Accounting equation and
double-entry bookkeeping
Financial Accounting and Reporting
Pre-test: Provide the missing item
Accounting equation
Balance sheet (Financial position)
ASSETS LIABILITIES EQUITY
Resources owned and/or controlled by an Obligations by the entity arising The residual interest in the assets of the
entity that will provide future economic from past events that will that will be enterprise after deducting all its
benefits, in the form of: liabilities. Total equity is the
settled thru
• Generation of revenues accumulation of:
• Reduction of expenditure • outflow of economic resources
(i.e., entity’s assets); or • Assets invested by the owner;
• Utilization in production of goods
• Amount withdrawn by or
• Settlement of the entity’s obligations • performance of obligation
• Conversion to cash
distributed to the owners; and,
(rendering service or delivering
• Distribution of profit and/or return of • Profits earned or loss incurred
goods) throughout the entity’s operation
investment to owners.
Income statement (Financial performance)
COSTS AND NET INCOME
REVENUES
EXPENSES (LOSS)
Inflow of economic Represents the outflow • When total revenues is higher
than total costs and expenses,
resources generated from an of economic resources the business will report net
entity's normal course of within the entity's normal income form its operations.
business and may include • When total revenues is lower
course of business. than total costs and expenses,
income incidental thereto.
the business will report net loss
form its operations.
Double-entry Bookkeeping
Definition of bookkeeping
• Bookkeeping is a business activity concerned with recording and classifying financial data
related to business operation in order of its occurrence.
• A mechanical task involving the following activities:
– Collection of basic financial information
– Identification of economic events and transactions
– Measurement of economic transactions in monetary terms
– Recording economic transactions chronologically
– Classifying effects of economic transaction
Types of bookkeeping system
Single-entry bookkeeping
• Uses only one entry in every transaction, similar to a check register.
• Does not track assets and liabilities from transaction.
• Applicable only to very small businesses with simple operations and low volume of activity.
Double-entry bookkeeping
• Used by most businesses.
• Discussed in detail in the succeeding slides.
Double entry bookkeeping
• Develop by Italian mathematician Luca Pacioli in 1494.
• Based on the principle of the duality of business transactions and events, i.e., every
transaction has a double (or dual) effect on the position of a business as recorded in the
accounts.
• Double entry bookkeeping has the following features:
– Transactions are recorded in specific accounts
– Every transaction has two fold aspects (one party giving the benefit and the other receiving the benefit).
– Every transaction is divided into two aspects, Debit and Credit.
– Every debit must have its corresponding and equal credit.
Advantage and limitation of
double-entry bookkeeping
Advantage of double-entry bookkeeping Limitations of double-entry bookkeeping
• Completely captures the economic effect • It does not disclose all the errors
of business transactions. committed in the books accounts.
• Ensures arithmetical accuracy of the • It is costly as it involves maintenance of
books of accounts, since every debits must numbers of books of accounts.
have an equal credit.
• Balances of receivables and payable are
properly tracked.
• Most errors can be easily detected and
rectified.
The accounting process
Step 3:
Step 5: Posting
Step 1: Step 2: Summarizing/ Step 4:
of adjusting
Identification Recording/ Posting in Preparation of
entries
of transaction Journalizing general ledger trial balance
Step 10: Step 9: Step 7: Step 6:
Step 8:
Reversing Preparation of Financial Worksheet
Preparation of
entries post-closing statements preparation
closing entries
(optional) trial balance preparation (optional)
Concepts of account,
debit and credit
Concept of account
• An account is defined as a summarized record of economic transactions related to the elements of the
financial statement. For example:
• The “Cash” account is a record of all money transactions of the entity (receipt/payment).
• The “Accounts receivable” account contains information about all credit sales transaction.
• An account is usually expressed as a statement in form of letter ‘T’.
• The left side is called as “Debit’ and the right side is called as “Credit’.
• The debit is denoted as ‘Dr’ and the credit by ‘Cr’.
Account name
“Debit” transactions “Credit” transactions
Types of account
Type Purpose of account
Real account • Accounts related to the entity’s assets, liabilities and owner’s equity
• Balances are carried-over from one accounting period to another.
• Also known as permanent accounts or balance sheet accounts.
Nominal account • Accounts related to the entity’s revenues and expenses.
• Balances are transferred to a real account at the end of an accounting period.
• Also known as temporary accounts or income statement accounts.
Contra account • Accounts that reduced the value of a related account.
• The normal balance of these account will be the opposite of the related
account (i.e., if asset account have normal debit balance, contra-asset accounts
will have a normal credit balance).
• Can either be a real account or nominal.
Concepts of debit and credit
Debit (Dr) Credit (Cr)
• Derived from the the Latin word “debitum”, meaning • Derived from the the Latin word “credere”, meaning
“What we will receive”. “What we will have to pay”.
• It is the “destination” of every transaction, or the • It is the “source” of the benefits received on every
benefit that the entity received (value received). transaction(value parted with or given up).
Additional notes:
• Every transactions debit entries must equal its credit entries.
• The difference between the total debits and total credits in an account is the account’s balance.
– If debits exceed credits, the account has a debit balance
– If credits exceed debits, the account has a credit balance.
Debiting and crediting elements
of the financial statement
Type of account Debit Credit Normal balance
Asset Increase Decrease Debit
Liability Decrease Increase Credit
Equity Decrease Increase Credit
Revenue Decrease Increase Credit
Expense Increase Decrease Debit
Chart of accounts
• A chart of accounts is a listing of the names of the accounts that a company has identified and made
available for recording transactions in its books of accounts.
• The chart of accounts is tailored to suit the needs of the business.
Typical accounts used by
business organizations
Asset accounts
Account name Purpose
Cash Paper bill, check and any other medium that will be accepted in the exchange of goods or service.
Accounts receivable Amount due to be collected by the entity from it s customer for service rendered or goods sold on credit.
Notes receivable A written pledge that a debtor will be pay the entity a fixed amount on a certain date.
Allowance for Doubtful Accounts A contra-asset account representing a portion of the entity’s receivable that is assessed to be uncollectible.
Inventories Goods that are held for sale in the ordinary course of business or used in production of goods and services.
• Merchandise inventory - goods bought by trading firms for resale at a mark-up.
• Raw materials inventory - goods to be used in making a finished goods by a manufacturing firm.
• Work-in-process inventory - inventories in the manufacturing line bur not yet completed.
• Finished goods inventory - inventories completed from the manufacturing process for sales.
• Production supplies – inventory of other supplies used in the production goods and services.
Prepaid expenses Represents cash paid by the entity to its supplier of goods or service that is yet to incurred used or consumed by the
entity and , hence, yet not incurred by the entity.
Asset accounts
Account name Purpose
Property, plant and Tangible properties that are held by an enterprise for use in the production or supply of goods or
equipment (Fixed asset) services, rental to other or use for administrative purposes that is expected to be useful within for more
than one year. Includes items such as land, building, machinery and equipment, furniture and fixture and
vehicles.
Accumulated depreciation A contra-asset account related to an item of fixed asset and contains the accumulated sum of periodic
depreciation charges. The balance of this account is deducted from the cost of the related asset (e.g.
building, equipment, vehicle) to obtain its net book value or carrying value.
Liability accounts
Account name Purpose
Accounts payable Amount due to be paid by the entity to its supplier for services rendered or good
received on credit.
Accrued expenses payable Amount owed to other for unpaid expense where the supplier’s billing or other
supporting document are still not yet received by the entity.
Unearned revenues Represents cash received by the entity from its customer prior to rendering of service
or delivery of goods, hence, still not earned by the entity.
Loans payable Represents cash obtained through debt financing from a bank or other financial
institution. Loans payable can also be called as:
• Short-term loan payable, if it is due to be paid within one year, or
• Long-term loan payable, if it is due to be paid for a period exceeding one year.
Equity accounts
Account name Purpose
Owner, capital Pertains to the owner’s invested capital and accumulated profit (loss), net of
withdrawals closed in this account.
Owner, withdrawals Contra-equity account; Temporary account used to record withdrawals of
business asset by the owner for personal purposes.
Revenue accounts
Account name Purpose
Service revenue Revenue earned by performing services for a customer or client; for example,
accounting services by a CPA firm, legal services by a law firm
Sales Revenues earned as a result of sale of goods, for example, sale of building
materials by a construction supply firm
Other revenues/ Revenue earned that is incidental to the operations of the business, for example,
income interest income earned on cash in bank
Gains Revenue earned from activities outside of the normal course of business, for
example, gain on sale of fixed assets sold for more than its carrying value.
Cost of sales/revenues accounts
Account name Purpose
Direct cost Expenditure spent by the entity that is directly related in earning service revenues;
for example, salaries of CPAs hired by an accounting firm or the fuel consumed
and salary of the drivers of a bus company.
Cost of sales Cost assigned to goods sold by a trader or manufacturer. This account is used in
the perpetual inventory system only.
Purchases Accumulated cost of goods purchased by a trading firm from suppliers. This
account is used in the periodic inventory system only.
Expense accounts
Account name Purpose
Salaries and wages expense Payments made as a result of an employer-employee relationship between the entity and its employees.
Utilities expense Expenses related to use of telecommunication facilities, consumption of electricity or water.
Rent expense Expense for leasing office space, equipment or other assets.
Office supplies expense Expense of using office supplies in the conduct of routing business activities
Insurance expense Payment of premium on insurance coverage of the entity’s assets.
Depreciation expense Portion of a tangible asset allocated or charged as expense during an accounting period.
Bad debts expense Amount of receivable estimated to be doubtful of collection and charge as expense during the period.
Interest expense Expense related to the use of borrowed funds.
Losses Outflow of economic resource that is outside of the normal of course business.
The Accounting Equation and
Effects of Business Transactions
Effect of business transactions
• Every accountable event has a dual but self-balancing effect on the accounting equation. The types of effect
of transactions are as follows:
• Increase in Asset = Increase in Liability
• Increase in Asset = Increase in Owner’s Equity
• Increase in one Asset = Decrease in another Asset
• Decrease in Asset = Decrease in Liability
• Decrease in Asset = Decrease in Owner’s Equity
• Increase in Liability = Decrease in Owner’s Equity
• Increase in Owner’s Equity = Decrease in Liability
• Increase in one Liability = Decrease in another Liability
• Increase in one Owner’s Equity = Decrease in another Owner’s Equity
Illustrative example on the acounting equation
Sample problem:
Analyze the impact on the accounting equation of the following transactions of GCQ Cleaning Services:
Jan 1 Invested capital in the business, P20,000
Jan 2 Purchased furniture and fixtures on credit from Das & Co., P2,000
Jan 4 Paid repair services , P3,000
Jan 8 Billed Mr. Cruz for services rendered, P2,500.
Jan 12 Paid 50% of the amount due to to Das & Co., P1,000
Jan 18 Collected amount billed to Mr. Cruz, P2,500
Illustrative example on the acounting equation
Owner's
Date Transaction Assets = Liabilities +
equity
Jan. 1 Invested capital in the business, P20,000 20,000 = - + 20,000
Jan 2 Purchased furnitures and fixtures on credit 2,000 = 2,000 + -
Sub-total 22,000 = 2,000 + 20,000
Jan 4 Paid repair services - 3,000 = - + - 3,000
Sub-total 19,000 = 2,000 + 17,000
Jan 8 Billed Mr. Cruz for services rendered 2,500 = + 2,500
Sub-total 21,500 = 2,000 + 19,500
Jan 12 Paid 50% of the amount due to to Das & Co. - 1,000 = - 1,000 +
Sub-total 20,500 = 1,000 + 19,500
Jan 18 Collected amount billed to Mr. Cruz 2,500 = - -
+
- 2,500
Sub-total 20,500 = 1,000 + 19,500
