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Fabm 1 - CL Module Week 7
Fabm 1 - CL Module Week 7
I. INTRODUCTION
Good Day! Welcome to the 7th week of our Correspondence Learning Modality for the
midterm. This week, you shall be given another lesson to study and another learning task/s to
submit.
Attached to this 7th week module is the weekly Study and Assessment Guide.
For this week, March 8-12, 2021 of this term, the following shall be your guide for the
different lessons and tasks that you need to accomplish. Be patient, read it carefully before
proceeding to the tasks expected of you. GOOD LUCK!
Accounting Equation
Double-entry System
Elements of Accounting Equation
Learning Competencies At the end of the lesson, you should be able to:
References Textbooks:
Florendo, J. 2016, Fundamentals of Accountancy, Business, and
Management 1, Rex Book Store
Books:
Ballada, W. 2017, Fundamentals of Accountancy Business &
Management 1, Made Easy
We always hear about the Statement of Assets, Liabilities, and Net Worth (SALN) of our
public officials. Almost every year, we always hear how Senator A increased his/her net worth by
a certain amount, or how Senator B becomes the richest senator in the Philippines, while Senator
C is the poorest. Generally, through this public document, we can see and monitor the changes
in the net worth of each of these officials of our country. Understanding a SALN is quite
straightforward as it is just an information sheet enumerating the properties and debts of a public
official. The document can be generally divided into three (3) parts: the official’s personal
information, the listing of his/her assets and liabilities, and the official’s sworn statement.
However, have you ever wondered how the net worth of each official is computed?
Basically, we can determine anyone’s net worth by just deducting the individual’s liabilities to
his/her assets. The result will equate to the net worth of the individual which, in a sense,
measures his/her value in money.
It may be a simple process, but it is an effective tool to actually see if whether or not that
particular official can justify his/her wealth. For example, if you compare the SALN of Senator A
from 2019 to 2020, the increase in the net worth of this senator should have been evidenced by
his/her earnings. But when the increase is substantially greater than his/her compensation as a
senator, there might be something suspicious going on.
The computation of net worth of an individual is derived from one of the most
fundamental concepts in the study of accounting – the accounting equation. This equation applies
to all business organizations regardless of its size and form.
Financial statements tell us how a business is performing. They are the final products of the
accounting process. But how do we arrive at the items and amounts that make up the financial
statements? The most basic tool of accounting is the accounting equation. This equation presents
the resources controlled by the enterprise, the present obligations of the enterprise and the
residual interest in the assets. It states that assets must always equal liabilities and owner’s equity.
A L OE
Assets = Liabilities + Owner’s Equity
Figure 7.1 – The Accounting Equation
Fundamentals of Accountancy, Business, & Management 1 P a g e 3 | 17
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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.
The logic of debiting and crediting is related to the accounting equation. Transactions may require
additions to both sides (left and right sides), subtraction from both sides (left and right sides), or
an addition and subtraction on the same side (left or right sides), but in all cases the equality must
be maintained. Hence, the two sides of the equation should always be balanced.
Accounting is based on the 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.
Take note:
Rule #1. For every value received, there is always a value parted with.
Rule #2. The values received and the values parted with are equal.
Rule #3. The values received and the values parted with are measurable in terms of pesos.
How can we observe the dual effect in accounting equation? – The Rules of Debit and Credit
The account type determines how increases and decreases in it is 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.
Expenses Income
Debit Credit Debit Credit
(+) (-) (-) (+)
Increases Decreases Decreases Increases
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.
The normal balance of any account refers to the side of the account – debit or credit – where
increases are recorded.
1. Assets
2. Liabilities
3. Owner’s Equity
Assets
These are resources that an entity owns in order to derive some future benefits. These assets
are used by the company in its normal operations such as the manufacture of goods or
delivery of services. The main feature of these assets is their capability to give benefits to the
entity. These benefits are usually in the form of their ability to directly or indirectly increase
the inflow of cash to the entity or a reduction of its outflows.
Liabilities
The claims of external parties from the entity. Basically, they are the debts of the entity to
external creditors. These debts do not always have to be paid in money. Some of these
liabilities are in the form of obligations to do some service or even give something.
Examples:
a. Accounts Payable
b. Notes Payable
c. Accrued Liabilities
d. Unearned Revenue
e. Mortgage Payable
f. Bond Payable
Equity
The equity reflects the residual claims or net assets of the owners of an entity. This is similar
to the net worth of the SALN of our public servants. Take note that these are only residual
claims of the owner since the creditors get their share of the entity first before the owners
are given their share. This is also why net worth of individuals is computed by subtracting
their liabilities from their assets.
Generally, equity comes from two sources. The first one comes directly from the owners in
the form of investments of capital. The other comes from the income of the business from its
normal operations. The net income or net loss of the business from its operations can be
determined by using the following equation:
A business will have net income if its revenues exceed expenses and will have a net loss if its
revenues are less than its expenses.
Let us also note that each element of the equation has different elements involved. For example,
assets include cash, accounts receivable, inventories, equipment, etc. Thus, we can now expand
the equation by a basic breakdown of its components:
Every financial transaction can be analyzed or expressed in terms of its effects on the accounting
equation. 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.
Illustration:
Refozar Accounting Services is a firm that provides a wide range of bookkeeping and accounting
services. This sole proprietorship business is owned by Dr. Rey Fernan Refozar, is also a CPA. The
office is managed by Jiexel Manongnong, CPA, MBA. The firm is located in a large office complex
that has easy public access.
To simplify record keeping and billing, Refozar permits clients to charge accounting services that
are provided by the firm. He bills clients on a monthly basis for the services they have received
during the period. Customers who prefer may pay in cash immediately after services are provided.
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. Note that the date
of the transaction is enclosed in parentheses. During October 2020, the first month of operations,
various financial transactions took place.
Initial Transactions
Starting a Business
Oct. 1 Rey Fernan Refozar obtained the funds to start the business by withdrawing
₱800,000.00 from his personal savings. He deposited the money in a new bank
account that he opened in the name of the firm, Refozar Accounting Services.
Oct. 3 Manongsong bought a computer, a copy machine, a fax machine, calculators and
other necessary equipment from M. Medina, Inc., at a cost of ₱100,000. M.
Medina, Inc., agreed to allow 60 days for the firm to pay the bill.
Oct. 5 Manongsong placed an order for toner, fax paper, bond paper, CDs, pens, folders,
and other supplies that had a total cost of ₱20,000. The entity that sold the items,
Cavite Supplies, Inc., requires cash payments from the businesses that are under
six months old. Refozar Accounting Services therefore included a check with its
order.
Owner’s
Assets = Liabilities +
Equity
Accounts Refozar,
Cash + Supplies + Equipment = +
Payable Capital
Bal. ₱800,000 ₱100,000 = ₱100,000 ₱800,000
(5) (20,000) ₱20,000 =
Bal. ₱780,000 + ₱20,000 + ₱100,000 = ₱100,000 + ₱800,000
₱900,000 = ₱900,000
This transaction did not change the total assets but it did change the composition of the assets –
it decreased one asset – cash and increased another asset – supplies by ₱20,000. Note that the
sums of the balances on both sides of the equation are equal. This equality must always exist.
Paying a Creditor
Oct. 9 Manongsong decided to pay ₱40,000 to M. Medina, Inc., to reduce the firm’s debt
to that business.
Owner’s
Assets = Liabilities +
Equity
Accounts Refozar,
Cash + Supplies + Equipment = +
Payable Capital
Bal. ₱780,000 ₱20,000 ₱100,000 = ₱100,000 ₱800,000
(9) (40,000) = (40,000)
Bal. ₱740,000 + ₱20,000 + ₱100,000 = ₱60,000 + ₱800,000
₱860,000 = ₱860,000
This transaction is a payment on account. The effect on the accounting equation is a decrease in
the asset – cash and a decrease in the liability – accounts payable. The payment of cash on
Shortly after Refozar opened his business on October 1, 2020, some of the tenants in the office
complex where the business is located became Rezofar’s first clients. Rezofar also used his
contacts in the community to gain other clients. Services to clients began a stream of revenue for
the business.
However, keeping a business running costs money, and these expenses reduce owner’s equity.
The expense figures are kept separate from the figures for the owner’s capital and revenue. The
separate record of expenses is kept for the same reason as the separate record of revenue is kept
– to help analyze operations for the period.
Oct. 13 Refozar Accounting Services earned ₱70,000 of revenue from charge account
clients. These clients are allowed 30 days to pay.
Owner’s
Assets = Liabilities +
Equity
Accounts Accounts Refozar,
Cash +
+ Supplies + Equipment = +
Receivable Payable Capital
Bal. ₱740,000 ₱20,000 ₱100,000 = ₱60,000 ₱800,000
(13) ₱70,000 = 70,000
Bal. ₱740,000 + ₱70,000 + ₱20,000 + ₱100,000 = ₱60,000 + ₱870,000
₱930,000 = ₱930,000
The entity has performed services to clients so income should already be recognized. Refozar is
entitled to receive payment for these but clients did not pay immediately. Performing the services
creates an economic resource, the clients’ promise to pay the amount which is called accounts
receivable. This transaction resulted to an increase in an asset – accounts receivable and an
increase in owner’s equity of ₱70,000.
Employees’ Salaries
Oct. 18 Refozar Accounting Services hired an accounting staff on October 1 to help in the
business. The business paid ₱25,000 in salaries for this employee and Jiexel
Manongsong.
Owner’s
Assets = Liabilities +
Equity
Collecting Receivables
Oct. 23 Refozar Accounting Services received ₱30,000 from clients who had previously
bought services on account. This cash was applied to their accounts.
Owner’s
Assets = Liabilities +
Equity
Accounts Accounts Refozar,
Cash +
+ Supplies + Equipment = +
Receivable Payable Capital
Bal. ₱715,000 ₱70,000 ₱20,000 ₱100,000 = ₱60,000 ₱845,000
(23) 30,000 (30,000) =
Bal. ₱745,000 + ₱40,000 + ₱20,000 + ₱100,000 = ₱60,000 + ₱845,000
₱905,000 = ₱905,000
Last October 13, Refozar billed clients for services already rendered. On October 23, the entity
was able to collect ₱30,000 from them. The asset – cash is increased by ₱30,000. The business
should not record service income on October 23 since it has already recorded the income last
October 13. Total assets are unchanged. The business merely reduced one asset – accounts
receivable and increased another – cash.
Oct. 27 Refozar Accounting Services earned a total of ₱210,000 in revenue from clients
who paid cash for accounting and bookkeeping services.
Owner’s
Assets = Liabilities +
Equity
Accounts Accounts Refozar,
Cash + + Supplies + Equipment = +
Receivable Payable Capital
Bal. ₱745,000 ₱40,000 ₱20,000 ₱100,000 = ₱60,000 ₱845,000
(27) 210,000 = 210,000
Bal. ₱955,000 + ₱40,000 + ₱20,000 + ₱100,000 = ₱60,000 + ₱1,055,000
₱1,115,000 = ₱1,115,000
Fundamentals of Accountancy, Business, & Management 1 P a g e 11 | 17
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The entity earned service income by rendering accounting and bookkeeping services to its clients.
Refozar rendered his professional services and collected revenues in cash. The effect on the
accounting equation is an increase in the asset – cash and an increase in owner’s equity. Income
increases owner’s equity. This transaction caused the business to grow, as shown by the increase
in total assets from ₱905,000 to ₱1,115,000.
Utilities Expense
Oct. 30 Refozar Accounting Services received a ₱35,000 bill for the utilities that it had used
during the month. A check was issued to pay the bill immediately.
Owner’s
Assets = Liabilities +
Equity
Accounts Accounts Refozar,
Cash + + Supplies + Equipment = +
Receivable Payable Capital
Bal. ₱955,000 ₱40,000 ₱20,000 ₱100,000 = ₱60,000 ₱1,055,000
(30) (35,000) = (35,000)
Bal. ₱920,000 + ₱40,000 + ₱20,000 + ₱100,000 = ₱60,000 + ₱1,020,000
₱1,080,000 = ₱1,080,000
Expenses are recorded when they are incurred. Expenses can be paid in cash when they occur, or
they can be paid later. The payment for utilities is an expense for the month of October. It
represented an outflow of resources and a reduction of owner’s equity. Expenses have the
opposite effect of income; they cause the business to shrink as shown by the smaller amount of
total assets of ₱1,080,000.
Rent Expense
Oct. 31 Refozar Accounting Services issued a check as payment for office rent for October.
The lease contract Refozar signed specified a monthly rent of ₱45,000.
Owner’s
Assets = Liabilities +
Equity
Accounts Accounts Refozar,
Cash + + Supplies + Equipment = +
Receivable Payable Capital
Bal. ₱920,000 ₱40,000 ₱20,000 ₱100,000 = ₱60,000 ₱1,020,000
(31) (45,000) = (45,000)
Bal. ₱875,000 + ₱40,000 + ₱20,000 + ₱100,000 = ₱60,000 + ₱975,000
₱1,035,000 = ₱1,035,000
The rent expense of ₱45,000 is an expense for October. The treatment is similar to the payment
of utilities. Thus, as in the previous transaction, the payment for rent caused the total assets to
diminish.
The owner of the business and the business are separate economic entities. If the owner’s
personal transactions are mixed up with those of the business, it will be very difficult to measure
the performance of the firm.
Oct. 31 Rey Fernan Refozar withdrew ₱150,000 in cash from the business to pay for
personal expenses.
Owner’s
Assets = Liabilities +
Equity
Accounts Accounts Refozar,
Cash + + Supplies + Equipment = +
Receivable Payable Capital
Bal. ₱875,000 ₱40,000 ₱20,000 ₱100,000 = ₱60,000 ₱975,000
(31) (150,000) = (150,000)
Bal. ₱725,000 + ₱40,000 + ₱20,000 + ₱100,000 = ₱60,000 + ₱825,000
₱885,000 = ₱885,000
On October 1, Refozar invested ₱800,000; both cash and owner’s equity increased. That
transaction was an investment by the owner and not an income-generating activity. Refozar
simply transferred funds from his personal account to the business.
A cash withdrawal is exactly the opposite. Withdrawals are not a business expense but a decrease
of the owner’s equity in the business. Withdrawal of cash or other assets for personal use is the
way by which the owner of the entity receives advance distribution of the profits. The ₱150,000
cash withdrawal transaction resulted to a reduction in both cash and owner’s equity.
Summary of Transactions
Refozar Accounting Services
Financial Transaction Worksheet
Month of October 2020
Owner’s
Assets = Liabilities +
Equity
Accounts Accounts Refozar,
Cash + + Supplies + Equipment = +
Receivable Payable Capital
(1) ₱800,000 = ₱800,000
(3) ₱100,000 = ₱100,000
(5) (20,000) ₱20,000 =
(9) (40,000) = (40,000)
(13) ₱70,000 = ₱70,000
(18) (25,000) = (25,000)
(23) 30,000 (30,000) =
(27) 210,000 = 210,000
(30) (35,000) = (35,000)
(31) (45,000) = (45,000)
SAMPLE EXERCISE
Listed below are the ten business transactions for Puring Company during its first month of
operations:
a. Owner invested cash in the business amounting to ₱300,000.
b. Purchased equipment for cash amounting to ₱50,000.
c. Purchased inventories through credit amounting to ₱35,000.
d. Purchased furniture amounting to ₱30,000. Made initial payment with cash ₱10,000 and
incurred an accounts payable for the balance ₱20,000.
e. Paid cash to the local government for the business permit ₱9,000.
f. Made sales of ₱17,000: ₱12,000 cash sales and ₱5,000 credit sales.
g. The cost of sales made in (f) amounted to ₱8,500.
h. Paid the accounts payable in (d).
i. Collected ₱2,500 out of the ₱5,000 credit sales in (f).
j. Paid employee ₱12,000.
Indicate the effects of the given transactions on each of the financial statement elements in the
table shown below. The answer for transaction (a) is given as an example:
Puring Company
Assets = Liabilities + Owner’s Equity
(a) ₱300,000 = ₱300,000
(b) =
(c)
(d)
(e)
(f)
(g)
(h)
(i)
(j)
Bal.
GENERALIZATION
The accounting equation as the most basic tool of accounting is stated as Assets = Liabilities +
Owner’s Equity. The elements of the accounting equation are: assets – what the entity owns;