Lecture 4

Accounting Principles 1
 Chapter Two
The Accounting Equation
and The Debit and Credit
Rule
 • Classification of transactions
• When we examine the accounting equation, we
find that each column contains changes of an
item of the statement of financial position. The
Classification total of the column shows the net amount of the
item after taking into consideration all the effects
of of different transactions on this item. The effect
Transactions of all transactions on each item can be shown by
and the Debit preparing a separate page or more for each item.
This page is divided into two sides. One side for
and Credit increases of the item and the other side for
Rule decreases of the item. The difference between the
two sides represents the net effect of all
transactions on the item. For example, we
prepare a page for cash, or another page for
capital, a third page for buildings, etc.
 • The following page is an example for cash:
cash
Collections from customers 10,000 Equipment 30,000
Capital 50,000 Expenses 5,000
Loan 10,000

Classification Total increases 70,000 Total decreases 35,000

Net position 35,000
of The above table shows:
Transactions 1. The name of the item is written on the top of the page for identification.
2. All transactions that increase cash are recorded on the left side of the
table.
3. All transactions that decrease cash are recorded on the right side of the
table.
4. The increases are added together, and the decreases are added together.
5. The difference between the two sides represents the net amount of cash
left after all changes. The difference is written on the left side,
indicating that we have a net increase in cash. If we have a net
decrease in cash, the difference is written on the right side.
 • Preparing a page for each item of the financial position
enables the accountant from including all changes in the
item in one place. The page for each item is called an
ACCOUNT. So, we have an account for each item of assets,
liabilities, and owner's equity, to show in it the changes in
each item. Normally these accounts are collected in one
The accounting book which is called a Ledger.
The account includes the following:
account. • Name of the account so, we have account for each item;
cash, accounts receivable, equipment, etc.
• Left side is called the debit side
• Right side is called the credit side.
• The shape of the simple form of the account looks like the
upper case of the English letter T. So, for this reason, it is
called the T-account.
 • there is a set of accounts that are widely used in practice
in many businesses.
1. Assets:
Each business keeps a group of accounts for changes in
assets, one account for each asset.
• Assets include:
Types of A) Long-term assets (Fixed assets), such as Properties
(land + buildings), Machines, equipment, Cars
Accounts (vehicles), and furniture.
B) B) Short-term Assets (Current Assets), such as: Cash in
hand, cash in Bank, Notes Receivables (N/R), Accounts
Receivables (A/R), inventory, Prepaid expenses,
Revenues
receivable (Revenues accrued).
C) Intangible assets: They are assets that do not have a
physical existence. Such as: Goodwill, Trade Name
(The brand), Patent, and Copyright.
 2. Liabilities:
The company keeps a set of accounts for its
liabilities. One account for each type of liabilities
whether short time or long time.
Liabilities include:
Types of A) Long-term Liabilities: Such as: Long-term Loans,
Accounts Bond Loan.
B) Current (Short-term) Liabilities: Such as: Notes
Payables (N/P), Accounts Payables (A/P),
Expenses payable, and Advance Revenues.
Note That:
1) Owners' Equity = Total Assets – Total Liabilities
2) Net Assets = Total Assets - Total Liabilities
This means that: Net Assets = Owner's Equity
 3. Owner's equity:
The company keeps a set of accounts for items
affecting the owner's equity. One of these
accounts is the capital account, to show all
Types of investments or withdrawals. Another group of
Accounts owner's equity accounts are revenues
accounts and expenses accounts for each item
of revenues and expenses. These accounts
include earned fees, commissions, sales
revenues, salaries expenses, rent expenses,
and advertising expenses.
 the account has two sides. The left side is called DEBIT side
and the right is called the CREDIT side. Now we should
determine whether the change in the account should be
recorded in the debit or the credit side.
. The debit and credit have different meanings in real life.
Debit and For accountants, Debit means left side and Credit means
Credit Rule right side and there is no other meaning for these two terms.
The normal balance of the assets accounts is the debit
balance which means that any increase in these accounts is
recorded in the debit side which is the left side of the
accounting equation. The normal balance of the liabilities
and owner's equity accounts is the credit balance which
means that any increase in these accounts is recorded in the
credit side which is the right side of the equation.
 • Assets Accounts:
• All assets accounts are debit accounts because
they appear in the left side of the statement of
Assets financial position. Thus, any increase in assets
Accounts represents an increase in the left side (Debit) and
any decrease in assets represents a credit. The
asset account appears as follows:
Assets Account
Debit Credit
Increase in asset Decrease in assets
 • Liability Accounts:
• All liability accounts are credit accounts because
they appear on the right side of the statement of
Assets the financial position. Any increase in liabilities is
Accounts recorded on the right side (credit) and any
decrease on the left is recorded on the left side.
The liability account appears as follows:
Liability Account
Debit Credit
Decrease in Liability Increase in Liability
 • Owner's equity Accounts:
• Owner's equity accounts appear in the right side of the
statement of financial position so, we apply the same rules
of liabilities as follows:
a. The capital account:
Assets Capital Account
Debit Credit
Accounts Decrease in Capital Increase in Capital

b. The drawings account:

• Drawings are money drawn from the company by owner
for his/her personal use. So, they reduce equity and should
be recorded by a debit in the left side as follows:
Drawings Account
Debit Credit
Any drawings
 • Revenues and expenses Accounts
• revenues increase owner's equity. So, all revenues
are credit accounts. On the other hand, all
Assets expenses reduce owner’s equity. So, all expenses
Accounts are debit accounts.
• To sum the effects of the changes of the different
accounts on the accounting equation, the
following shows the rules for all items:
Asset accounts Liabilities and Owner's equity
Any increase is a debit Any increase is credit
Any decrease is a credit Any decrease is debit
 • The double entry system states that “Each
transaction has two sides. One debit and one
credit. The debit should be equal to the credit”.
The Double • The double entry system is one of the most
important concepts of accounting that are widely
Entry rule used by businesses, regardless of its type or form.
and Debit • All activities that we record on the accounting
and Credit records affect the two sides of the equation
equally. So, the equation remains balanced after
recording each transaction. This means that the
effect of each transaction on the debit accounts is
equal to the effect on the credit accounts to keep
the equation balanced.
 1. Deposit cash in the bank as capital
Assume that Ahmed deposits $50,000 cash in the
bank as capital for his business.
Analysis of
transactio
Increase Cash by $50,000
Analysis of
Increase Capital by
Transaction
$50,000
ns using the
debit and Applying Debit and
Increase in Cash is a debit
Increase in Capital is a
credit:
Credit rule
credit
 2. Getting a loan from a bank :
• Assume that Ahmed got a loan from the bank
for $25,000 in cash
Analysis of Increase cash by $25,000
transactio Analysis of
Transaction
Increase loans payable by
$25,000
ns using the
debit and Applying Debit and
Increase in cash is a debit
Increase in loans payable

credit:
Credit rule is a credit
 3. Purchase of assets in cash
• Assume that Ahmed purchased an office
building for $30,000 in cash.
Analysis of Increase Buildings by
transactio Analysis of
Transaction
$30,000
Decrease cash by $30,000
ns using the
debit and Applying Debit and
Increase in Buildings is a
debit

credit: Credit rule Decrease in cash is a

credit
 4. Purchase of assets on credit
• Assume that Ahmed purchased a computer for
business for $5,000 on credit
Analysis of Increase Computer by
transactio Analysis of
Transaction
$5,000
Increase Accounts payable
ns using the by $5,000

debit and Applying Debit and

Increase in computers is a
debit
credit: Credit rule Increase in Accounts
payable is a credit
 5. Purchase of assets with partial cash payment
• Assume that Ahmed purchased office supplies
for $3,000, paid $1,000 in cash and signed a
note payable for the remaining amount.
Analysis of Increase supplies by
transactio Analysis of
$3,000
Increase Notes payable by
ns using the Transaction $2,000
Decrease in cash by

debit and $1,000

credit: Increase in supplies is a

debit
Applying Debit and Increase in Notes payable
Credit rule is a credit
Decrease in cash is a
credit
 6. Sale of assets at cost in cash
• Assume that Ahmed sold half of the building for
$15,000 in cash.
Analysis of Increase cash by $15,000
transactio Analysis of
Transaction
Decrease Buildings by
$15,000
ns using the
debit and Applying Debit and
Increase in cash is a debit
Decrease in Buildings is a

credit:
Credit rule credit
 7. Sale of asset on credit
• Assume that Ahmed sold the computers on
credit for $5,000.
Analysis of Increase Accounts
transactio Analysis of
Transaction
receivable by $5,000
Decrease Computers by
ns using the $5,000

debit and Applying Debit and

Increase in Accounts
Receivable is a debit
credit: Credit rule Decrease in Computers is
a credit
 8. Repayment of loan in cash.
• Assume that Ahmed repaid $10,000 of the loan
in cash.
Analysis of Decrease loans payable by
transactio Analysis of
Transaction
$10,000
Decrease cash by $10,000
ns using the
debit and Applying Debit and
Decrease in Loans payable
is a debit

credit:
Credit rule Decrease cash is a credit
 9. Collecting Accounts Receivable
• Assume that Ahmed collected $5,000 in cash
from the computer's buyer.
Analysis of Increase Cash by $5,000
transactio Analysis of
Transaction
Decrease accounts
receivable by $5,000
ns using the
debit and Applying Debit and
Increase in cash is a debit
Decrease in accounts

credit:
Credit rule receivable is a credit
 10. Additional Investment by Owner
• Assume that Ahmed invested $20,000 in cash as
capital.
Analysis of Increase Cash by $20,000
transactio Analysis of
Transaction
Increase in capital by
$20,000
ns using the
debit and Applying Debit and
Increase in Cash is a debit
Increase in Capital is a

credit:
Credit rule credit
 11. Reduction in owner's investments (Capital)
• Assume that Ahmed withdrew $10,000 to reduce
his capital.
Analysis of Decrease in Capital by
transactio Analysis of
Transaction
$10,000
Decrease Cash by $10,000
ns using the
debit and Applying Debit and
Decrease in Capital is a
debit

credit: Credit rule Decrease in Cash is a

credit
 12. Drawing by the owner for his personal use:
• Assume that Ahmed withdrew $5,000 cash for
his personal use
Analysis of Increase in drawings
transactio Analysis of
(decrease in
equity) by $5,000
owner's

ns using the
Transaction
Decrease in cash by
$5,000

debit and Increase in Drawings is a

credit: Applying Debit and
Credit rule
debit
Decrease in Cash is a
credit
 13. Rendering service and collecting cash
• Assume that Ahmed rendered services to
customers for $7,000 in cash
Analysis of Increase Cash by $7,000
transactio Analysis of
Transaction
Increase in revenues
(owner's equity) by $7,000
ns using the
debit and Applying Debit and
Increase in cash is a debit
Increase in Revenues is a

credit:
Credit rule credit
 14. Collection of revenues later
• Assume that Ahmed rendered the service for
$5,000 on account.
Analysis of Increase Accounts
transactio Analysis of
Transaction
Receivable by $5,000
Increase in revenues
ns using the (owner's equity) by $5,000

debit and Applying Debit and

Increase in Accounts
Receivable is a debit
credit: Credit rule Increase in Revenues is a
credit
 15. Collecting Accounts Receivable
• Assume that Ahmed collected the $5,000 from
customers for the services rendered
Analysis of Increase in cash by $5,000
transactio Analysis of
Transaction
Decrease Accounts
Receivable by $5,000
ns using the
debit and Applying Debit and
Increase in cash is a debit
Decrease in Accounts

credit:
Credit rule Receivable is a credit
 16. Cash Expenses
• Assume that Ahmed paid $8,000 salaries
expenses in cash.
Analysis of Increase in Salaries
transactio Analysis of
Expenses (Decrease in
owner's equity) by $8,000
ns using the
Transaction
Decrease in cash by
$8,000

debit and Increase in Salaries

credit: Applying Debit and
Credit rule
Expenses is a debit
Decrease in cash is a
credit
 17. Expenses on credit
• Assume Ahmed will pay rent expenses of $2,000
later.
Analysis of Increase in Rent Expenses
transactio Analysis of
(Decrease in owner's
equity) by $2,000
ns using the
Transaction
Increase in Rent Payable
by $2,000

debit and Increase in Rent Expenses

credit: Applying Debit and
Credit rule
is a debit
Increase in Rent Payable
is a credit
 18. Payment of rent later
• Assume that Ahmed paid the rent payable later

Analysis of Decrease in Rent Payable

transactio Analysis of
Transaction
by $2,000
Decrease in Cash by
ns using the $2,000

debit and Applying Debit and

Decrease in Rent Payable
is a debit
credit: Credit rule Decrease in Cash is a
credit
Thank you