Accounting Equation and Double Entry System PDF

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A C F A R 1 1 3 0 _ 1s t S e m 2 0 2 0 _ L e c t u r e N o t e s _ C h a p 2 _ A c c o u n t i n g E q u a t i o n a ndChapter 2 LECTURE NOTES Accounting Equation and theDouble-Entry SystemThe Learning Objectives and the Formative Assessment/s to achieve these objectives are as follows:No. Learning ...

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Chapter 2

LECTURE NOTES

Accounting Equation and the Double-Entry System

The Learning Objectives and the Formative Assessment/s to achieve these objectives are as follows:

No. 1 2 3 4 5 6 7

Learning Objective Master the basic accounting equation Analyze transactions to determine if business/financial transactions and/or events Analyze the effect of business/financial transactions on the elements of the basic accounting equation Prepare a financial transaction worksheet as a result of the analysis of business/financial transactions Identify account titles Explain how double-entry system follows the rules of the accounting equation Master the rules of debit and credit

Formative Assessment 2-1-2; 2-1-3 2-2-1; 2-2-2; 2-2-3 2-3-1; 2-3-2

2-4-1; 2-4-2; 2-4-3

2-7-1; 2-7-2; 2-7-3; 2-7-4; 2-7-5; 2-7-6; 2-7-7

The topics are presented in accordance with the number of the learning objective. Thus, the student is advised to answer the formative assessment after s/he has read the topic. For example, after studying the first topic, i.e., basic accounting equation (the 1st learning objective), s/he is expected to answer Formative Assessment Nos. 2-1-2 and 2-1-3, before proceeding to the next topic.

Objective #1: BASIC ACCOUNTING EQUATION  

accounting is governed by a fundamental accounting equation that shows the relationship among the three accounting elements the equation is: Assets  

=

Liabilities

+

Owner’s Equity

Assets represent those economic resources owned and/or controlled by the enterprise, and which are expected to have future usefulness to the business Liabilities include those economic obligations of the enterprise, and which require future settlements that are expected to result in outflows of economic resources

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

Equity is the residual interest of the owner or owners over the assets of the enterprise, after deducting its total liabilities

 it also follows that: Liabilities = Assets – Equity  if the focus is placed on the equity of the proprietor (the owner), the accounting is: Equity = Assets – Liabilities   

another important equation in accounting is used to compute for the result of the operations of the business during a given period of time makes use of temporary accounting elements – revenues, expenses, and losses the equation is: Profit or period 



loss

for

the =

Income

-

Expenses

the term income is used in connection with the inflow of assets and/or outflow of liabilities that are related to the activities of the business the term expenses is used in connection with the outflow of assets and/or inflow of liabilities that are directly or indirectly related to the activities of the business enterprise



the EQUITY of the proprietor may be computed independently from the asset and liability elements, if information about profit and withdrawals for personal use is available



the equation is: Equity of beginning

the

owner, +

Additional Investments less Personal Withdrawals add (deduct) Profit (loss)

=

Equity of the owner, ending

Putting it all together: Assets = Liabilities + Original/Initial Investment + Additional Investment - Withdrawals + Income – Expenses We will be using the above equation in analyzing financial/business transactions and later on, in explaining the rules of DEBIT and CREDIT.

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Reminder: ANSWER THE FORMATIVE ASSESSMENTS FOR THIS TOPIC BEFORE YOU PROCEED TO THE NEXT TOPIC Objective #2: BUSINESS/FINANCIAL TRANSACTIONS AND EVENTS 

not all activities are “recordable” in the books of accounts of the business o hiring of employees^ o death of a company president^ ^ - cannot be quantified or expressed in terms of unit of measure, thus cannot be recorded in the books of accounts of the business enterprise



activities are said to be accountable/recordable and are called business/financial transactions and events when they affect the assets, liabilities, and owner’s equity

accounting elements or accounting values or elements of the basic accounting equation 

a detailed discussion and analysis on the effects of business/financial transactions and events on the elements of the basic accounting equation is presented in the next section

Reminder: ANSWER THE FORMATIVE ASSESSMENTS FOR THIS TOPIC BEFORE YOU PROCEED TO THE NEXT TOPIC

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Objective #3: EFFECT OF BUSINESS/FINANCIAL TRANSACTIONS ON THE ACCOUNTING EQUATION The two-fold effects of the transactions completed by ABC Repair Shop during its first halfmonth operations are individually analyzed below and in the following pages in what we call a financial transactions worksheet. Transaction 1 – Juan dela Cruz, proprietor, invested P100,000 cash in a repair shop. Juan registered the business under the name “ABC Repair Shop”. Analysis: Assets: Increase (in the form of Cash) Equity: Increase (the Capital of Juan increased) EFFECT OF FINANCIAL TRANSACTION ON THE ACCOUNTING EQUATION: (where “+” means increase by the amount; and “-“ decrease by) Initial Additional No. Assets = Liabilitie + Investmen + Investmen - Withdrawal + Incom - Expense s t t s e s 1 +100,00 +100,000 0 (JC, (Cash) Capital)

Note: As early as Transaction 1, please observe the words or phrases inside the parenthesis. These are “account titles” which will be used when the transactions are recorded in the general journal. Transaction 2 – Bought shop tools on cash basis, P12,000. Analysis: Asset: Increase (in the form of Tools) Asset: Another form of asset (in the form of Cash) would decrease EFFECT OF FINANCIAL TRANSACTION ON THE ACCOUNTING EQUATION: Initial Additional No. Assets = Liabilitie + Investmen + Investmen s t t 2 +12,000 (Tools) 2 -12,000 (Cash)

Withdrawal s

+

Incom e

-

Expense s

Transaction 3 – Bought shop equipment from Granada Equipment Corporation, P65,500; Terms: on credit. Analysis: Asset: Increase (in the form of Equipment) ACFAR1130_1

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Liability:

Increase (in the form of Accounts Payable)

EFFECT OF FINANCIAL TRANSACTION ON THE ACCOUNTING EQUATION: Initial Additional No. Assets = Liabilities + Investmen + Investmen t t +65,500 3 +65,500 (Account (Equipment s ) Payable)

-

Withdrawal s

+

Incom e

-

Expense s

Transaction 4 – Paid the Business Bureau for business permits and other required licenses, P1,950. Analysis: Asset: Decrease (in the form of Cash) Expenses: Increase (in the form of Taxes and Licenses) [Note: Expenses will decrease the equity of the owner.] EFFECT OF FINANCIAL TRANSACTION ON THE ACCOUNTING EQUATION: Initial Additional No. Assets = Liabilitie + Investmen + Investmen s t t 4 -1,950 (Cash)

-

Withdrawal s

+

Incom e

-

Expense s +1,950 (Taxes & Licenses)

Transaction 5 – Bought supplies from ZZZ Industries, Inc., for cash, P3,000. Analysis: Asset: Decrease (in the form of Cash) Expenses: Increase (in the form of Supplies Expenses) [Note: Expenses will decrease the equity of the owner.] EFFECT OF FINANCIAL TRANSACTION ON THE ACCOUNTING EQUATION: Initial Additional No. Assets = Liabilitie + Investmen + Investmen s t t 5 -3,000 (Cash)

-

Withdrawal s

+

Incom e

-

Expense s +3,000 (Supplie s Expense)

Transaction 6 – Bought supplies from JJJ Company, on credit, P8,500. Analysis: Expense: Increase (in the form of Supplies Expense) [Note: Expenses will decrease the equity of the owner.] Liability Increase (in the form of Accounts Payable) would increase. EFFECT OF FINANCIAL TRANSACTION ON THE ACCOUNTING EQUATION: Initial Additional No. Assets = Liabilities + Investmen + Investmen t t ACFAR1130_1

s t

-

Withdrawal s

+

Incom e

-

Expenses

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6

+8,500 (Account s Payable)

+8,500 (Supplies Expenses )

Transaction 7 – Borrowed P20,000 from a finance company to be used to meet the cash requirements of the shop. Term: 2-year, 12% note, maturing on June 10, 20x9 Analysis: Asset: Increase (in the form of Cash) Liability: Increase (in the form of Notes Payable) EFFECT OF FINANCIAL TRANSACTION ON THE ACCOUNTING EQUATION: Initial Additional No. Assets = Liabilitie + Investmen + Investmen s t t 7 +20,000 +20,000 (Cash) (Notes Payable)

Withdrawal s

+

Income

-

Expense s

Transaction 8 – Rendered services to customers who paid cash in the amount of P13,250. Analysis: Asset: Increase (in the form of Cash) Income: Increase (in the form of Service Revenue) [Income earned increases the equity of the owner.] EFFECT OF FINANCIAL TRANSACTION ON THE ACCOUNTING EQUATION: Initial Additional No. Assets = Liabilitie + Investmen + Investmen s t t 8 +13,250 (Cash)

Withdrawal s

+

Income

-

Expense s

+13,250 (Service Revenue )

Transaction 9 – Rendered repair services to various customers, on credit basis, P18,500. Analysis: Asset: Increase (in the form of Accounts Receivable) – The business has a “receivable” from its customers who did not pay for the services rendered. Income: Increase (in the form of Service Revenue) [Income earned increases the equity of the owner.] ACFAR1130_1

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EFFECT OF FINANCIAL TRANSACTION ON THE ACCOUNTING EQUATION: No.

Assets

9

+18,500 (Accounts Receivable)

=

Liabilitie s

+

Initial Investmen t

+

Additional Investmen t

-

Withdrawal s

+

Income

-

Expense s

+18,500 (Service Revenue )

Transaction 10 – Paid in full the amount due to Granada Equipment Corporation. Transaction 3) Analysis: Asset: Decrease (in the form of Cash) Liability: Decrease (in the form of Accounts Payable) EFFECT OF FINANCIAL TRANSACTION ON THE ACCOUNTING EQUATION: Initial Additional No. Assets = Liabilities + Investmen + Investmen t t 10 -65,500 -65,500 (Cash) (Account s Payable)

-

Withdrawal s

+

Incom e

(Refer to

-

Expense s

Transaction 11 – Collected in full the P2,500 due from Karlo Moreno, one of the customers who received services from the business on credit basis (Refer to Transaction 9 ) Analysis: Asset: Increase (in the form of Cash) Asset: Decrease (another form of asset, the Accounts Receivable from customers) EFFECT OF FINANCIAL TRANSACTION ON THE ACCOUNTING EQUATION: Initial Additional No. Assets = Liabilitie + Investmen + Investmen s t t 11 +2,500 (Cash) 11 -2,500 (Accounts Receivable) ACFAR1130_1

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-

Withdrawal s

+

Incom e

-

Expense s

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Transaction 12 – Paid the wages of a part-time shop assistant, P3,000 Analysis: Asset: Decrease (in the form of Cash) Expenses: Increase (in the form of Wages Expense) EFFECT OF FINANCIAL TRANSACTION ON THE ACCOUNTING EQUATION: Initial Additional No. Assets = Liabilitie + Investmen + Investmen s t t 12 -3,000 (Cash)

-

Withdrawal s

+

Incom e

-

Expenses +3,000 (Wages Expenses )

Transaction 13 – Paid rent to Fame Realty, P14,000. Analysis: Asset: Decrease (in the form of Cash) Expenses: Increase (in the form of Rent Expense) EFFECT OF FINANCIAL TRANSACTION ON THE ACCOUNTING EQUATION: Initial Additional No. Assets = Liabilitie + Investmen + Investmen s t t 13 -14,000 (Cash)

-

Withdrawal s

+

Incom e

-

Expenses +14,000 (Rent Expenses )

Transaction 14 – A tenant, who operates a copier machine, is using a small corner of the shop. Rent collected for this amounted to P800. Analysis: Asset: Increase (in the form of Cash) Income: Increase (in the form of Rent Income) EFFECT OF FINANCIAL TRANSACTION ON THE ACCOUNTING EQUATION: Initial Additional No. Assets = Liabilitie + Investmen + Investmen s t t 14 +800 (Cash) ACFAR1130_1

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-

Withdrawal s

+

Income

-

+800 (Rent Income

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Expense s

)

Transaction 15 – Juan dela Cruz withdrew P10,000 cash for his family’s use. Analysis: Asset: Decrease (in the form of Cash) Withdrawals Increase : EFFECT OF FINANCIAL TRANSACTION ON THE ACCOUNTING EQUATION: Initial Additional No. Assets = Liabilitie + Investmen + Investmen s t t 15 -10,000 (Cash)

-

Withdrawals

+

Incom e

-

Expense s

+10,000 (JC Cruz, Withdrawals )

When the foregoing transactions are plotted in a single financial transactions worksheet, the following is the result (with individual asset and liability accounts having their own column for a more detailed analyses):

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ASSETS Accounts

1 2

Cash

+

100,000 (12,000) 88,000

+ + + + + + + + + + + + + + + + + + + + + + + + + + + + +

3 4 5

88,000 (1,950) 86,050 (3,000) 83,050

6 7 8

83,050 20,000 103,050 13,250 116,300

9 10 11 12 13 14 15

116,300 (65,500) 50,800 2,500 53,300 (3,000) 50,300 (14,000) 36,300 800 37,100 (10,000) 27,100

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Tools

12,000 12,000 12,000 12,000 12,000 12,000 12,000 12,000 12,000 12,000 12,000 12,000 12,000 12,000 12,000

+

+ + + + + + + + + + + + + + + + + + + + + + + + + + + + +

Equipmen t

65,500 65,500 65,500 65,500 65,500 65,500 65,500 65,500 65,500 65,500 65,500 65,500 65,500 65,500

+

+ + + + + + + + + + + + + + + + + + + + + + + + + + + + +

Receivabl e

=

= = = = = = = = = = = = = = = 18,500 = 18,500 = = 18,500 = (2,500) = 16,000 = = 16,000 = = 16,000 = = 16,000 = = 16,000 =

LIABILITIES Account Notes s Payable + Payable

65,500 65,500 65,500 65,500 8,500 74,000 74,000 74,000 74,000 (65,500) 8,500 8,500 8,500 8,500 8,500 8,500

+ + + + + + + + + + + + + + + + + + + + + + + + + + + + +

EQUITY J. Cruz,

J. Cruz, +

+ + + + + + + + + + + 20,000 + 20,000 + + 20,000 + + 20,000 + + 20,000 + + 20,000 + + 20,000 + + 20,000 + + 20,000 + + 20,000 +

Capital

-

100,000

-

100,000 100,000 100,000 100,000 100,000 100,000 100,000 100,000 100,000 100,000 100,000 100,000 100,000 100,000

Drawing

Income +

+ + + + + + + + + + + + + + + + + + + + + + + + + + + 10,000 + 10,000 +

(Expenses )

(1,950) (1,950) (3,000) (4,950) (8,500) (13,450) (13,450) 13,250 (200) 18,500 18,300 18,300 18,300 (3,000) 15,300 (14,000) 1,300 800 2,100 2,100

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120,600

=

28,500

+

92,100

The following points should be remembered after preparing the Financial Transactions Worksheet:  The balance of the fundamental accounting equation (Assets = Liabilities + Equity) must be maintained at all times.

 There is profit if the total income earned exceeds the total expenses incurred.  There is net loss if the total expenses incurred exceed the total income earned.

 An increase in asset may be accompanied by o increase in liability o increase in owner’s equity o decrease in another asset o increase in income

 A decrease in asset may be accompanied by o decrease in liability o decrease in owner’s equity o increase in another asset o increase in expense

 An increase in liability may be accompanied by o increase in asset o decrease in owner’s equity o decrease in another liability o increase in expense

 A decrease in liability may be accompanied by o decrease in asset o increase in owner’s equity o increase in another liability o increase in income

 An increase in equity may be accompanied by o increase in asset o decrease in liability

 A decrease in equity may be accompanied by o decrease in asset o increase in liability

 An decrease in equity may be accompanied by o decrease in asset o increase in liability

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 Owner’s equity increases because of o Additional investment o Profit or net income

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Objective #5: ACCOUNTS In the financial transaction worksheet, we determined the effect or two or more of the accounting elements, i.e., either an increase or accountants do not record the transactions in the financial transaction recorded in accounting journals using account titles and written in entry.

of a transaction in one a decrease. However, worksheet. These are an accounting journal

Account Titles  



Account titles are identifications or brief descriptions of items that fall to same kind, class or nature In recording business transactions, the elements of financial statements which are better known as “accounting elements ” are to be assigned with their individual names called “account titles” In Transaction #1, Juan dela Cruz invested P100,000 for the business. However, we do not record the transaction as “Juan dela Cruz invested P100,000 for the business.”, rather, we use account titles in recognizing the increase in assets and the increase in owner’s equity. This is done by using account titles.

The following table summarizes some of the recurring account titles that are used in recording increases or decreases in the accounting elements: STATEMENT OF FINANCIAL POSITION (previously called Balance Sheet) [Permanent Accounts] ASSET ACCOUNTS Current Assets – refer to all assets that are Non-current assets – “all other assets not classified as current assets are non-current expected to be realized, sold, or consumed within the...