCTURE OF ACCOUNTING PRINCIPLES

Chapter 3

Learning objectives:

Paminaw Mo Mga Classmate :D

2To have a better

understanding of the rules of

debit and credit.

3

To gain knowledge of the two-fold affect of the double-entry

bookkeeping. 1

To have a knowledge of the

basic and expanded form of

accounting equation.

ACCOUNTING EQUATIONBusiness transaction affect the assets, liabilities, and proprietorship of the business. These effects can be expressed in the accounting equation:

ASSETS = EQUITES

THE TOTAL ASSETS OWNED OR BELONGING TO AN ENTITY SHOULD ALWAYS EQUAL THE TOTAL FINANCIAL CLAIMS.

Liabilities - represent such claim or interest of a person over the assets of the business proprietorship is the owner’s or owners’ interest in the business.

Equity - is the right, claim or interest of a person over the assets of the business.

Equities represent the sources of assets. The equity of outside sources of assets is referred to as creditors equity, provided by the internal source is known as owner’s equity.

Liabilities

Owner’s Equity

EQUITIES

It is noted that in all of the above accounting equation liabilities is represented ahead of the owner’s equity. The reason for this is that the creditors do have a preferential claim on the assets over the owner of the business. In other words, owner’s claim is only secondary to the creditor's claim. In the event that business ceases its operation, claim of the creditor should be satisfy before any assets is said to taken by the owner as a return of investment. Hence, the accounting equation arises which stresses the importance of the creditors

It is noted that in all of the above accounting equation liabilities is represented ahead of the owner’s equity. The reason for this is that the creditors do have a preferential claim on the assets over the owner of the business. In other words, owner’s claim is only secondary to the creditor's claim. In the event that business ceases its operation, claim of the creditor should be satisfy before any assets is said to taken by the owner as a return of investment. Hence, the accounting equation arises which stresses the importance of the creditors

THE EXPANDED ACCOUNTING EQUATIONSo far, all possible transactions that may occur in a business are analyzed with the use of the basic accounting equation. However, the use of the basic accounting alone cannot provide information about the profitability if the business. Fortunately, the same framework can also be used to further analyze transaction involving revenues and expenses, two vital information that is needed for the preparation of the income statement.

ASSETS = LIABILITIES + OWNER’S EQUITY

ASSETS = LIABILITIES – WITHDRAWALS + REVENUES - EXPENSES

CAPITALThis is the right of the owner for cash

or other assets invested or put into the business. This is used to present the amount of the beginning capital plus any additional investment made by

the owner.

WITHDRAWALS

The owner may need to withdraw cash or other assets taken from the

business for his personal needs that do not relate to the business. It is a subdivisions of owner’s equity that

records personal expenses outside the normal operation of the business.

Is also known as income consist of assets received by any entity

arising from the sale of goods or performance of services to the

costumer. The increased in assets also increased the owner’s equity.

REVENUES

THE T – ACCOUNT

Business transaction causes increase and decrease in the accounting value. To record these changes, a business firm makes use of accounts. An Account is an accounting device use to summarize the increases and decreases in the assets, liability and proprietorship of the business.

The account has two sides. The left side of any account is called the debit side, while the right side is the credit side.

Name of item

Right sideLeft side

“To debit” is to enter the amount on the left side of a T-account and “To credit” is to enter any

amount on the right side of a T-account.

Increase and Decrease side of a T-accountSince assets are on the left side of the accounting equation, increases in the assets items are placed on the left or debit side of the assets account, and decreases in assets on the opposite or credit side. On the other hand, since liabilities and proprietorship are on the right side of the accounting equation, increases in the liability and proprietorship items are placed on the right or credit side of the accounts , and decreases of the opposite or debit side.

Income and expenses affects proprietorship. The income earned increases proprietorship.Expenses affects proprietorship..

T - accounts

AssetsDebit Increase

Debit Increase

Credit Increase

Credit Increase

Debit Decrease

Debit Decrease

Credit Increase

Debit Decrease

Credit Decrease

Credit Decrease

Liabilities

Proprietorship

Expenses Income

THE RULES OF DEBIT AND CREDIT“To debit” and “To credit” , however, should not be confused with “To increase” and “To decrease”. To debit and to credit may mean neither a decrease or increase depending on the accounts affected.

1. Increase assets2. Decrease liabilities3. Decrease proprietorship due to: a. Withdrawal of assets by the owner b. Increase in expenses and loses c. Decrease in income

1. Decrease assets2. Increase in liabilities3. Increase proprietorship due to: a. Investment by the owner b. Decrease in expenses and losses. c. Increase in income.

DEBIT TO: CREDIT TO:

1. Dual Effects

Each recorded event affect at

least two items in the financial accounting record. The double-entry system of

recording is based on this

principle.

2. Increases in assets

a.exchanges in which assets are required;

b.investments of assets in the enterprise by owners;

c.nonreciprocal transfer of assets to an enterprise by other than the owners;

d.shifts of cost to different assets categories in production; and

e.Occasionally, increases in amounts ascribed to produce assets.

arise from:

3. Decreases in assets

a. exchanges in which assets are disposed of;

b. withdrawals of assets in the enterprise by owners;

c. nonreciprocal transfer of assets to an enterprise by other than the owners;

d. certain external events other than transfers that reduce the market price or utility of assets;

e. shifts or allocation of cost of different assets categories or to expenses in production; and

f. casualties

arise from:

4. Increases in liabilities

a.exchanges in which liabilities are incurred ;

b.transfer between a enterprise and its owner(divided declaration); and

c.nonreciprocal transfer with other than owners in which liabilities are reduced (forgiveness of indebtedness).

arise from:

5. Increases on owners’

equity

a.investment in an enterprise by its owner;

b.the net result of all revenue and expenses recognized during a period (net income);

c.nonreciprocal transfer to an enterprise from other than owners (gifts and donation); and

d.external events other than transfer (revaluation of property, and plant and equipment);

e.prior period adjustment.

arise from:

6. Decreases in owners’

equity

a.transfer from an enterprise to its owner (dividends, treasury acquisition of capital stock); and

b.net losses for a period;c.adjustment from prior

period adjustment and quasi-reorganization.

arise from:

DOUBLE-ENTRY BOOKKEEPING AND SINGLE-ENTRY BOOKKEEPING.

and/or

assets

liabilities

proprietorship

Every business transaction has a two-fold effect on the:

of the business. For every debit element, there is corresponding credit

element. The money values of these two element are equal.

The manner of recording both the debit and credit elements of each

transaction is referred to as double-entry bookkeeping .

The double-entry bookkeeping is generally preferred to the single-entry method because it result in more accurate accounting records and statement. It offers a more convenient means of recording business transaction.

It also requires less time to get information about any item. Moreover, it affords numerous checks ad safeguard which reduce a minimum the chances of loss through international or unintentional errors committed by accounting cycle.

There are nine possible types of transactions (or combination of two or more of these types) which may occur in the basic accounting equation. Some of these nine types may occur frequently, while some may be seldom. A summary of the nine possibilities may appear in a tabular form as follows:

TYPICAL BUSINESS TRANSACTION ANALYSIS ASSETS LIABILITIES OWNER’S EQUITY

1. Increase in Assets = increase in Owner’s Equity + +2. Increase in Assets = increase in liabilities + +

3. Increase in one form Assets = Decrease in other form of Assets

+ (-)

4. Decrease in Assets = Decrease in Owner’s Equity (-) (-)

5. Decrease in Assets = Decrease in Liabilities (-) (-)

6. Increase in Liabilities = Decrease in Owner’s Equity + (-)

7. Increase in one form of Liabilities= Decrease in other form of Liabilites

(-) + +

8. Increase in Owner’s Equity = Decrease in Liabilities

(-) (-)

9. Increase in one form of Owner’s Equity = Decrease in other form of Owner’s Equity

+ (-)

Types of Transactions Affecting the Accounting Equation

1. Increase in Assets = Increase in owner’s Equity two kinds of transactions may be given for this type. The investment of assets in the business by the owner is one of these. For example, if the owner invested cash, there is an increase in asset cast with a corresponding increase in owner’s equity since the owner provides the cash.The other one is a transaction that generates revenue. For instance, when services are rendered to customers on credit, there is an increase in assets accounts receivable and an in crease in owner’s equity as a result of revenue generated.

Assets = Liabilities + Owner’s Equity 2,000,000 = 0 + 2,000,000

Asses Invested by the OwnerTransaction 1: Mark Castillano opened a freight forwarders within the Philippine

port and invested cash of P2,000,000; non-cash items with current values as follows: one-unit electric typewriter @ P18,000; office tables and chairs @ P100,000; and repair tools and dies @ P35,000; the business will be named Road-Runner Freight Forwarders.

Assets = Liabilities + Owner’s Equity

100,000 = 0 + 100,000

Received Cash for Service Rendered

Transaction 2. Received cash from a customers for freight delivery services rendered amounting to P100,000.


150,000 = 0 + 150,000

Billed a Customer for Service Rendered on Credit

Transaction 3: Sent a bill to a customer for freight forwarder services rendered @ P150,000.


120,000 = 120,000 + 0

2. Increase in Assets=Increase in Liabilities-acquisitions of assets on credit fall under this category. For example, equipment was purchase on account. Assets equipment will increase and liability accounts payable with likewise. Issuance of promissory note arising from money borrowed is another example. Asset in the form of cash will

increase, and notes payable, which is a liability, similarity will increase.

Borrowed Money from the Bank

Transaction 4: Cash in the amount of P120,000 was borrowed from Land Bank of the Philippines, due and payable after 90 days plus interest of 14% per annum.

BASIC STRUCTURE OF ACCOUNTING PRINCIPLES

Chapter 3

THROWBACK LESSON• Accounting Equation• Expanded Accounting Equation• T- Account• Double- Entry Bookkeeping & Single- Entry Bookkeeping

ASSETS = LIABILITIES + OWNER’S EQUITYASSETS = EQUITESName of item

Right sideLeft side

Assets Acquired on Account

Transaction 5: Purchase on account four(4) units of delivery trucks form Racal Philippines Inc., ₱500,000 each unit. Instead of demanding an outright cash payment, Racal Philippines Inc., agrees to deliver the delivery trucks and allowing buyer(Road Runner Freight Forwarder)to pay the involve in 10 months equal installment.


2,000,000 = 2,000,000 + 0


3,200,000 = 1,600,000 + 0 (1,600,000)

Assets Acquired on Account with a Partial Payment

Transaction 6: Purchase from Racal Philippines Inc., additional four (4) units of freezer Van with total amount of ₱ 3, 200, 000. the seller requires of ₱ 1, 600,000 and the balance to be paid within 60 days.

3. Increase in one form of Assets = Decrease in other form of Assets several transaction involving payments of liabilities will be included in this

category. As an example, the payment of accounts payable will decrease assets in the form of cash with corresponding decrease in the liability accounts payable.Assets acquired on Cash basis

Transaction 7: Purchased one unit of Computer and printer from AGBU Computer Supplies @30,000 on cash basis


30,000 = 0 + (30,000)

Assets Withdrawn by the Owner

Transaction 8: The owner withdrew ₱ 100,000 cash for personal use.


(100,000) = 0 + (100,000)

4. Decrease in Assets = Decrease in Owner’s EquityAll transaction involving payments of liabilities will be included in this category. As

an example, the payment of accounts payable will decrease assets in the form of cash with corresponding decrease in the liability accounts payable.


(₱ 58,000) = 0 + (₱ 58,000)

Paid Salaries of Employees

Transaction 9: Paid salaries of the employees, ₱ 58,000.

5. Decrease in Assets = Decrease in LiabilitiesAll transaction involving payments of liabilities will be included in this category. As

an example, the payment of accounts payable will decrease assets in the form of cash with corresponding decrease in the liability accounts payable.Partial Payment of a Liability

Transaction 10: The first installment payment was made to Racal Philippines Inc.


(200,000) = (200,000) + 0

6. Increase in Liabilities = Decrease in Owner’s EquityTransaction of this type is the incurrence of an expense the payment of which is to

be made at a later date.Receive the Telephone Bill from PLDT

Transaction 11: telephone bill was received from PLDT, to be paid next month, ₱ 3, 700.


0 = 3, 700 + (3, 700)

7. Increase in One form of Liability = Decrease in other form of Liabilityif one form, of liability is substituted for another form of liability. If an accounts

payable becomes due and there is no cash available to settle such liability, a promissory note may be sign in lieu of cash.


0 = 1, 600, 000 + 0 (1, 600, 000)

Issued Promissory Note in lieu of cash

Transaction 12: Assume that the accounts payable of Racal Philippines Inc., amounts to ₱ 1, 600,00 becomes due and that the business does not have available cash. The owner offered to issue a promissory note which Racal Phil. Inc., accepted.

8. Increase in Owner’s Equity = Decrease in LiabilitiesReclassification of creditor’s equity will fit in this category. Liability may be

converted and replaced by shares of stocks, an elements of owner’s equity. If the bondholder or the creditor, exercise the option and converted the bonds into stocks,

the bondholders becomes stockholder.

Adjustment for Erroneous Billing

Transaction 13: Received a letter from PLDT acknowledging that an error was made in billing. The billed amount should have been ₱ 3,000 instead of ₱ 3,700


0 = (700) + 700

9. Increase in on form of Owner’s Equity = Decrease in other form of Owner’s Equity-

This type of transaction may involve a transfer of owner’s equity to another owner’s equity. The reclassification of

one type of revenue to another type is an example of this category. The existence of this type of transaction is also

infrequent.Repair Service Revenue reclassified as Computer Rental RevenueTransaction 14. Freight forwarders Service Income of ₱185,000

is erroneously recorded as Miscellaneous Income, hence, a reclassification is necessary.

Assets =

Liabilities + Owner’s Equity

0 =

0 +

185, 000(185,000)

These nine categories cover all possible effects in the accounting equation of business transactions that may occur. Each type has a dual effect, a value received accompanied by an equal value parted with. Thus, the equality of the basic accounting equation is always maintained every after every business transaction.

1 • Increase in Assets = Increase in owner’s Equity

2 • Increase in Assets=Increase in Liabilities-

3• Increase in one form of Assets = Decrease in other form of

Assets

4 • Decrease in Assets = Decrease in Owner’s Equity

5 • Decrease in Assets = Decrease in Liabilities

6 • Increase in Liabilities = Decrease in Owner’s Equity

7• Increase in One form of Liability = Decrease in other form of

Liability

8 • Increase in Owner’s Equity = Decrease in Liabilities

9• Increase in on form of Owner’s Equity = Decrease in other form

of Owner’s Equity

Before a transaction can be recorded in the books of account, it must be analyzed into its debit and credit elements. The following questions will prove helpful in mentally analyzing a business transaction.

What titles should be used to record the debit and credit items.

According to the rules of debit and credit, is the increased or decreased in the item to be debited or credited?

How is each item affected – is it increased or decreased?

Which item/items is/are affected assets, liabilities, and/or proprietorship?

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