Analyzing Transactions To Start A Business

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Chapter 2

Analyzing Transactions to Start a Business

At the end of this module you are expected to:


1. Define and identify the first three basic elements of accounting.
2. Define business transaction and discuss its three features.
3. Analyze the transactions and present the accounting elements in a
statement of financial position.
4. Discuss the qualitative attributes financial information must possess.
5. Discuss the accounting principles underlying the recognition and
measurement of the assets and liabilities.

The Financial Structure of a Business


Based on the Framework of Accounting, the financial position or structure
of a business entity is based on three elements- assets, liabilities, and owner’s
equity while its financial performance is based on two elements called revenues
and expenses. Only the financial position or structure will be discussed in this
chapter.
Assets are economic resources owned by the business, they are used in
operating the business and are expected to benefit the business over a number of
years. The school’s assets to name a few , are : land, building, cash or money,
furniture and fixtures ( tables, chairs, blackboards, filing cabinets, and electric
fans), equipment ( computers, printers, and fax machines), school bus, supplies
( paper, pencils, erasers, printer’s ink, and pieces of chalk).
Liabilities can be simply defined as an obligation to do or pay. Or it may be
defined as debts of the business owing to outside parties like the banks, financing
companies and suppliers of goods and services.
Net assets or net worth of the business is determined by deducting the
total liabilities from the total assets. The net assets claimable by the owner is
called owner’s equity.

The Accounting Equation


It shows a relationship of balance or fundamental identity of the three
elements. Since the assets are claimable by the creditors (represented by
liabilities) and owner or investor (represented by the equity), this relationship of
balance should always be respected. The relationship is expressed in an
accounting equation: ASSETS = LIABILITIES + OWNER'S EQUITY.

The Account
The account is a device used to record the changes (increases or decreases)
in the accounting elements. For the assets, the accounts used are cash, accounts
receivable, notes receivable, merchandise, supplies, land, furniture, equipment,
building and machinery. Similar assets are grouped together under one account.
Cash refers to currencies, coins, checks, and bank drafts. Furniture and fixtures
refers to tables, chairs, desks and cabinets. Cash may be designated as CASH ON
HAND (located within the entity) and CASH IN BANK (for money deposited in a
bank). Equipment includes typewriters, adding machines, duplicating machines,
air condition units, printers and computers.
Liabilities are usually identified as payable or due to. Examples: accounts
payable, notes payable, loans payable and mortgage payable.
Owner’s equity are represented by two accounts: owner’s capital and
owner’s drawing. Owner’s capital represents investment made by the owner. In
contrast, owner’s drawing represents withdrawal of business assets for personal
use by the owner.
Business Transactions and the Accounting Elements
The accounting elements are affected by the business transactions or
economic activities of a business. A transaction is defined as exchange of values
between two parties express in monetary terms. It has three characteristics: (1)
exchange of values, (2) between two parties, (3) in terms of money. The values
exchanged are assumed to be of equal amount.
The business transaction must always have a dual effect and that is for
every value received there is an equal value parted. This bookkeeping system is
called double entry bookkeeping or the venetian model. A transaction either
increases or decreases the assets, liabilities, or owner’s equity but the equation or
fundamental identity of the three elements should always be maintained.
There are at least two parties involved. The transaction must be stated in
terms of money.
It should be also be noted at this point that transactions considered non-
financial in nature, in that there is no exchange of values, should not be recorded
in the books of the entity.

Examples:
1. The travel agency hired tourist guides for a salary of P10,000 each.
2. The travel agency signed a lease contract for the use of an office space at a
monthly rental of P18,000.
3. An order for office supplies was place with Good Trading amounting to
P5,000.

To make these financial in nature:


1. The travel agency paid cash for services rendered by the workers.
2. The travel agency used the office space and paid the lessor.
3. The travel agency received the supplies and paid cash.
Demonstrated Problem 1:
Assets invested by the owner.
March 1 May Gomez opened a tour and travel service by contributing cash of
P50,000. She has three cars worth P1,200,000 but only contributed only two cars
worth P750,000. Analysis: The assets of the business will increase in the form of
cash P50,000 and cars P750,000 with a corresponding increase in owner’s equity.
ASSETS = OWNER’s EQUITY
Cash P50,000 Gomez Capital P800,000
Cars 750,000 P800,000
P800,000
Cash borrowed from the bank.
March 3 Gomez borrowed P100,000 cash from PNB for use in the business.
Analysis: The assets of the business will increase again in cash by P100,000 with a
corresponding increase in liability.
ASSETS = LIABILITIES + OWNER’s EQUITY
Cash P150,000 Loans Payable P100,000 Gomez Capital P800,000
Cars 750,000 P100,000 P800,000
P900,000

Asset Purchased for cash.


March 7 Bought tables and chairs from Blim’s and paid cash, P45,000.
Analysis: The assets of the business will increase in the form of furniture and
decrease in the form of cash. Total assets will still be the same since there was
only a change in its form.
ASSETS = LIABILITIES + OWNER’s EQUITY

Cash P105,000 Loans Payable P100,000 Gomez Capital P800,000

Cars 750,000 P100,000 P800,000

Furniture 45,000

P900,000
Asset purchased on account
March 15 Various equipment were purchased on account from National
Winners for P55,000. Analysis: The assets of the business will increase in the form
of equipment with a corresponding increase in liabilities.
ASSETS = LIABILITIES + OWNER’s EQUITY

Cash P105,000 Loans Payable P100,000 Gomez Capital P800,000

Cars 750,000 Accounts Payable 55,000

Furniture 45,000 P155,000 P800,000

Equipment 55,000

P955,000

Cash withdrawn by owner


March 18 Gomez made a cash withdrawal of P5,000 for personal use. Analysis:
The assets of the business will decrease in cash with a corresponding
decrease in the owner’s equity since owner recovered part of her
investment.
ASSETS = LIABILITIES + OWNER’s EQUITY

Cash P100,000 Loans Payable P100,000 Gomez Capital P800,000

Cars 750,000 Accounts Payable 55,000 Gomez Drawing(P5,000 )

Furniture 45,000 P155,000 P795,000

Equipment 55,000

P950,000

Payment of liability
March 20 The account due to National Winners was paid in cash. Analysis:
Assets of the business in the form of cash will decrease with a
corresponding decrease in liabilities.
ASSETS = LIABILITIES + OWNER’s EQUITY

Cash P45,000 Loans Payable P100,000 Gomez Capital P800,000

Cars 750,000 Gomez Drawing(P5,000 )

Furniture 45,000 P100,000 P795,000

Equipment 55,000

P895,000

Note that the accounting equation was maintained all throughout the
presentations made. This so because of the dual effect of the transactions in the
accounting elements. If the assets and liabilities are affected, the effect should be
the same as illustrated in March 3 and 15, that is an increase in the assets will
bring a corresponding increase in the liabilities. Or assets will decrease with a
corresponding decrease in liabilities as illustrated on March 20. The same rule is
applicable if the assets and owner’s equity are affected as illustrated on March 1.
When the increase in assets carries a corresponding increase in owner’s equity as
illustrated on March 18. If only one accounting value is affected as illustrated on
March 7, the accounting equation will not change since the increase in one asset
item carries a corresponding decrease in another asset item. Recall that this
Venetian Model or Double Entry Bookkeeping requires that for every value
Received there is an equal value parted with. Note that the owner’s equity
Increased when investment was put in the business and decreased when owner
Exercised her claim by withdrawing cash from the business, In analyzing the
transactions, take note of the accounting principles that were applied.
The following table summarizes the effects of these transactions always
expressed in an accounting equation. The balances are given after each
transaction.

DATE ASSETS LIABILITIES OWNER’S EQUITY


March Cash Cars Equipment Furniture Loans Payable Accounts Payable Gomez Capital Gomez Drawing

1 50,000 750,000 800,000

3 100,000 100,000________________________________________________

Bal 150,000 750,000 100,000 800,000

7 -45,000 +45,000_________________________________________________________

Bal 105,000 750,000 45,000 100,000 800,000

15 55,000 55,000____________________________________

Bal 105,000 750,000 55,000 45,000 100,000 55,000 800,000

18 -5,000 -5,000_____

Bal 100,000 750,000 55,000 45,000 100,000 55,000 800,000 -5,000

20 -55,000 -55,000___________________________________

Bal 45,000 750,000 55,000 45,000 100,000 0 800,000 -5,000____

P895,000 = P100,000 + P795,000

Statement of Financial Position


The Statement of Financial Position is a list of assets, liabilities, and owner’s
equity of a business. This statement informs users of the wealth and obligations
accumulated by the business, and is used to determine liquidity and solvency of
the business. It was formerly called the Balance Sheet because it shows the
balances of each account and the grand total shows a balance between the assets
on one hand and the liabilities and owner’s equity on the other hand.
This statement is not prepared every time is a change in the accounting
equation. Under the principle of period of time, this is usually prepared yearly
with balances shown only at the end of the particular year. Interim statements
may be prepared monthly or quarterly as needed by the users. An interim
statement of financial position for HAPPY TOUR AND TRAVEL on March 20 will
appear as follows:

Happy Tour and Travel


Statement of Financial Position
March 20, 2018
Assets Liabilities and Owner’s Equity
Cash P45,000 Loans Payable P100,000
Cars 750,000 Gomez Capital 795,000
Equipment 55,000
Furniture & Fixtures 45,000
Total P895,000 Total P895,000

Demonstration Problem 2
Copyclear and Bindery Center situated at Taft Avenue, Manila was
set up on January 2, 2018. The owner Susan Alegre contributed cash of P20,000
and equipment of P 48,000. The following are the additional transaction for
January:
Jan 5 Bought furniture and fixtures worth P6,000, on account
7 Bought photo copier machine for P20,000. Terms: 50 % down,
balance on account
10 An emergency prompted Ms. Alegre to withdraw P1,500 cash for
personal use
15 Purchased supplies costing P3,000 and paid cash
20 The account of January 5 is due. Ms. Alegre paid this from her
personal cash
31 The account of January 7 is due. Issued a 60 day promissory note for
this.

Solution to Demonstrated Problem 2

Date Assets = Liabilities + Owner’s Equity


January Cash Supplies Furniture & Fixtures Equipment Accounts Payable Notes Payable Alegre Capital Alegre Drawing

2 20,000 48,000 68,000

5 +6,000 +6,000__________________________________________________

Bal 20,000 6,000 48,000 6,000 68,000

7 -10,000 +20,000 +10,000_________________________________________________

Bal 10,000 6,000 68,000 16,000 68,000

10 -1,500 -1,500_____

Bal 8,500 6,000 68,000 16,000 68,000 -1,500

15 -3,000 +3,000_________________________________________________________________________________________

Bal 5,500 3,000 6,000 68,000 16,000 68,000 -1,500

20 -6,000 ________________+6,000 ________________

Bal 5,500 3,000 6,000 68,000 10,000 74,000 -1,500

31 -10,000 +10,000__________________________________

Bal 5,500 3,000 6,000 68,000 0 10,000 74,000 -1,500

P82,500 = P10,000 + P72,500


Copyclear and Bindery Center
Statement of Financial Position
January 31, 2018
Assets Liabilities and Owner’s Equity
Cash P5,500 Notes Payable P10,000
Supplies 3,000 Alegre Capital 72,500
Equipment 68,000
Furniture & Fixtures 6,000
Total P82,500 Total P82,500

Summary of Transactions and Effects on Accounting Elements


Transactions Assets Liabilities Owner’s Equity
Investment of Increase Increase
assets by the
owner
Withdrawal of Decrease Decrease
assets by the
owner
Purchase of assets Increase &
in cash Decrease
Purchase of assets Increase Increase
on account
Settlement of Decrease Decrease
liabilities in cash
Settlement of Increase &
account with a Decrease
note
Settlement of Decrease Increase
liabilities from
owner’s personal
cash
Qualitative Attributes
The framework for the preparation and presentation of financial statement
describes, among others, the attributes or characteristics that financial
information must possess to make them trustworthy and useful in making
informed judgement and decision. The framework identifies four principal
attributes: Understandability, relevance, reliability, and comparability.
Understandability
Of what use are the financial reports if statement users do not know how
to read and use them? Understandability requires that 1) users have a reasonable
knowledge of finance, accounting and economics to come up with a good
assessment and sound judgement, 2) terminologies used must be clear, 3)
presentation of reports must be orderly.
Relevance
It prescribes the quality of information that will make a difference and
influence a statement user to make a meaningful decision. The information must
give the past performance of the business (feedback value) which is useful in
predicting what might take place in the future (predictive value).
Reliability
Can the financial statements be depended upon by the users? Yes, if
information is objective and free from material errors or misstatements. There
are four ingredients to be considered: faithful representation, substance over
form, prudence, and neutrality.
Comparability
Comparability helps one identify changes taking place in the entity between
two or more periods so users will be able to determine the change or trend of its
performance or position. Comparability may also be made between two or more
entities so users will be able to make a meaningful assessment of the entity’s
competitiveness.
Accounting Principles
Principles are laws or rules that guide the conduct and practice of the
profession. In accounting, these are specially used in identifying, measuring, and
reporting financial information. These generally accepted accounting principles
(GAAP) are not natural laws but man made laws usually as a result of longed used
accounting practice, norm of conduct of a place or standards promulgated by an
authoritative body.

Going Concern Principle


It is expected that the business will continue to exist indefinitely, thus,
financial statements should be prepared on a going concern basis unless
management intends to close the business or cease trading. Using this principle,
assets such as properties acquired by the business are intended to be used by the
business which is expected to operate indefinitely and therefore should be
recognized at cost without regard to the changes in their market values.
Business Entity Concept
This concept assumes that a business enterprise is separate and distinct
from its owner or investor. In preparing financial statements of an entity, only the
assets, liabilities, revenues and expenses of that entity should be contained
herein. Personal assets and liabilities of the owner should not be included.
Likewise, it is required that if an owner has more than one business, the records
and reports of each one should be separately maintained.
Exchange Price or Cost Principle
Assets, liabilities, revenues, and expenses should be recorded based on
cost. Cost is the amount agreed upon in an arm’s length transaction. It may be
based on cash or its cash equivalent if no cash was exchanged at the time the
transaction occurred.
Measurement in Terms of Money
All business transactions are measured and recorded using only one unit of
measurement. Since money is used as a medium of exchange, it is therefore the
most practical unit of measuring financial data. At this point, it is worth noting
that in accounting only data measurable in terms of money are recognized and
recorded in the books of the entity.
Accrual Assumption
It is required that financial statements be prepared under the accrual basis.
Assets, liabilities, revenues, and expenses should be recognized based on the
period they relate or based on the occurrence of the transaction rather than
based on cash received or paid.
Objectivity
The concept of objectivity requires that assets must be verifiable and
substantiated by documents such as invoices, vouchers or official receipts. This
compliments the cost principle since valuation of resources at cost is definite as it
represents the actual price of acquiring them.
Reporting Period
How often should the accountant prepare the financial statements
especially since it is assumed that the business is a continuing concern? It is
understood that a complete and accurate financial picture of the business may
only be made at the end of its life. However, since the statement users need
financial information on a regular basis and the success of the business operation
defends on financial information contained in the accounting reports, then its life
has to be divided into specific time intervals called accounting period. This will
enable the enterprise to prepare periodic financial statements. The basic
accounting period is one year with interim reports prepared for shorter period of
time such as monthly, quarterly or semi-annualy.

References
1. Zenaida Vera Cruz Manuel ( 2019 ). 21st Century Accounting Process:
Financial Accounting and Reporting for Servicers and Merchandisers.
2. Arganda, Amelia M., Cardenas –Atis, Teresa ( 2011 ). Accounting Principles:
Textbook/Workbook.
Assessment # 1
Cely Kalaw started a new business in advertising called Straight and True
Advertising on February 2019. The following are the transactions which you are
required to summarize using the copy clear format. Extract the balances only after
the last transaction. Include money column for cash, art supplies, office supplies,
equipment, furniture and fixtures, accounts payable, notes payable, and Kalaw
Capital.
February
5 She transferred half of her P300,000 savings to the account of the business
9 Purchased art supplies and paid P15,000 in cash
16 Purchased Photo equipment at a cost of P105,000 from camera work. She
paid one third and promised to pay another one third at the end of the month
20 A friend Liza, bought a fax machine a year ago for P10,000. She sold this to
Cely who promised to pay her after 30 days
22 Bought paper for the fax machine and paid cash, P1,500
25 Bought furniture and fixtures on credit, P8,000
28 Paid one half of the account owing to camera work and issued a note
promising to pay the balance within 30 days.
Assessment # 2
The following table shows the effect of five transactions (from a through e)
on the assets, liabilities and owner’s equity of Vera’s Boutique. Fill up the table for
the missing items and describe the transactions that took place.

Cash Office Office Furnitur Accounts Loans Vera


Supplies Equipmen e& Payable Payable Capital
t Fixtures
A +105,00 +15,000 +95,000 ?
0
B -25,000 +50,000 ?
C ? +1,500
D -750 ?
E ? -15,000
F +100,00 ?
0
Total ? ? ? ? ? ? ?
so on. These ledgers are filed in a book called general ledger which is also called
the book of final entry. If there are 20 accounts then you will need 20 ledgers to
be compiled in the general ledger. The process of transferring the debits and
credits from the journal to the ledger is called posting.

Posting Procedure
A. Based on the first debit entry in the journal, look for the account in the
general ledger.
B. On the debit side date column, copy the date.
C. Copy the amount in the debit column extend the balance in the last
column.
D. Insert the journal page number in the folio column or posting reference
column of the ledger.
E. Insert the ledger account number in the folio column or posting reference
of the journal.
F. The next account to be posted is the Cars account. Repeat steps A to E. The
third account to be posted is the capital account and so on until all the
accounts have been posted or transferred from the journal to the ledger.
Steps D and E, called reference, facilitates the tracing of an entry to and
from the journal and ledger. Also, if the F columns of the journal and the
ledger are both filled up. It signifies that an entry has already been posted. The
folio column in the journal will be gradually filled up as the postings are made.
The general ledger of Happy Tours and Travel will completely appear as follows:

CASH ACCOUNT NO. 101


Date Explanation Ref Debit Credit Balance
2018 Debit Credit
March 1 J1 50 000 00 50 000 00
3 J1 100 000 00 150 000 00
7 J1 45 000 00 105 000 00
18 J1 5 000 00 100 000 00
20 J2 55 000 00 45 000 00
21 J2 15 000 00 60 000 00
22 J2 1 500 00 58 500 00
25 J2 500 00 58 000 00
30 J2 8 000 00 66 000 00
31 J2 19 000 00 47 000 00

ACCOUNTS RECEIVABLE ACCOUNT NO. 102


Date Explanation Ref Debit Credit Balance
2018 Debit Credit
March 24 J2 16 000 00 16 000 00
27 J2 20 000 00 36 000 00
30 J2 8 000 00 28 000 00
CARS ACCOUNT NO. 201
Date Explanation Ref Debit Credit Balance
2018 Debit Credit
March 1 J1 750 000 00 750 000 00

EQUIPMENT ACCOUNT NO. 202


Date Explanation Ref Debit Credit Balance
2018 Debit Credit
March 10 J1 55 000 00 55 000 00

FURNITURE & FIXTURES ACCOUNT NO. 203


Date Explanation Ref Debit Credit Balance
2018 Debit Credit
March 7 J1 45 000 00 45 000 00

ACCOUNTS PAYABLE ACCOUNT NO. 301


Date Explanation Ref Debit Credit Balance
2018 Debit Credit
March 10 J1 55 000 00 55 000 00
20 J1 55 000 00 0

LOANS PAYABLE ACCOUNT NO. 302


Date Explanation Ref Debit Credit Balance
2018 Debit Credit
March 3 J1 100 000 00 100 000 00

GOMEZ CAPITAL ACCOUNT NO. 501


Date Explanation Ref Debit Credit Balance
2018 Debi Credit
t
March 1 J1 800 000 00 800 000 00

GOMEZ DRAWINGS ACCOUNT NO. 502


Date Explanation Ref Debit Credit Balance
2018 Debit Credit
March 18 J1 5 000 00 5 000 00
SERVICE INCOME ACCOUNT NO. 601
Date Explanation Ref Debit Credit Balance
2018 Debit Credit
March 21 J1 15 000 00 15 000 00
24 J1 16 000 00 31 000 00
27 J2 20 000 00 51 000 00

GAS AND OIL EXPENSE ACCOUNT NO. 701


Date Explanation Ref Debit Credit Balance
2018 Debit Credit
March 22 J1 500 00 500 00

RENT EXPENSE ACCOUNT NO. 702


Date Explanation Ref Debit Credit Balance
2018 Debit Credit
March 31 J2 10 000 00 10 000 00

REPAIR EXPENSE ACCOUNT NO. 703


Date Explanation Ref Debit Credit Balance
2018 Debit Credit
March 22 J1 1 000 00 1 000 00

SALARIES EXPENSE ACCOUNT NO. 704


Date Explanation Ref Debit Credit Balance
2018 Debit Credit
March 31 J2 9 000 00 9 000 00

UTILITIES EXPENSE ACCOUNT NO. 705


Date Explanation Ref Debit Credit Balance
2018 Debit Credit
March 25 J2 500 00 500 00
Trial Balance
At this point we should establish again the equality of the debits and credits
by using another tool called the trial balance. The double entry bookkeeping rule
extends to the trial balance- ensure that the debit total is the same as the credit
total. A trial balance is a list of accounts with ledger balances. Assets, owner’s
drawings and expenses have normal balances on the debit side while liabilities,
owner’s capital and revenues have normal balances on the credit side. The trial
balance of Happy and Tour will appear as follows:
HAPPY TOUR AND TRAVEL
TRIAL BALANCE
March 31, 2018
ACCOUNT No. ACCOUNT TITLES DEBIT CREDIT
101 Cash P47 000 00
102 Accounts Receivable 28 000 00
201 Cars 750 000 00
202 Equipment 55 000 00
203 Furniture & Fixtures 45 000 00
301 Accounts Payable P 000 00
302 Loans Payable 100 000 00
501 Gomez Capital 800 000 00
502 Gomez Drawings 5 000 00
601 Service Income 51 000 00
701 Gas & Oil Expense 500 00
702 Rent Expense 10 000 00
703 Repair Expense 1 000 00
704 Salaries Expense 9 000 00
705 Utilities Expense 500 00
TOTALS P951 000 00 P951 000 00

Observe the following rules in preparing the trial balance:


1. Heading consists of three lines: Name of the Business, Title of the Report,
and Date.
2. Accounts titles are arranged in the following order: Assets, Liabilities,
Capital, Revenues, and Expenses.
3. Note that even the accounts payable, although it is zero, still appears in the
trial balance. It may be omitted but the readers may wonder what
happened to this account.
4. The peso sign is placed only on the first debit amount, first credit amount
and on the totals.
5. The totals are ruled (one horizontal line drawn under the last amounts of
the debit and credit columns) and double ruled (two horizontal lines are
drawn on the total figures).
6. If the total debit do not equal the total credit, then error(s) must have been
committed which should be located before ruling and double ruling the
totals. It is possible that any of the following errors may have been
committed:
a. Posting from the journal to ledger on the wrong side (cash debit posted
to cash credit).
b. Posting a wrong amount (cash debit P40, 000 posted to cash debit P400,
000).
c. Ledger footing (debit or credit side) is wrong.
d. Wrong balances were copied from the general ledger.

References
1. Zenaida Vera Cruz Manuel ( 2019 ). 21st Century Accounting Process:
Financial Accounting and Reporting for Servicers and Merchandisers.
2. Arganda, Amelia M., Cardenas –Atis, Teresa ( 2011 ). Accounting Principles:
Textbook/Workbook.

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