PAMANTASAN NG LUNGSOD NG VALENZUELA
College of Accountancy
FINANCIAL ACCOUNTING AND REPORTING (FAR1)
Lecture 01: The Accounting Equation
ELEMENTS OF FINANCIAL STATEMENTS: FINANCIAL POSITION
ASSETS – are the resources controlled by the enterprise as a result of past events and
from which future economic benefits are expected to flow to the enterprise.
Essential elements in the definition of asset are:
 Controlled by the enterprise – Control is the ability to obtain the economic
benefits and to restrict the access of others.
 Past events – The control over a resource have resulted from a past event or
transaction.
 Future economic benefits – These are evidenced by the prospective receipt of
cash.
For example, an asset may be:
 Used singly or in combination with other assets in the production of goods
or services to be sold by the enterprise;
 Exchanged for other assets;
 Used to settle a liability;
 Distributed to the owners of the enterprise.
LIABILITIES – are present obligation of the enterprise arising from past events, the
settlement of which is expected to result in an outflow from the enterprise of
resources embodying economic benefits.
Essential elements in the definition of liability are:
 Obligations – these are responsibilities to pay someone because of an
obligating event. An obligating event is an event that creates either a legal
obligation or a constructive obligation.
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 Transfer of economic benefits – This could be a transfer of cash, or other
property, or the provision of a service.
 Past transactions or events – The obligation have resulted from a past event or
transaction.
EQUITY – the residual interest in the assets of the enterprise after deducting all its
liabilities. Equity may be any of the following depending on the form of business
organization:
 In a sole proprietorship, there is only one owner’s capital account because
there is only one owner.
 In a partnership, an owner’s equity account exists for each partner.
 In a corporation, owner’s equity or stockholders’ equity consists of share
capital, retained earnings and reserves representing appropriations of retained
earnings among others.
The Basic Accounting Equation
All the process in an accounting system must observe the equality of the accounting
equation shown below:
Assets=Liabilities+ Equity
Illustration:
You decided to put up a barbecue stand and have estimated that you will be needing
P2,000.00 as start-up capital.
You then went to your closet and open your “52-Week Challenge Piggy Bank” which
you have been saving for quite some time but you only found P800.00 from there.
You resorted to lend from the friendly Mr.Bombay in your neighborhood for the
remaining start-up capital.
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ELEMENTS OF FINANCIAL STATEMENTS: PERFORMANCE
INCOME – is increase in economic benefit during the accounting period in 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:
Revenue – arises in the course of the ordinary activities of an enterprise and is
referred to by a variety of different names including, sales, fees, etc.
Gains – represent other items that meet the definition of income and may, or may
not, arise in the course of ordinary activities of an enterprise. Gains represent
increases in economic benefits and as such are no different in nature from
revenue.
EXPENSES – are decreases in economic benefits during the accounting period in the
form of outflows or depletions of assets or incurrence of liabilities that result in
decrease in equity, other than those relating to distributions to equity participants.
The definition of expenses encompasses expenses and losses.
Expenses – arises in the course of ordinary activities of the enterprise. There are
various classes of expenses but they are generally classified as cost of services
rendered or cost of goods sold, distribution or selling expenses, administrative
expenses or other operating expenses.
Losses – represent other items that meet the definition of expenses and may or
may not, arise in the course of ordinary activities of an enterprise. Losses
represent decreases in economic benefits and as such are no different in nature
from expenses.
The Expanded Accounting Equation
We can expand the basic accounting equation by including two more elements –
income and expenses, as shown below:
Assets=Liabilities+ Equity + Income – Expenses
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Illustration 2: (Continuation of Illustration 1)
During the period, you earned income of P10,000.00 and incurred expenses of
P6,200.00, all of which were collected in cash. On the other hand, you paid P800.00
partial payment to your debt to Mr.Bombay.
TYPICAL ACCOUNT TITLES USED: Statement of Financial Position
Assets
Assets should be classified into two: current assets and non-current assets. Per
revised Philippine Accounting Standards (PAS) No. 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 (as defined in PAS No. 7) 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
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 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. Liabilities
Cash Equivalents – Per PAS No. 7, these are short-term, highly liquid Per revised Philippine Accounting Standards (PAS) No. 1, an entity shall classify
investments that are readily convertible to known amounts or cash and which are a liability as current when:
subject to an insignificant risk of changes in value. a. it expects to settle the liability in its normal operating cycle;
Notes Receivable – is a written pledge that the customer will pay the business a b. it holds the liability primarily for the purpose of trading;
fixed amount of money on a certain date. c. the liability is due to be settled within twelve months after the reporting
Accounts Receivable – are claims against customers arising from sale of services period; or
or goods on credit. This type of receivable offers less security than a promissory d. the entity does not have an unconditional right to defer settlement of the
note. liability for at least twelve months after the reporting period.
Inventories – Per PAS No. 2, these are assets which are (a) held for sale in the
All other liabilities should be classified as non-current liabilities.
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
Current Liabilities
the rendering of services.
Accounts Payable – by accepting the goods or service, the buyer agrees to pay
Prepaid Expenses – are expenses paid for by the business in advance. It is an
for them in the near future.
asset because the business avoids having to pay cash in the future for a specific
Notes Payable – the business entity is the maker of the note; that is, the business
expense
entity is the party who promises to pay the other party a specified amount of
money on a specified future date.
Non-Current Assets
Accrued Liabilities – Amounts owed to others for unpaid expenses. This account
Property, Plant and Equipment – Per PAS No. 16, these are tangibles assets
includes salaries payable, utilities payable, interest payable and taxes payable.
that are held by an enterprise for use in the production or supply of goods or
Unearned Revenues – when the business entity receives payment before
services, or for rental to others, or for administrative purposes and which are
providing its customers with goods or services, the amounts received are recorded
expected to be used during more than one period. Included are such items as land,
in the unearned revenue account (liability account). When the goods or services
building, machinery and equipment, furniture and fixtures and vehicles.
are provided to the customer, the unearned revenue is reduced and income is
Accumulated Depreciation – is a contra account that contains the sum if the
recognized.
periodic depreciation charges. The balance in this account us deducted from the
Current Portion of Long-Term Debt – these are portion of mortgage notes,
cost of the related asset to obtain book value.
bonds and other long-term indebtedness which are to be paid within one year from
Intangible Assets – Per PAS No. 38, these are identifiable, nonmonetary assets
the balance sheet date.
without physical substance held for use un the production or supply of goods or
services, for rental to others, or for administrative purposes. These include
Non-Current Liabilities
goodwill, patents, copyrights, licenses, franchises, trademarks, brand names,
secret processes, etc.
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 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.
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 the contract between the
issuer and the lender specifying the terms of repayment and the interest to be
charged.
Owner’s Equity
Capital – 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 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.
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.
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.
TYPICAL ACCOUNT TITLES USED: Income Statement
Income
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.
Sales – Revenues earned as a result of sale of merchandise; for example, sale of
building materials by a construction supplies firm.
Expenses
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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.
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
allowance and other benefits.
Telecommunications, Electricity, Fuel and Water Expense – expenses related
to the use or consumption of telecommunication facilities, electricity, fuel and
water.
Rent Expense – Expense for rentals for space, equipment or other asset.
Supplies Expense – Expense of using supplies (e.g. office supplies) in the
conduct of daily business.
Insurance Expense – Portion of premiums paid on insurance coverage which has
expired.
Depreciation Expense – The portion of the cost of tangible asset allocated or
charged as expense during the accounting period.
Uncollectible Accounts Expense – The amount of receivables estimated to be
doubtful of collection and charged as expense during an accounting period.
Interest expense – An expense related to use of borrowed funds.
THE ACCOUNT
The basic summary device of accounting is the account. A separate account
maintained for each element that appears in the balance sheet (assets, liabilities and
equity) and in the income statement (income and expense). Thus, an account may be
defined as a detailed record of the increases, decreases and balance of each element
that appears in an entity’s financial statements. The simplest form of the account is
known as “T-account” because of its similarity to the letter “T”.
ACCOUNT TITLE
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 Left side or Right side or
Debit side Credit side
Dr. Cr.

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