Fundamentals of Accounting, Business, and

Management

Chapter 7

Business Transactions and

Their Analysis

Fundamentals of Accounting, Business and Management | ABM S1

Chapter 7
Business Transactions and Their Analysis
Introduction

Accounting cycle is the financial process starting with recording business transactions
up to the preparation of financial statements. This process demonstrates the purpose of financial
accounting, i.e., to create useful financial information in the form of general-purpose financial
statements. In other words, the sole purpose of recording transactions and keeping track of
expenses and revenues in to turn this data into meaning financial information by presenting it
in the form of a balance sheet, income statement, statement of owner’s equity, and statement
of cash flows.

Specific Objectives

At the end of the lesson, the students should be able to:

1. Describe the nature and give examples of business transactions.
2. Identify the different types of business documents.
3. Analyze common business transactions using the rules of debit and credit
4. Solve simple problems and exercise in the analyses of business transaction.

Duration

Chapter 7: Business Transactions and their Analysis [3 Hours]

7.1 The Accounting Cycle

The Accounting Cycle

The accounting cycle represents the steps or procedures used to record transactions and
prepare financial statements. The accounting cycle implements the accounting processes dpf
identifying, recording, and communicating economic information.

Steps in the Accounting Cycle

1. Identifying and analyzing business documents or transactions

- The accountants gather information from source documents and determines
the effect of the transactions on the accounts.
2. Journalizing – the identified accountable events are recorded in the journal.
3. Posting – information from the journal are transferred to ledger.
4. Preparing the unadjusted trial balance – the balances of the general ledger accounts
proved as to the equality of debits and credits. The unadjusted trial balance serves as
basis for adjusting entries.
5. Preparing the adjusting entries – the accounts are updated as of the reporting date of
on an accrual basis of recording accruals, expiration of deferrals, estimations, and other
events often not signaled by new source documents.

Fundamentals of Accounting, Business and Management | ABM S1

 6. Preparing the adjusted trial balance (or worksheet preparation) – the equality of debits
and credits are rechecked after adjustments are made. The adjusted trial balance serves
as basis for the preparation of the financial statements.
7. Preparing the financial statements – these are the means by which the information
proceed is communicated to users.
8. Closing the books – this involves journalizing and posting closing entries and ruling
the ledger. Temporary accounts (or nominal accounts) are closed and the resulting profit
or loss is transferred to an equity account.
9. Preparing the post-closing trial balance – the equality of debits and credits are again
rechecked after the closing process.
10. Recording of reversing entries – reversing entries are usually made at the beginning of
the next accounting period and are made to simplify the recording of certain
transactions in the next accounting period.

Identifying and analyzing transactions and events

This is the first step in the accounting cycle. It involves identifying a business transaction
and analyzing whether or not the transaction affects the assets, liability, equity, income or
expenses of the business.
A transaction that has an effect on the accounts is a “accountable event” which needs to
be recorded in the books of accounts. On the other hand, a transaction that has no effect on the
account is a “non-accountable event” which is not recorded in the books of accounts.
Examples of source documents:
1. Sales invoices
2. Official receipts
3. Purchase orders
4. Delivery receipt
5. Bank deposit slips
6. Bank statements
7. Checks
8. Statements of account.

Types of Events

1. External events – are transactions that involve the business and another external party.
Examples include sale, purchase, borrowing of money, and payment of liabilities.

2. Internal events – are events that do not involve and external party. Examples include
production (cooking of barbecue) and casualty losses (e.g., destruction of properties
due to storm earthquake, and the like).

Journalizing
The second step is to record in the journal by means of a journal entry. This recording
process is called journalizing.

The journal is a chronological record of the entity’s transactions. A journal entry shows all the
effects of a business transaction in terms of debits and credits. Each transaction is initially
recorded in a journal rather than directly in the ledger. A journal is called the book of original
entry.

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 A journal entry has the following format:

Date Account title to be debited ₱xx

Account title to be credited ₱xx
short description of the transaction

1. Date. The year and month are not rewritten for every entry unless the year or month
changes a new page is needed.
2. Account Titles and Explanation. The account to be debited is entered at the extreme left
of the first line while the account to be credited is entered slightly indented on the next
line. Generally, skip a line after each entry.
3. P.R. (posting reference). This will be used when the entries are posted, that is, until the
amounts are transferred to the related ledger accounts.
4. Debit. The debit amount for each account is entered this column.
5. Credit. The credit amount for each account is entered in this column.

Simple and Compound journal entries

A journal entry may have one of the following formats:
a. Simple journal entry – one which contains a single debit and a single credit element.
The illustrated journal entry above is an example of a simple journal entry.
b. Compound journal entry - one which contain two or more debits and credits.

Illustration 1: Journal entries – Start-up

You opened a barbecue stand on January 1, 2018. The following were the business
transactions on the date.

Transaction #1 : Initial Investment

You provided P800 cash initial investment to your business.

Step 1: Transaction analysis

➢ Accounts affected: ‘Cash” (asset) and “Owner’s capital” (equity)
➢ Effect on accounts: Cash is increased; Owner’s capital is increased.
➢ Debit/Credit Asset is increased through debit. Equity is increased
through credit.

Step# 2 Journal Entry

Your initial investment is recorded in the journal as follows:
JOURNAL
Date Account titles Debit Credit
2018
Jan. 1 Cash 800
Owner's equity 800
to record the owner's initial
investment to the business

Transaction #2: Loan

The business obtained a loan of P1,200.

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Step 1: Transaction analysis
➢ Accounts affected: ‘Cash” (asset) and “Notes payable” (liability)
➢ Effect on accounts: Cash is increased; Notes payable is increased.
➢ Debit/Credit Asset is increased through debit. Liability is increased
through credit.

Step 2: Journal entry

The business loan is recorded as follows
JOURNAL
Date Account titles Debit Credit
2018
Jan. 1 Cash 1,200
Notes payable 1,200
to record the loan obtained

Both the journal entries above are examples of simple journal entries because they
have single debits and credits.

Transaction #3: Capital expenditures

The business acquired the following for cash:

Item description Cost

Barbeque grill P1,000
Cooking accessories 120
Beach umbrella 400

Step #1: Transaction Analysis

➢ Accounts affected: “Equipment” (asset) and ‘Cash” (asset)
➢ Effect on accounts Equipment is increased; Cash is decreased
➢ Debit / Credit Asset is increased through debit and decreased
through credit.

Step #2: Journal entry

The acquisition of equipment is recorded as follows:
JOURNAL
Date Account titles Debit Credit
2018
Jan. 1 Equipment - Barbeque grill 1,000
Equipment - Cooking accessories 120
Equipment - Beach umbrella 400
Cash (1,000 + 120 + 400) 1,520
to record the acquisition of
Equipment

The journal entry above is example of a compound journal entry because it has more
than one debit.

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Transaction #4: Acquisition of inventory
The business purchased inventory for P480 cash.

Step #1: Transaction analysis

➢ Accounts affected: “Inventory” (asset) and “Cash” (asset)
➢ Effect on accounts Inventory is increased; Cash is decreased.
➢ Debit / Credit Asset is increased through debit and decreased
through credit.

Step #2: Journal entry

The purchase of inventory is recorded as follows:
JOURNAL
Date Account titles Debit Credit
2018
Jan. 1 Inventory 480
Cash 480
to record the acquisition of
inventory

Illustration 2: Journal entries – Operations

Your barbecue operations started on January 2, 2018. The following were the business
transactions on this date:

Transaction #5: Sale

Total cash sales of barbecue amounted to P700. The total cost of the barbecues sold in P280.

Step #1: Transaction analysis

➢ Accounts affected: ➢ “Cash” (asset) and ”Sales” (income);
➢ “Cost of sales” (expense) and
“Inventory” (asset)
➢ Effect on accounts ➢ Cash is increased; Sales is increased.
➢ Cost of sales is increased; Inventory is
decreased.
➢ Debit / Credit ➢ Asset is increased through debit and
decreased through credit.
➢ Income is increased through credit.
➢ Expense is increased through debit.

Step #2: Journal entry

The sales are recorded as follows:

JOURNAL
Date Account titles Debit Credit
2018
Jan. 2 Cash 700
Sales 700
to record total sales of barbecue

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The cost of sales is recorded as follows:
JOURNAL
Date Account titles Debit Credit
2018
Jan. 2 Cost of goods sold 280
Inventory 280
to record the cost of the barbecue
sold as expense
The entry above to record the cost of goods sold is an application of the matching
concept. This concept costs that are directly associated with the earning of revenue are
recognized as expenses in the same period where the related revenue is recognized.
Transaction #6: Expense
The business paid P20 for supplies expense.

Step #1: Transaction analysis

➢ Accounts affected: “Supplies expense” (expense) and “Cash” (asset)
➢ Effect on accounts Cash is decreased; Supplies expense is
increased.
➢ Debit / Credit Expense is increased through debit. Asset is
decreased through credit.

Step #2: Journal entry

The supplies expense is recorded as follows:

JOURNAL
Date Account titles Debit Credit
2018
Jan. 2 Supplies expense 20
Cash 20
to record the supplies expense

Illustration 3: Non-accountable events

A. You are planning to purchase new equipment in the future. You have not yet placed an
order for the new equipment because you don’t have the money yet.

Step #1: Transaction analysis

➢ Accounts affected: None. A mere plan to purchase does not affect
the accounts of the business.
➢ Effect on accounts None
➢ Debit / Credit None

Step #2: Journal entry

No journal entry shall be made because the transaction is non-accountable.
B. Your dog “Buloy” died because he ate a barbecue stick.
Step #1: Transaction analysis

Fundamentals of Accounting, Business and Management | ABM S1

 ➢ Accounts affected: None. The event does not affect any of the
accounts of the business.
➢ Effect on accounts None
➢ Debit / Credit None

Step #2: Journal entry

No journal entry shall be made because the transaction is non-accountable.

Recording drills:
Let us have the following recording drills:
Case #1.1 Initial investment in cash
On January 1, 2019, the owner invests P100,000 cash to the business.

The journal entry to record the transaction is as follows:

JOURNAL
Date Account titles Debit Credit
2019
Jan. 1 Cash 100,000
Owner's capital 100,000
to record the owner's initial
investment
to the business

Case #1.2: Initial investment in non-cash assets

On January 20, 2019, the owner provides a building valued at P1,000,000 and an automobile
valued at P500,000 to the business.

Step #1: Transaction analysis

➢ Accounts affected: “Building” (asset), “Transportation equipment”
(asset), and “Owner’s capita” (equity)
➢ Effect on accounts Building and Transportation equipment are
increased; Owner’s capital is increased.
➢ Debit / Credit Asset is increased through debit. Equity is
increased through credit.

Step #2: Journal entry

The compound journal entry to record the transaction is as follows:

Fundamentals of Accounting, Business and Management | ABM S1

 JOURNAL
Date Account titles Debit Credit
2019
Jan. 20 Building 1,000,000
Transportation equipment 500,000
Owner's capital 1,500,000
to record the owner's non-
cash
investment to the business

Alternatively, the transaction above can be recorded through simple journal entries as
follows:

JOURNAL
Date Account titles Debit Credit
2019
Jan. 20 Building 1,000,000
Owner's capital 1,000,000
to record the owner's non-
cash
investment to the business

Jan. 20 Transportation equipment 500,000

Owner's capital 500,000
to record the owner's non-
cash
investment to the business

Both entries above – compound and simple, are acceptable.

Case #2.1: Acquisition of asset – Equipment
On January 25, 2019, the business acquires a machine for P20,000.

The journal entry to record the transaction is as follows:

JOURNAL
Date Account titles Debit Credit
2019
Jan. 20 Machinery 20,000
Cash 20,000
to record the acquisition
of machine

Case #2.2 : Acquisition of asset – Inventory (Cash basis)

On January 26, 2019, the business acquires inventories for P50,000 cash.

The journal entry to record the transaction is as follows:

Fundamentals of Accounting, Business and Management | ABM S1

 JOURNAL
Date Account titles Debit Credit
2019
Jan. 26 Inventory 50,000
Cash 50,000
to record the acquisition
of inventory on cash basis

Case #2.3A: Acquisition of asset – Inventory (On account/Credit)

On January 27, 2019, the business purchases inventories worth P70,000 on account.

Step #1: Transaction analysis

➢ Accounts affected: “Inventory” (asset) and “Accounts payable”
(liability)
➢ Effect on accounts Inventory is increased. Accounts payable is
increased.
➢ Debit / Credit Asset is increased through debit. Liability is
increased through credit.

Step #2: Journal entry

The journal entry to record the transaction is as follows:
JOURNAL
Date Account titles Debit Credit
2019
Jan. 27 Inventory 70,000
Accounts payable 70,000
to record the acquisition
of inventory on account

Case #2.3B: Payment of accounts payable

On January 31, 2019, the business settles the P70,000 account payable from the January 27,
purchase.

Step #1: Transaction analysis

➢ Accounts affected: “Accounts payable” (liability) and “Cash”
(asset)
➢ Effect on accounts Accounts payable is decreased through debit.
Asset is decreased through credit.
➢ Debit / Credit Liability is decreased through debit. Asset is
decreased through credit.

Step #2: Journal entry

The journal entry to record the transaction is as follows:

Fundamentals of Accounting, Business and Management | ABM S1

 JOURNAL
Date Account titles Debit Credit
2019
Jan. 26 Accounts payable 70,000
Cash 70,000
to record the settlement
of accounts payable

Case #3.1: Liability

On February 1, 2019, the business obtains a bank loan of P80,000.

The journal entry to record the transaction is as follows:

JOURNAL
Date Account titles Debit Credit
2019
Feb. 1 Cash 800,000
Notes payable 800,000
to record the loan taken from
a bank

Case #3.2: Payment of liability

On March 1, 2019, the business makes a partial payment of P400,000 on the bank loan.

Step #1: Transaction analysis

➢ Accounts affected: ‘Notes payable” (liability) and “Cash” (asset)

➢ Effect on accounts Notes payable is decreased. Cash is decreased
➢ Debit / Credit Liability is decreased through debit. Asset is
decreased through credit.

Step #2: Journal entry

The journal entry to record the transaction is as follows:

JOURNAL
Date Account titles Debit Credit
2019
Mar.1 Notes payable 400,000
Cash 400,000
to record the partial payment
of notes payable

Case #4.1: Income – Cash sale

On March 2, 2019, the business makes a cash sale of P100,000. The cost of inventories sold is
P30,000.

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The journal entries to record the transaction are as follows:

JOURNAL
Date Account titles Debit Credit
2019
Mar.2 Cash 100,000
Sales 100,000
to record the cash sale

Mar. 2 Cost of sale 30,000

Inventory 30,000
to charge the cost of inventories
sold as expense

Case #4.2A: Income – Credit sales (Sales on account)

On March 4, 2019, the business makes a sales on account of P80,000. The sales price is
collectible on March 8, 2019. The cost of the inventories sold is P20,000.

Step #1: Transaction analysis

➢ Accounts affected: ➢ “Accounts receivable” (asset) and

“Sales” (income);
➢ “Cost of Sales” (expense) and “Inventory
(asset)
➢ Effect on accounts ➢ Account receivable is increased; Sales is
increased.
➢ “Cost of Sales is increased; Inventory is
decreased.
➢ Debit / Credit ➢ Asset is increased through debit and
decreased through credit.
➢ Income is increased through credit.
➢ Expense is increased through debit.

Step #2: Journal entry

The journal entry to record the transaction is as follows:

JOURNAL
Date Account titles Debit Credit
2019
Mar.4 Accounts receivable 80,000
Sales 80,000
to record the sales on account

Mar. 4 Cost of sale 20,000

Inventory 20,000
to charge the cost of inventories
sold as expense

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Case #4.2B: Collection of accounts receivable
On March 8, 2019, the business collects P80,000 accounts receivable.

Step #1: Transaction analysis

➢ Accounts affected: “Cash” (asset) and “Accounts receivable” (asset)

➢ Effect on accounts Cash is increased. Accounts receivable is
decreased
➢ Debit / Credit Asset is increased through debit and decreased
through credit.

Step #2: Journal entry

The journal entry to record the transaction is as follows:

JOURNAL
Date Account titles Debit Credit
2019
Mar.8 Cash 80,000
Accounts receivable 80,000
to record the collection of
accounts receivable

Case #5 – Expense –Paid in cash

On March 20, 2019, the business pays P5,000 an advertisement that was aired on the radio.

The journal entry to record the transaction is as follows:

JOURNAL
Date Account titles Debit Credit
2019
Mar.20 Advertising expense 5,000
Cash 5,000
to record the cost of advertisement
as expense

Case #6 – Owner’s drawings

On April 7, 2019, the owner makes temporary withdrawal of P10,000 cash from the business.

Step #1: Transaction analysis

➢ Accounts affected: “Owner’s drawings” (contra-equity) and “Cash”

(asset)
➢ Effect on accounts Owner’s drawings is increased. Cash is
decreased
➢ Debit / Credit Contra-equity is increased through debit. Asset
is decreased through credit.

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Step #2: Journal entry
The journal entry to record the transaction is as follows:

JOURNAL
Date Account titles Debit Credit
2019
April. 7 Owner's drawings 10,000
Cash 10,000
to record the owner's drawings

Fundamentals of Accounting, Business and Management | ABM S1