Chapter 3

THE ACCOUNTING
EQUATION AND THE
DOUBLE-ENTRY SYSTEM
An accounting event is an economic occurence that
causes changes in an enterprise's assets, liabilities, and/or
equity.

A transaction is a particular kind of event that involves

the transfer of something of value between two entities.

An accounting information system is a combination

of personnel, records and procedures that a business uses
to meet its need for financial information.
 ELEMENTS OF FINANCIAL STATEMENTS

BALANCE SHEET (FINANCIAL POSITION)

 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 STATEMENT (PERFORMANCE)

 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
 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
-Owners’ Equity / Equity
-Income
 Revenue
Income Statement  Gains
-Expense
 Losses
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
ASSETS -Cash or cash equivalent unless restricted 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

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

ASSETS
* Current
 Cash
 Cash equivalents
 Notes receivable
 Accounts receivable
 Inventories
 Prepaid expenses
* Non-current
 Property, Plant and Equipment
 Accumulated depreciation – a contra asset account
 Intangible assets
TYPICAL ACCOUNT TITLES USED - BALANCE SHEET

LIABILITIES
* Current
 Accounts payable
 Notes payable
 Accrued liabilities
 Unearned revenues
 Current portion of long-term debt

* Non-current
 Mortgage payable
 Bonds payable
TYPICAL ACCOUNT TITLES USED - BALANCE SHEET

OWNER’S EQUITY

 Capital
 Withdrawals
TYPICAL ACCOUNT TITLES USED – INCOME STATEMENT

INCOME
 Service income
 Sales
EXPENSES
 Cost of sales / Cost of goods sold
 Salaries or Wages expense
 Telecommunications, Electricity, Fuel and Water Expenses / Utilities
expense
 Supplies expense
 Rent expense
 Insurance expense
 Depreciation expense
 Uncollectible accounts expense / Bad debt expense
 Interest expense
 THE ACCOUNTING EQUATION

Owner’s
Assets Liabilities
Equity

Remember: Assets must ALWAYS equal liabilities and owner’s equity.

Note: The most basic tool of accounting is the accounting

equation.
 Accounting equation is a tool for analyzing the effects of business
transactions. The most basic tool of accounting is the accounting
equation.

 This equation presents the resources controlled by the enterprise,

present obligations of the enterprise and the residual interest in the
assets.

 Assets = Liabilities+ Owner's Equity

Assets are on the left side of the equation opposite the liabilities and
owner's equity. This explains why increases and decreases in assets are
recorded in opposite manner (mirror image) as liabilities and owner's
equity are recorded. The equation also explains why liabilities and
owner's equity follow the same rule of debits and credits.
The logic of debiting and crediting is related to
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 side), but
in all cases the equality must be maintained.
 Accounting for Business Transaction

 A business transaction is an occurence of an

event or a condition that affects financial position and
can be reliably recorded.

 Every transaction can be analyzed or expressed in

terms of its effects on the accounting equation. The
financial transaction will be analyzed by means of a
financial transaction worksheet which is a form
used to analyze the increases and decreases in the
assets, liabilities and/owner's equity of a business.
Oct. 1 - Mr. Andy Cruz invested P150,000 to
start a welding shop.
 Cruz Welding Shop
 Financial Transaction Worksheet
 for the month of October 2019

 ASSETS = LIAB + OWNER'S EQ

 Cash = A. Cruz, Capital
 P150,000 = 0 + P150,000
 ======= ========
Purchasing Equipment on credit
Oct 3 - Cruz bought a welding equipment on
account, P50,000.

 ASSETS = LIAB + OE
 Cash + Equip = Acct Pay + Cruz, Capital
P150,000 + P50,000 = P50,000+ P150,000
 P200,000 = P200,000
 ======= ========
Oct 5 Purchased supplies for cash, P5,000

 ASSETS = LIAB + OE
 Cash + Sup +Equip = Acct Pay + Cruz, Capital
 P150,000 +P5,000 + P50,000 = P50,000 + P150,000
 (P 5,000)
 ________________________________________
 P145,000 + P5,000 + P50,000 = P50,000 + P150,000
 P200,000 = P200,000
 ======= ========
 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.
- is the basic summary device of accounting.

Group of accounts : Ledger

“T” ACCOUNT - simplest form of the account.

Account Title

left right
left
side or side or
side or

DEBIT CREDIT
DEBIT
side side
side
 Debits and Credits - The Double-Entry System

Accounting is based on a Double Entry System

which means that the dual effects of a business
transaction is recorded.
A debit side entry must have a corresponding credit
side entry.
For every transaction, there must be one or more
accounts debited and one or more accounts credited.
Each transaction affects at least two accounts. The
total debits for a transaction must always equal the
total credits.
 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