Accounting Equation and

the Double Entry System

 ACCOUNTING EVENTS & TRANSACTIONS

Accounting event – an economic occurrence

that causes changes in an enterprise’s
assets, liabilities, and/or equity.
• Internal
• External
 ACCOUNTING EVENTS & TRANSACTIONS

• Transaction – a particular kind of event that

involves the transfer of something of value
between two entities
• Business transaction – any financial event
that changes the resources of firm
 ELEMENTS OF FINANCIAL STATEMENTS
• Asset – a resource controlled by the enterprise
as a result of past events and from which future
economic benefits are expected to flow to the
enterprise
• Liability – a present obligation of the enterprise
arising from past events, the settlement of which
is expected to result in an outflow from the
enterprise of resources embodying economic
benefits
• Equity – residual interest in the assets of the
enterprise after deducting all its liabilities
 ELEMENTS OF FINANCIAL STATEMENTS
• Income – increases in economic benefits during
the accounting period in the form of inflows or
enhancements of assets or decreases of liabilities
that result in increases in equity other than those
relating to contributions from equity participants
• Revenue – arises in the course of the ordinary activities of
an enterprise
• Gains – other items that meet the definition of income and
may, or may not, arise in the course of the ordinary
activities of an enterprise
 ELEMENTS OF FINANCIAL STATEMENTS
• Expense – decreases in economic benefits during
the accounting period in the form of outflows or
depletions of assets or incurrence of liabilities that
result in decreases in equity, other than those
relating to distributions to equity participants
• Losses - other items that meet the definition of expense
and may, or may not, arise in the course of the ordinary
activities of an enterprise
ELEMENTS OF FINANCIAL STATEMENTS

FINANCIAL
ELEMENTS
STATEMENTS
Asset
Balance Sheet Liability
Equity / Capital

Income
Income Statement
Expense
TYPICAL ACCOUNT TITLES USED - BALANCE SHEET

CURRENT ASSETS
-Expected to be realized, sold or consumed
within the normal operating cycle;
-Primarily for the purpose of trading;
-Expected to be realized within 12 months
AFTER the end of the reporting period; or
-Cash or cash equivalent unless restricted
ASSETS from being exchanged or used to settle
liability for at least 12 months after the end
of the reporting period

NON-CURRENT ASSETS
- All other assets which are not
considered current
 TYPICAL ACCOUNT TITLES USED - BALANCE SHEET

ASSETS
* Current * Non-current
§Property, Plant and
§Cash
Equipment
§Cash Equivalents
§Accumulated
§Notes Receivable Depreciation – a contra
§Accounts Receivable asset account
§Inventories §Intangible Assets
§Prepaid Expenses §Long-term Notes
Receivable
 TYPICAL ACCOUNT TITLES USED - BALANCE SHEET

Cash – any medium of exchange that a bank will accept for

deposit at face value. Coins, currency, checks, money
orders, bank deposits, bank drafts.
Cash Equivalents – short-term highly liquid investments that
are readily convertible to known amounts of cash and
which are subject to an insignificant risk of changes in
value.
Accounts Receivable – claims against customers arising
from sale of services or goods on credit (on account). This
offers less security than a promissory note.
Notes Receivable – a written pledge that the customer will
pay the business a fixed amount of money on a certain
date.
 TYPICAL ACCOUNT TITLES USED - BALANCE SHEET

Inventories – assets which are (a) held for sale in the

ordinary course of business; (b) in the process of
production for such sale; (c) in the form of materials or
supplies to be consumed in the production process or in
the rendering of services.
Prepaid Expenses – expenses paid for by the business in
advance.
Property, Plant and Equipment – tangible assets that are
held by an enterprise for the use in the production or
supply of goods or services, or for rental to others, or for
administrative purposes and which are expected to be
used during more than one period.
 TYPICAL ACCOUNT TITLES USED - BALANCE SHEET

Accumulated Depreciation – A contra account that contains

the sum of the periodic depreciation charges. The balance
in this account is deducted from the cost of the related
asset (equipment or buildings) to obtain book value.
Intangible Asset – Identifiable, nonmonetary assets without
physical substance held for use in the production or supply
of goods or service, for rental to others, or for
administrative purposes. Goodwill, patents, copyrights,
licenses, franchises, trademarks, brand names, secret
processes, subscription lists and non-competition
agreements.
 TYPICAL ACCOUNT TITLES USED - BALANCE SHEET
CURRENT LIABILITIES
-Expected to be settled within the normal
operating cycle;
-Primarily for the purpose of trading;
-Expected to be settled within 12 months
AFTER the end of the reporting period; or
LIABILITIES -Entity does not have an unconditional
right to defer settlement of the liability for
at least 12 months AFTER the end of the
reporting period

NON-CURRENT LIABILITIES
- All other liabilities which are
not considered current
 TYPICAL ACCOUNT TITLES USED - BALANCE SHEET

LIABILITIES
* Non-current
* Current
§Mortgage Payable
§Accounts Payable
§Bonds Payable
§Notes Payable
§Long-term Notes
§Accrued Liabilities Payable
§Unearned Revenues
§Current portion of long-
term debt
 TYPICAL ACCOUNT TITLES USED - BALANCE SHEET

Accounts Payable – this account represents the reverse

relationship of the accounts receivable. By accepting the
goods or services, the buyer agrees to pay for them in the
near future.
Notes Payable – like a note receivable but in a reverse
sense. In the case of a note payable, the business entity is
the maker of the note; that is, the business entity is the
party who promises to pay the other party a specified
amount of money on a specified future date.
Accrued Liabilities – Amounts owed to others for unpaid
expenses. This account includes salaries payable, utilities
payable, interest payable and taxes payable.
 TYPICAL ACCOUNT TITLES USED - BALANCE SHEET

Unearned Revenues – When the business entity receives

payment before providing its customers with goods or
services, the amounts received are recorded in the
unearned revenue account (liability method). When the
goods or services are provided to the customer, the
unearned revenue is reduced and income is recognized.
Current portion of long-term debt – These are portions of
mortgage notes, bonds and other long-term indebtedness
which are to be paid within one year from the balance
sheet date.
 TYPICAL ACCOUNT TITLES USED - BALANCE SHEET

Mortgage Payable – This account records long-term debt of

the business entity for which the business entity has
pledged certain assets as security to the creditor. In the
event that the debt payments are not made, the creditor
can foreclose or cause the mortgaged asset to be sold to
enable the entity to settle the claim.
Bonds Payable – Business organization often obtain
substantial sums of money from lenders to finance the
acquisition of equipment and other needed assets. They
obtain these funds by issuing bonds. The bond is a
contract between the issuer and the lender specifying the
terms of repayment and the interest to be charged.
 TYPICAL ACCOUNT TITLES USED - BALANCE SHEET

OWNER’S EQUITY

§Capital
§Withdrawals
§Income Summary
 TYPICAL ACCOUNT TITLES USED - BALANCE SHEET

Capital – Used to record the original and additional

investments of the owner of the business entity. It is
increased by the amount of profit earned during the year or
is decreased by a loss. Cash or other assets that the
owner may withdraw from the business ultimately reduce
it. This account bears the name of the owner (sole
proprietorship).
Withdrawals – When the owner of a business entity
withdraws cash or other assets, such are recorded in the
drawing or withdrawal account rather than directly reducing
the owner’s equity account.
 TYPICAL ACCOUNT TITLES USED - BALANCE SHEET

Income Summary – A temporary account used at the end of

the accounting period to close income and expenses. This
account shows the profit or loss for the period before
closing to the capital account.
 TYPICAL ACCOUNT TITLES USED – INCOME STATEMENT

INCOME §Supplies Expense

§Service income §Rent Expense
§Sales §Insurance Expense
EXPENSES §Depreciation Expense
§Cost of Sales / Cost of §Uncollectible accounts
goods sold Expense / Bad debts
Expense / Doubtful
§Salaries or Wages
Accounts Expense
Expense
§Interest Expense
§Telecommunications,
Electricity, Fuel and
Water Expenses /
Utilities Expense
 TYPICAL ACCOUNT TITLES USED - BALANCE SHEET

Service Income – Revenues earned by performing services

for a customer or client; e.g. accounting services by an
accounting firm, laundry services by a laundry shop
Sales – Revenues earned as a result of sale of merchandise;
e.g. sale of building materials by a construction supplies
company
Cost of Sales – The cost incurred to purchase or to produce
the products sold to customers during the period; also
called “Cost of goods sold.”
Salaries or Wages Expense – includes all payments as a
result of an employer-employee relationship; Salaries,
wages, 13th month pay, cost of living allowances, other
related benefits.
 TYPICAL ACCOUNT TITLES USED - BALANCE SHEET

Telecommunications, Electricity, Fuel and Water expense

/ Utilities Expense – expenses related to the use of
telecommunication facilities, consumption of electricity, fuel
and water.
Supplies Expense – expense of using supplies (office
supplies) in the conduct of daily business.
Rent Expense – Expense for the use of space, equipment or
other asset rentals.
Insurance Expense – Portion of premiums paid on
insurance coverage (e.g. on motor vehicle, health, life, fire,
typhoon or flood) which has expired.
 TYPICAL ACCOUNT TITLES USED - BALANCE SHEET

Depreciation Expense – The portion of the cost of a tangible

asset (buildings and equipment) allocated or charged as
expense during an accounting period.
Uncollectible Accounts Expense – The amount of
receivables estimated to be doubtful of collection and
charged as expense during an accounting period.
Interest Expense – An expense related to the use of
borrowed funds.
THE ACCOUNTING EQUATION

• The most basic tool of accounting

• Used to arrive at the items and amounts
that make up the financial statements

- The final products of the accounting process

 THE ACCOUNTING EQUATION
Assets are on the left side of the equation
opposite the liabilities and owner’s equity.
Increases and decreases in assets are
recorded in the opposite manner (“mirror
image”) as liabilities and equity are
recorded.
Liabilities and equity follow the same rules of
debit and credit.
 THE ACCOUNTING EQUATION
The logic of debiting and crediting is related to
the accounting equation. Transactions may
require additions to both sides (left and
right), subtractions from both sides (left and
right), or an addition and subtraction on the
same side (left or right), but in all cases, the
equality must be maintained.
 THE ACCOUNTING EQUATION

Remember: Assets must ALWAYS equal liabilities

and owner’s equity.
 ACCOUNTING FOR BUSINESS
TRANSACTIONS
Financial transaction worksheet – a form used
to analyze increases and decreases in the
assets, liabilities and equity of a business
entity
 ACCOUNTING FOR BUSINESS
TRANSACTIONS
Starting a business
Oct. 1
Ironman started his business by withdrawing
P800,000 from his personal savings. He
deposited the amount in a new account
under his firm’s name, Ironman Accounting
Services.
 ACCOUNTING FOR BUSINESS
TRANSACTIONS
Purchasing equipment on credit
Oct. 3
Ironman bought a computer, a copy machine,
a fax machine, calculators and other
necessary equipment from Hulk Ent., at a
cost of P100,000. Hulk Ent. Agreed to allow
60 days for the firm to pay the bill.
 ACCOUNTING FOR BUSINESS
TRANSACTIONS
Purchasing supplies for cash
Oct. 5
Ironman ordered for toner, fax paper, bond
paper, CDs, pens, folder and other supplies
with a total cost of P20,000. Ironman issued
a check to pay for the supplies.
 ACCOUNTING FOR BUSINESS
TRANSACTIONS
Paying a creditor
Oct. 9
Ironman paid Hulk Ent. for the equipment
purchased. He issued a check for P40,000.
 ACCOUNTING FOR BUSINESS
TRANSACTIONS
Selling services on credit
Oct. 13
Ironman Accounting Services earned P70,000
revenue from charge account clients. These
clients are allowed 30 days to pay.
 ACCOUNTING FOR BUSINESS
TRANSACTIONS
Employees’ salaries
Oct. 18
Ironman Accounting Services hired an
accounting clerk on Oct. 1 to help in the
business. The firm paid P25,000 for the
salaries.
 ACCOUNTING FOR BUSINESS
TRANSACTIONS
Collecting receivables
Oct. 23
The firm received P30,000 from clients who
had previously bought services on account.
 ACCOUNTING FOR BUSINESS
TRANSACTIONS
Selling services for cash
Oct. 27
A total of P210,000 was earned by the firm as
revenue from clients who paid cash for
accounting and bookkeeping services.
 ACCOUNTING FOR BUSINESS
TRANSACTIONS
Utilities expense
Oct. 30
The firm received a P35,000 bill for the
utilities used during the month. A check was
issued to pay for the bill.
 ACCOUNTING FOR BUSINESS
TRANSACTIONS
Rent expense
Oct. 31
Ironman Accounting Services issued a check
as payment for office rent for October. The
amount is P45,000.
 ACCOUNTING FOR BUSINESS
TRANSACTIONS
Effect of owner’s withdrawals
Oct. 31
Ironman withdrew P150,000 cash from the
business to pay for personal expenses.
James A. Hall, an IT auditor, started his IT consultancy firm last
October 2018. The following transactions occurred.
1 Invested P200,000 cash in the firm.
3 Acquired additional computer equipment costing P80,000.
Paid P16,000 cash and signed a note for the balance.
7 Purchased office supplies from Cengage Supply Company on
account P14,000.
9 Rendered consulting services on account for P10,000.
12 Paid salaries of office staff and receptionist, P12,000.
16 Billed clients P22,500 for services rendered.
17 Paid 60% of Cengage Supply Company’s account.
22 Received P7,500 from patients billed on October 16.
25 Returned some defective supplies to Cengage Supply
Company, P2,000.
26 Withdrew P13,000 for personal use.
29 Paid salaries, P12,000.
 THE ACCOUNT
ACCOUNT
- “name” used to record transactions
* Asset
* Liability
* Owner’s Equity
* Income
* Expense
- a detailed record of the increases, decreases and balance
of each element that appears in an entity’s financial
statements; the basic summary device of accounting

Group of accounts : Ledger

 “T” ACCOUNT
Account Title

DEBIT (Dr.) CREDIT (Cr.)

Left side Right side
Debit balance Credit balance

HOW CAN WE COMPUTE

FOR THE BALANCE?
 ENTRIES
BALANCE SHEET ACCOUNTS
Asset Liability Owner’s Equity
Debit Credit Debit Credit Debit Credit
 ENTRIES
INCOME STATEMENT ACCOUNTS
Income Expense
Debit Credit Debit Credit
 ENTRIES
DRAWING ACCOUNT
Drawing
Debit Credit
NORMAL BALANCE

DEBIT CREDIT

Asset Liability

Expense Owner’s Equity

Drawing Income
 SUMMARY

ASSET, EXPENSE & DRAWING

Debit Credit
 SUMMARY
LIABILITY, OWNER’S EQUITY &
INCOME
Debit Credit
 SUMMARY
TO COMPUTE FOR THE BALANCE OF AN ACCOUNT:

Debit Credit
500 1,500
800 250
1,200 750
1,000
3,500 2,500

1,000
 EFFECTS OF TRANSACTIONS
1. Increase in Asset = Increase in Liability
2. Increase in Asset = Increase in Owner’s Equity
3. Increase in one Asset = Decrease in another Asset
4. Decrease in Asset = Decrease in Liability
5. Decrease in Asset = Decrease in Owner’s Equity
6. Increase in Liability = Decrease in Owner’s Equity
7. Increase in Owner’s Equity = Decrease in Liability
8. Increase in one Liability = Decrease in another Liability
9. Increase in one Owner’s Equity = Decrease in another
Owner’s Equity
 RECEIPT vs. REVENUE
1. Cash sales made this year; P20,000.
2. Credit sales made last year, cash received this year;
P30,000.
3. Credit sales made this year; cash received this year;
P40,000.
4. Credit sales made this year; cash to be received next
year; P10,000.