DM 2 223 FINANCIAL MANAGEMENT Lecture 3

THE STATEMENT OF FINANCIAL POSITION

THE ACCOUNTING EQUATION

Assets = Liabilities + Owner’s Equity

ASSETS
The resources owned by a business.
Examples: cash, accounts receivable, inventory, supplies, land, buildings, equipment and vehicles.

LIABILITIES
The rights of creditors are the debts of the business.
Examples: accounts payable, notes payable, salaries payable and interest payable

OWNER’S EQUITY
The rights of the owners which usually represents (Investments – withdrawals ± net income/loss).
Example: share capital, withdrawals, profits/losses

T-ACCOUNTS
A graphic representation of a general ledger account. The name of the account is placed above the "T".
Debit entries are depicted to the left of the "T" and credits are shown to the right of the "T". The grand total
balance for each "T" account appears at the bottom of the account.

DETERMINING PROFIT THROUGH OPERATION

Accrual basis of accounting vs. Cash basis of accounting – accrual basis recognizes revenue when earned
and recognizes expenses when incurred

Under the expense recognition principle, expenses can be recognized either as: (1) matching; (2)
systematic allocation, or; (3) direct association.

Profit measures the performance of the company. If the revenue exceeds expenses, then it is a net
profit; otherwise, it is a net loss.

EXPENSE RECOGNITION PRINCIPLE

Expense recognition will typically follow one of three approaches, depending on the nature of the cost:

1. Associating cause and effect

Many costs are linked to the revenue they help produce. For example, a sales commission owed to an
employee is based on the amount of a sale. Therefore, commission expense should be recorded in the same
accounting period as the sale. Likewise, the cost of inventory delivered to a customer should be expensed
when the sale is recognized.
This is what is meant by associating cause and effect and is also referred to as the matching principle.

Instructor: Danica M. Almario, CPA 1

DM 2 223 FINANCIAL MANAGEMENT Lecture 3

2. Systematic and rational allocation

In the absence of a clear link between a cost and revenue item, other expense recognition schemes
must be employed. Some costs benefit many periods. Stated differently, these costs expire over time.
For example, a truck may last many years; determining how much cost is attributable to a particular year
is difficult. In such cases, accountants may use a systematic and rational allocation scheme to spread a
portion of the total cost to each period of use (in the case of a truck, through a process known as
depreciation).

3. Immediate recognition
Last, some costs cannot be linked to any production of revenue, and do not benefit future periods
either. These costs are recognized immediately.
An example would be severance pay to a fired employee, which would be expensed when the employee
is terminated.

EFFECTS OF THE TRANSACTION IN THE ACCOUNTING ELEMENTS

1. Assets invested by the owner

July 1 – Paolo Reyes started a delivery service on July 1, 2013. The following transactions
occurred during the month of July. He invested PHP800,000 cash and cars amounting to PHP200,000.

Cash 800,000
Transportation vehicle 200,000
Reyes, Capital 1,000,000

2. Borrowings from the bank

July 2 – Reyes borrowed PHP100,000 cash from PNB for use in his business.

Cash 100,000
Loans Payable 100,000

3. Assets purchased for cash

July 7 – Bought tables and chairs from Orocan and paid PHP45,000 cash.

Furnitures 45,000
Cash 45,000

4. Assets purchased on account

July 15 – Various equipment were purchased on account from Fortune for PHP55,000.

Equipment 55,000
Accounts Payable 55,000

5. Cash withdrawal by the owner

July 18 – Reyes made a cash withdrawal of PHP5,000 for personal use.

Reyes, Drawing 5,000

Cash 5,000

6. Payment of liability
July 20 – The account due to Fortune was paid in cash.

Accounts Payable 55,000

Cash 55,000

7. Received cash for revenue earned

July 21 – A customer hired the services of Reyes. Cash of PHP15,000 was received from the
customers.

Cash 15,000
Service Revenue 15,000

Instructor: Danica M. Almario, CPA 2

DM 2 223 FINANCIAL MANAGEMENT Lecture 3

8. Paid cash for expenses incurred

July 22 – Cash was paid for the following: gas and oil, PHP500 and car repairs, PHP1,000.

Fuel and lubricant Expense 500

Repairs Expense 1,000
Cash 1,500

9. Revenue rendered on account

July 24 – Another customer hired the services of Reyes and promised to pay PHP16,000 on
July 31.

Accounts Receivable 16,000

Service Revenue 16,000

10. Paid for expenses incurred

July 25 – Paid PHP500 for telephone bill.

Telephone Expense 500

Cash 500

11. Revenue earned with a down payment, balance on account

July 27 – Another customer hired the services of Reyes. A bill was issued to them for PHP20,000,
50% of which was collected.

Cash 10,000
Accounts Receivable 10,000
Service Revenue 20,000

12. Customer’s account collected in cash

July 30 – The customer on July 24 paid 50% of his account in cash.

Cash 8,000
Accounts Receivable 8,000

13. Paid cash for expenses incurred

July 31 – Paid PHP10,000 for rental of office space, and salaries of PHP9,000.

Rent Expense 10,000

Salaries Expense 9,000
Cash 19,000

Instructor: Danica M. Almario, CPA 3