UM Digos College

Department of Accounting Education

Roxas Extension, Digos City

Big Picture in Focus: ULOb. Summarize how the double-entry system follows
the rules of the accounting equation

Metalanguage

For you to demonstrate ULOb, you will need to have an operational understanding of
the following terms below. Please note that you will also be required to refer to the previous
definitions found in ULOa section.

1. Financial statements. This is the end report of the financial process. This financial
statements will tell its users of the financial position and financial performance of the entity
for the period.
2. Statement of financial position. Also called as balance sheet. This provides information
regarding the assets, liabilities and capital of the entity.
3. Assets. These are resources controlled by the entity as a result of past events and are
expected to provide inflow of future economic benefit.
4. Liabilities. These are financial obligations of the entity as a result of past event, the
settlement of which requires an outflow of resources from the entity.
5. Equity or Capital. This is the residual interest in the assets of a company after deducting
its liabilities.
6. Income statement. This provides information about the financial performance of the
entity for the period by presenting the revenue, expenses and net income of the entity.
7. Income. It 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.
8. Revenue. It 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.
9. Gains. It 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.
10. Expenses. These 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.
10.1 The definition of expenses encompasses losses as well as those expenses that
arise in the course of the ordinary activities of the enterprise.
10.2 There are various classes of expenses but they are generally classified as cost of
services rendered or goods sold, distribution or selling expenses, administrative
expenses or other operating expenses.
11. Losses. These represent other items that meet the definition of expense and may or
may not, arise in the course of the ordinary activities of an enterprise. Losses represent
decreases in economic benefits and as such are no different in nature from other expenses.

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Department of Accounting Education
Roxas Extension, Digos City

12. Account. A detailed record of the increases, decreases and balance of each element that
appears in an entity's financial statements.
13. Debit. This is the left portion of a T-account.
14. Credit. This represents the right portion of a T-account.
15. Accounting equation. Most basic tool of accounting. This equation presents the resources
controlled by the enterprise, the present obligations of the enterprise and the residual
interest in the assets.
16. Normal balance. This refers to the side of the account – debit or credit – where increase
are recorded.
17. Accounting event. It is an economic occurrence that causes changes in an enterprise’s
assets, liabilities, and/or equity.
18. Transaction. It is a particular kind of event that involve the transfer of something of
value between two entities.
19. Philippine Accounting Standard (PAS). This is one of the reporting standard of
accounting in the Philippines.
20. Operating cycle. It is the time between the acquisition of assets for processing and their
realization in cash or cash equivalents. When the entity's normal operating cycle is not clearly
identifiable, it is assumed to be twelve months.
21. Business transaction. This is an occurrence of an event or a condition that affects financial
position and can be reliably recorded.
22. 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.

Essential Knowledge

A. Double Entry System

The Account
The basic summary device of accounting is the account. A separate account is maintained
for each element that appears in the balance sheet (assets, liabilities and equity) and in the
income statement (income and expenses). The simplest form of the account is known as
the "T" account because of its similarity to the letter "T". The account has three parts as
shown below:
Account Title
Left side or Debit side Right side or Credit side

Accounting Equation

It states that assets must always equal liabilities and owner's equity. The basic accounting
model is:
Asset = Liabilities + Owner’s Equity

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 UM Digos College
Department of Accounting Education
Roxas Extension, Digos City

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.

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 least two accounts. The total debits for a
transaction must always equal the total credits.

An account is debited when an amount is entered on the left side of the account and
credited when an amount is entered on the right side. The abbreviations for debit and credit
are Dr. (from the Latin debere) and Cr. (from the Latin credere), respectively.

The account type determines how increases or decreases in it are recorded.

Increases in assets are recorded as debits (on the left side of the account) while decreases
in assets are recorded as credits (on the right side). Conversely, increases in liabilities and
owner's equity are recorded by credits and decreases are entered as debits.

The rules of debit and credit for income and expense accounts are based on the
relationship of these accounts to owner's equity. Income increases owner's equity and
expense decreases owner's equity. Hence, increases in income are recorded as credits and
decreases as debits. Increases in expenses are recorded as debits and decreases as credits.
These are the rules of debit and credit. The following summarizes the rules:

Balance Sheet Accounts

Assets Liabilities and Owner’s Equity
Debit Credit Debit Credit
(+) (-) (-) (+)
Increases Decreases Decreases Increases

Normal balance Normal balance

Income Statement Accounts

Debit for Credit for
decreases in owner’s equity increases in owner’s equity

Expenses Income
Debit Credit Debit Credit
(+) (-) (-) (+)
Increases Decreases Decreases Increases

Normal balance Normal balance

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Department of Accounting Education
Roxas Extension, Digos City

Normal Balance of an Account

Normal balance (or where increases are recorded)

Account Category Debit Credit
Assets 
Liabilities 
Owner’s equity:
Owner’s Capital 
Withdrawals 
Income 
Expenses 

Types and 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. Although business entities engage in numerous transactions, all
transactions can be classified into one of four types, namely:

1. Source of Assets (SA). An asset account increases and a corresponding claims

(liabilities or owner's equity) account increases. Examples: (1) Purchase of supplies
on account; (2) Sold goods on cash on delivery basis.

2. Exchange of Assets (EA). One asset account increases and another asset account
decreases. Example: Acquired equipment for cash.

3. Use of Assets (UA). An asset account decreases and a corresponding claims

(liabilities or equity) account decreases. Example: (1) Settled accounts payable; (2)
Paid salaries of employees.

4. Exchange of Claims (EC). One claims (liabilities or owner's equity) account increases
and another claims (liabilities or owner's equity) account decreases. Example:
Received utilities bill but did not pay.

The four types of transactions above may be further expanded into nine types of effects as
follows:
a. Increase in Assets = Increase in Liabilities (SA)
b. Increase in Assets = Increase in Owner's Equity (SA)
c. Increase in one Asset = Decrease in another Asset (EA)
d. Decrease in Assets = Decrease in Liabilities (UA)
e. Decrease in Assets = Decrease in Owner's Equity (UA)
f. Increase in Liabilities = Decrease in Owner's Equity (EC)
g. Increase in Owner's Equity = Decrease in Liabilities (EC)
h. Increase in one Liability = Decrease in another Liability (EC)
i. Increase in one Owner's Equity = Decrease in another Owner's Equity (EC)

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 UM Digos College
Department of Accounting Education
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Typical Account Titles Used

STATEMENT OF FINANCIAL POSITION

Assets
Assets are should be classified only into two: current assets and non-current assets.
According to PAS 1, an entity shall classify assets 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;
c. it expects to realize the asset within twelve months after the reporting period; or
d. the asset is cash or a cash equivalent unless the asset is restricted from being
exchanged or used to settle a liability for at least twelve months after the reporting
period.
All other assets should be classified as non-current assets.

Current Assets
1. Cash. 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.
2. 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.
3. 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.
4. 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.
5. 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.
6. 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 include 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
1. Property, Plant and Equipment. 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.
2. Accumulated Depreciation. It is a 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—equipment or buildings—to obtain book value.

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Department of Accounting Education
Roxas Extension, Digos City

3. Intangible Assets. These are identifiable, nonmonetary assets without physical

substance held for use in the production or supply of goods or services, rental to
others, or for administrative purposes. These include secret goodwill, processes,
patents copyrights, licenses, franchises, trademarks, brand names, Subscription lists
and noncompetition agreements.

Liabilities
An entity shall classify a liability as current when:
a. it expects to settle the liability in its normal operating cycle;
b. it holds the liability primarily for the purpose of trading;
c. the liability is due to be settled within twelve months after the reporting period; or
d. the entity does not have an unconditional right to defer settlement of the liability
for at least twelve months after the reporting period.
All other liabilities should be classified as non-current liabilities.

Current Liabilities
1. Accounts Payable. This account represents the reverse relationship of the accounts
receivable. By accepting the goods or services, the buyer agrees to pay for them in
the near future.
2. 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.
3. Accrued Liabilities. Amounts owed to others for unpaid expenses. This account
includes salaries payable, utilities payable, interest payable and taxes payable.
4. 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.
5. 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
1. 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.
2. 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.

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Owner's Equity
1. Capital (from the Latin capitals, 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 or other assets that the owner may withdraw from the business ultimately
reduce it. This account title bears the name of the owner.
2. 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.
3. 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.

NCOME STATEMENT
Income
1. Service Income. Revenues earned by performing services for a customer or client;
for example, accounting services by a CPA firm, laundry services by a laundry shop.
2. Sales. Revenues earned as a result of sale of merchandise; for example, sale of
building materials by a construction supplies firm.

Expenses
1. 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.
2. Salaries or Wages Expense. Includes all payments as a result of an employer-
employee relationship such as salaries or wages, 13th month pay, cost of living
allowances and other related benefits.
3. Telecommunications, Electricity, Fuel and Water Expenses. Expenses related to use
of telecommunications facilities, consumption of electricity, fuel and water.
4. Rent Expense. Expense for space, equipment or other asset rentals.
5. Supplies Expense. Expense of using supplies (e.g. office supplies) in the conduct of
daily business.
6. Insurance Expense. Portion of premiums paid on insurance coverage (e.g. on
motor vehicle, health, life, fire, typhoon or flood) which has expired.
7. Depreciation Expense. The portion of the cost of a tangible asset (e.g. buildings
and equipment) allocated or charged as expense during an accounting period.
8. Uncollectible Accounts Expense. The amount of receivables estimated to be
doubtful of collection and charged as expense during an accounting period.
9. Interest Expense. An expense related to use of borrowed funds.

Accounting for Business Transaction using Financial Transaction Worksheet

Illustration. Mark Medina decided to establish a sole proprietorship business and named it
as Medina Graphics Design. Medina is a graphic designer who has extensive experience in
drawing, layout, typography, lettering, diagramming and photography.
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Department of Accounting Education
Roxas Extension, Digos City

When a specific asset, liability or owner's equity item is created by a financial

transaction, it is listed in the financial transaction worksheet using the appropriate
accounts. The worksheet that follows shows the first transaction of the Medina Graphics
Design. The dates are enclosed in parentheses. During March 2020, the first month of
operations, various financial transactions took place. These transactions are described and
analyzed as follows:

Mar 1. Medina started his new business by depositing P350,000 in a bank account in the
name of Medina Graphics Design at BPI Digos Branch.

Medina Graphics Design

Financial Transaction Worksheet
Month of March 2020

Mar 5. Computer equipment costing P145,000 is acquired on cash basis. The effect of the
transaction on the basic equation is:

Mar 9. Computer supplies in the amount of P25,000 are purchased on account.

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Mar 11. Medina Graphics Design collected P88,000 in cash for designing interactive websites
for two exporters based inside the Davao Ecozone.

Mar 16. Medina paid P18,000 to Bills Express, a one-stop bills payment service company, for
the semi-monthly utilities.

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Mar 17. The entity has service agreements with several entrepreneurs to maintain and
updater their websites weekly. Medina billed these clients P35,000 for services already
rendered during the month.

Mar 19. Medina made a partial payment for P17,000 for the Mar. 9 purchase on account.

Mar 20. Checks totaling P25,000 were received from clients for billings dater Mar. 17

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Mar 21. Medina withdrew P20,000 from the business for his personal use

Mar 27. Loqueloque Publishing submitted a bill to Medina for P8,000 worth of newspaper
advertisements for this month. Medina will pay this bill next month.

Mar 31. Medina paid his assistant designer salaries of P15, 000 per month

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Self-Help: You can also refer to the sources below to help you further
understand the lesson:

Merino, D. N. (2016). Basic accounting and finance. 2nd edition; engineering management
handbook, 2nd edition, huntsville (2nd edition ed., pp. 199-223). Huntsville:
American Society for Engineering Management (ASEM). Retrieved from
[Link]

Ballada, W. (2016). Basic Accounting 2016 issue (21st edition). DomDane Publishers and Made
Easy Books: Manila

BASIC ACCOUNTING: BASIC ACCOUNTING CONCEPTS, PRINCIPLES, AND PROCEDURES,

VOLUME 2, 2ND EDITION. (2018). Kirkus Reviews, Retrieved from
[Link]

Let’s Check
Activity 1. Fill in the Blanks. Rules of Debit and Credit.
The account type determines how increases or decreases in it are recorded. Determine
whether the word debit or credit is appropriate for each statement.
1. Asset accounts normally have ____________ balances. An increase in asset is
recorded as a ____________ while a decrease in asset is recorded as a
____________.
2. Liability accounts normally have ____________ balances. An increase in liability is
recorded by a ____________ and a decrease is entered as a ____________.
3. The owner's capital account normally has a ____________ balance. This account
increases on the ____________ side and decreases on the ____________ side.
4. Income accounts normally have ____________ balances. These accounts increase
on the ____________ side and decrease on the ____________ side.
5. Expense accounts normally have ____________ balances. These accounts increase
on the ____________ side and decrease on the ____________ side.

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 UM Digos College
Department of Accounting Education
Roxas Extension, Digos City

Activity 2. Elements of Financial Statements

Fill in the amount of the missing element of financial position.
Assets Liabilities Owner’s Equity
a. 760,000 360,000 ?
b. 860,000 ? 592,000
c. ? 108,000 760,000
d. 626,600 376,240 ?
e. ? 800,000 (100,000)

Let’s Analyze

Activity 1. Classification of Events as to Source, Use or Exchange of Assets

Transactions:
a. Established a CPA firm with cash contribution from owner.
b. Received cash proceeds of loan from the ABN Amro bank.
c. Purchased supplies with cash.
d. Made plans to purchase office equipment.
e. Traded a used car for a computer system. Both assets had identical values.
f. Used supplies in the process of rendering services to customers.
g. Agreed to represent a client in a BIR audit.
h. Received cash from customers who had received services.
i. Paid employees' salaries with cash.
j. Repaid a bank loan with cash.
k. Transferred cash from its current account to a money market account.
l. Sold land for P600,000 cash. The land originally cost P600,000.
m. Distributed cash to the owner.

Required: Identify each of the above unrelated events as a source, use or exchange of assets
transaction. Some events may not be recordable under current accounting practice. In this
case, classify the events as not applicable (n/a). Also for each event, indicate whether total
assets will increase, decrease or remain Unchanged. The first event has been recorded in
the table as an example.

Type of Event Effect on Total Assets

a. Source of Assets Increase
b.
c.
d.
f.
g.
h.
i.
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Department of Accounting Education
Roxas Extension, Digos City

j.
k.
l.
m.

Activity 2. Recording Transactions in a Financial Transaction Worksheet

Elizabeth Reyes, a graphic artist, opened a studio for her professional practice on Aug.1,
2020. Transactions completed during the month follow:

a. Reyes deposited P155,000 in a bank account in the name of the business.

b. Bought office equipment on account from Mandaluyong Equipment Company,
P41,200.
c. Salvador invested personal photographic equipment, P62,600.
d. Paid rent for the month, P5,000.
e. Bought supplies for cash, P3,450.
f. Acquired insurance for two years, P8,200.
g. Received cash P29,850 for graphic services rendered.
h. Paid salaries of the part-time assistants, P5,000.
i. Received and paid the bill for telephone service, P730.
j. Paid cash for minor repairs to graphics equipment, P860.
k. Performed graphic services for cash, P29,360.
l. Paid accounts to Mandaluyong Equipment Company, P5,200.
m. Reyes withdrew cash for personal use, P 10,000.

Required: Record the transactions for the month of August 2020 using a financial
transaction worksheet. Use the following accounts: Cash; Accounts Receivable; Prepaid
Insurance; Photo Equipment; Office Equipment; Accounts Payable; and Reyes, Capital. If the
owner's equity account is affected by a transaction, identify it as revenue, expense,
investment or withdrawal.

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 UM Digos College
Department of Accounting Education
Roxas Extension, Digos City

In a Nutshell

Activity 1. Analyzing business transactions is an important skill an accountant should possess.

In this part, you will be required to draw conclusions, perspectives, arguments and ideas from
the unit lesson. I will supply the first item and you will continue the rest.

1. Understanding the normal balance of each account will help an accountant in analyzing and
recording business transactions. It is crucial in determining the balance of each debit and
credit side.

2.

3.

4.

5.

6.

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7.

8.

9.

10.

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