Unit III: Business Organizations and the Accounting Equation

The structural classification of a business organization is defined primarily by its underlying source of capital:

• Sole Proprietorship: A business owned, funded, and managed by a single individual who maintains complete structural control. The owner receives all corporate profits but assumes full personal liability for all corporate debts, losses, and legal obligations. Registration requires formal business name verification with the Department of Trade and Industry (DTI).
• Partnership: An association of two or more co-owners established under the Civil Code as a distinct juridical person with a separate legal personality from its members. Partnerships are split into:
  • General Partnership: All partners bear unlimited liability for corporate obligations.
  • Limited Partnership: General partners maintain unlimited liability, while limited partners are liable only up to their explicit capital contribution amount.
  • Note: Partnerships with capital balances exceeding 3,000 Pesos must register with the Securities and Exchange Commission (SEC).
• Corporation: A distinct juridical entity created under the Corporation Code with a separate legal personality from its stockholders. Stockholder liability is strictly capped at their individual share capital investment. It requires regular SEC tracking and can be classified into multiple configurations:
  • Stock Corporation: Capital stock is split into distinct shares, allowing the board of directors to distribute surplus earnings as dividends.
  • Non-Stock Corporation: Formed for public, charitable, or educational purposes; it does not issue stock shares to members.
  • One Person Corporation (OPC): A single stockholder entity limited to a natural person of legal age, a trust, or an estate.

Businesses extract financial revenues through three primary modes of operation:

• Service Business: Offers non-physical, intangible products rooted in technical skills, professional expertise, or specialized advice (e.g., salons, schools, accounting firms, law practices).
• Merchandising Business: Operates as a wholesale or retail reseller, purchasing finished goods and selling them to customers at a higher price without altering the physical shape or form of the product.
• Manufacturing Business: Combines raw materials, production labor, and factory overhead costs to physically transform inputs into entirely new finished goods ready for customer distribution.

The foundational baseline of double-entry bookkeeping relies on the principle of continuous balance. Assets represent things of value controlled by an enterprise that generate future economic benefits. These assets are funded either by creditors (liabilities) or by owners (capital).

The relationship is expressed through the Accounting Equation:

$\text{Assets} = \text{Liabilities} + \text{Owner's Equity}$

In the event of business liquidation, creditors maintain top priority; their claims must be satisfied before any residual capital can be returned to the owners:

$\text{Assets} - \text{Liabilities} = \text{Owner's Equity}$

By mathematical convention, the left side of the accounting equation is designated as Debit (Dr.), while the right side is Credit (Cr.).

Normal Balances: Accounts naturally maintain a normal balance on the side of the equation where they increase.

An increase in an account value must always be recorded on its normal balance side; a decrease is logged on the opposite side.

        ASSETS                     LIABILITIES                 OWNER'S EQUITY
-------------------------  -------------------------  -------------------------
Debit (+)   | Credit (-)   Debit (-)   | Credit (+)   Debit (-)   | Credit (+)
            |                          |                          |
Normal Bal. |              			| Normal Bal.  |           | Normal Bal.

Owner's Equity is dynamically influenced by four operational events:

• Owner Investments (+ Equity): Initial or additional cash/assets placed into the business.
• Revenues (+ Equity): Inflows from standard business operations (e.g., service fees). Since revenues increase equity, their normal balance is a Credit.
• Expenses (- Equity): Asset outflows or liabilities incurred to generate revenue. Since expenses reduce equity, their normal balance is a Debit.
• Drawings/Withdrawals (- Equity): Cash or assets extracted by the owner for personal use. Because drawings reduce equity, their normal balance is a Debit.