Review of Financial Statement Preparation, Analysis, and Interpretation

Accounting overview
Accounting is the systematic and comprehensive recording of financial transactions pertaining
to a business.

Basic Accounting Equation is:

ASSET = LIABILITIES + OWNER’S EQUITY
 This means that the whole asset of the company comes from the liability, or debt of the
company, and from the capital of the owner of the business, and the income it generated
from the business operations. This reflects the double-entry bookkeeping, and shown in
the balance sheet.
 Double entry bookkeeping tells us that if we add something from the one side, which is
asset, we must add the same amount to the other side to keep them in balance.
 For example, if we were to increase cash (an asset) we might have to increase note
payable (a liability account) so that the basic accounting equation remains in balance.

ASSETS = LIABILITIES + OWNER’S EQUITY

P 500.00 P 500.00

 In double-entry bookkeeping, there is the concept of debit (dr) and credit (cr). Debit is the
left, and credit is the right.
 There is also a concept of normal balances. A normal balance, either a debit normal balance
or a credit normal balance, is the side where a specific account increases.
 In the accounting equation, asset is on the left side, while liabilities and equity is on the
right side. Therefore, asset has a debit normal balance, meaning that cash as an asset is
debited to increase, while credited to decrease.
 On the other hand, liabilities and owners’ equity have a credit normal balance. This means
that a liability account is credited to increase, while debited to decrease. The accounting
equation provides the foundation for what eventually becomes the balance sheet.
T-Account Analysis
In double-entry bookkeeping, the terms debit and credit are used to identify which side of the
ledger account an entry is to be made. Debits are on the left side of the ledger and Credits
are on the right side of the ledger. It does not matter what type of account is involved.
CASH ACCOUNTS PAYABLE

DEBIT (DR) CREDIT (CR) DEBIT (DR) CREDIT (CR)

Php 500.00 Php 500.00

 The debit to cash increases the Cash Account by PHP500 while the credit to Accounts
Payable increases this liability account by the same PHP500.
 In the above example, we analyzed the accounting equation in terms of assets, liabilities,
and owners’ equity. These are called Real or Permanent Accounts. These accounts remain
open and active for the life of the enterprise.
 In contrast, there are accounts that reflect activities for a specific accounting period. These
are called Nominal or Temporary Accounts. After the end of the specific period and the
start of a new period, the balance of the nominal accounts is zero.
 Using the accounting equation, we can now expand the analysis that will include both real
and nominal accounts. All nominal accounts will be then closed to a Retained Earnings
account at the end of the period, which is an owner’s equity account.
Illustrative Example:
Calvo Delivery Service is owned and operated by Noel Calvo. The following selected
transactions were completed by Calvo Delivery Service during February:
A. Received cash from owner as additional investment, P35, 000.
B. Paid creditors on account, P1, 800.
C. Billed customers for delivery services on account, P11, 250.
D. Received cash from customers on account, P6, 740.
ASSETS = LIABILITIES + OWNER’S EQUITY

ACCOUNTS ACCOUNTS CALVO, SERVICE

CASH
RECEIVABLE PAYABLE CAPITAL REVENUE

A PHP35,000 PHP35,000

B PHP1,800 PHP1,800

C PHP11,250 PHP11,250

D PHP6,740 PHP6,740

Nominal Accounts
There are two major categories of nominal accounts: Expense and Revenue accounts.
Expense Accounts
 A resource, when not yet used up for the current period, is considered an Asset and will
provide benefits at a future time.
 On the other hand, a resource that has been used for the current period is called an
Expense. At the end of each accounting period, expenses are closed out to the Retained
Earnings Account which decreases the Owners’ Equity. Since expenses decrease the
owners’ equity, those expense accounts carry a normal debit balance.
Revenue Accounts
 Revenue Accounts reflect the accumulation of potential additions to retained earnings
during the current accounting period.
 At the end of the accounting period accumulation of revenues during the period are
closed to the Retained Earnings Account which increases Owners’ Equity.
 Therefore revenue accounts carry a normal credit balance meaning the same balance as
the Retained Earnings Account.
Illustrative Example:
J. F. Outz, M.D., has been a practicing cardiologist for three years. During April 2009, Outz
completed the following transactions in her practice of cardiology:
Mar 1 Provide medical services to clients for cash P35,000.
Paid rent for the month, P3,000.
Mar 2
Paid advertising expense, P1,800.
Mar 6 Purchased office equipment on account, P12,300.
Mar 15 Paid creditor on account, P1,200.
Mar 27 Paid cash for repairs to office equipment, P500.
Mar 30 Paid telephone bill for the month, P180.
Mar 31 Paid electricity bill for the month, P315.

ASSETS = LIABILITIES + OWNER’S EQUITY

ACCOUNTS OFFICE ACCOUNTS SERVICE

MAR CASH EXPENSES
RECEIVABLE EQUIPMENT PAYABLE REVENUE

1 PHP35,000 PHP35,000

2 PHP3,000 PHP3,000

2 PHP1,800 PHP1,800

6 PHP12,300 PHP12,300

15 PHP1,200 PHP1,200

27 PHP500 PHP500

30 PHP180 PHP180

31 PHP315 PHP315

If journalized:

March 1 Debit Cash for PHP35,000; Credit Service Revenue for PHP35,000
2 Debit Rent Expense for PHP3,000; credit Cash for PHP3,000

2 Debit Advertising Expense for PHP1,800; Credit Cash for PHP1,800

6 Debit Office Equipment for PHP12,300; Credit Accounts Payable for PHP12,300

15 Debit Accounts Payable for PHP1,200; Credit Cash for PHP1,200

27 Debit Repairs Expense for PHP500; credit Cash for PHP500

30 Debit Utilities Expense (or telephone) for PHP180; Credit Cash for PHP180

31 Debit Utilities Expense (or energy) for PHP315; credit Cash for PHP315