Review of the Previous Lesson

ACCOUNTING EQUATION & THE DOUBLE-ENTRY

SYSTEM

Week 2

ACCOUNTING INFORMATION SYSTEM

Learning Objectives

• Differentiate the elements of financial statements• Explain the meaning of the account• Discuss the accounting equation• Explain the nature of debits and credits – the

double-entry system• Discuss accounting events and transactions• Identify and differentiate typical account titles

used – Balance Sheet & Income Statement• Explain the accounting procedures for business

transactions

ELEMENTS OF FINANCIAL STATEMENTS

1.Assets2.Liabilities

3.Owner’s Equity or Capital

4. Income or Revenue5. Expenses

• The elements of financial statements refer to the quantitative information shown in the statement.

ACCOUNT T-ACCOUNT

A detailed record of the increases, decreases & balance of each element that appears in an entity’s financial statements.

The simplest form of the account.

It has 3 parts: account title, debit side & credit side.

Account Title

Left side or Debit side

Right side or Credit Side

ASSET ACCOUNTS - Debit

Cash

Petty Cash Fund

Cash Equivalents

Notes Receivable

Accounts Receivable

Allowance for Bad Debts

Accrued Interest Income

Advances to Employees

Inventories

Prepaid Expenses

Unused Supplies

Property, Plant & Equipment

Land

Building

Equipment

Furniture & Fixtures

Accumulated Depreciation

Intangible Assets

Current Assets Non-Current Assets

LIABILITIES ACCOUNTS - Credit

Accounts Payable

Notes Payable (short-term)

Accrued Expenses or Accrued Liabilities

Unearned Revenues or Unearned Income

SSS Premium Payable

Philhealth Premium Payable

Pag-ibig Premium Payable

Withholding Tax Payable

Pre-collected or Unearned Income

Mortgage Payable

Bonds Payable

Notes Payable (Long-term)

Accounts Payable

Current Liabilities Non-Current Liabilities

OWNER’S EQUITY ACCOUNTS

- The original and additional investments of the owner of the business entity.

- Increased by net income

- Decreased by net loss

When the owner of a business entity withdraws cash or other assets

Capital (Credit)

Withdrawals(Debit)

INCOME OR REVENUE ACCOUNTS - Credit

Professional Income

Accounting or Auditing Fees Income

Legal Fees Income

Dental Fees Income

Medical Fees Income

Rental Income

Interest Income

Miscellaneous Income

Income or revenue derived from the sale of merchandise.

Sales

Service Income or Service Revenue Income or revenue derived from rendering services.

EXPENSES ACCOUNTS - Debit

Cost of Sales or Cost of Goods Sold

Salaries or Wages Expense

Bad Debts or Uncollectible Accounts Expense

Utilities Expense

Depreciation Expense

Taxes & Licenses

SSS Contribution

Philhealth Contribution

Pag-ibig Contribution

Insurance Expense

Supplies Expense

Miscellaneous Expense

CHART OF ACCOUNTS – list of account titles or account name.

ACCOUNT T-ACCOUNT

A detailed record of the increases, decreases & balance of each element that appears in an entity’s financial statements.

The simplest form of the account.

It has 3 parts: account title, debit side & credit side.

Account TitleLeft side or Debit side (Dr.)

Value received

Right side or Credit Side (Cr.)

Value parted with

In every transaction, there is a value received, we call Debit and value parted with, we call a Credit.

Debit balance Credit balance

Account Title

Left side or Debit side (Dr.)

Value received

Right side or Credit Side (Cr.)

Value parted with

Debit total Credit total = account balance

Account titles are identifications or brief descriptions of items that fall to same kind, class or nature. In other words, are assigned names to various accounts.

DEBIT ENTRY:

An amount entered on the left-hand side of the account.

CREDIT ENTRY:

An amount entered on the right-hand side of the account.

ACCOUNT BALANCE the difference between the debit total & credit total of an account.

DEBIT BALANCE if the debit total exceeds credit total.

CREDIT BALANCE if the credit total exceeds debit total.

IN BALANCE or CLOSED ACCOUNT if the debit total equals credit total.

Example of Chart of Accounts

Account titles are identifications or brief descriptions of items that fall to same kind, class or nature. In other words, are assigned names to various accounts.

CHART OF ACCOUNTS – list of account titles or account name.

THE NATURE OF DEBITS AND CREDITS – The double-entry system

• A double-entry system means that the dual effects of a business transaction is recorded.

Dual effects

Business transactions

A debit side entry must have a corresponding credit side entry.

Each transaction affects at least two accounts. The total debits for a transaction must always equal the total credits.

THE RULES OF DEBIT & CREDIT

Rule 1 – Asset: debit to increasecredit to decrease

Rule 2 - Liabilities: credit to increasedebit to decrease

Rule 3 – Owner’s Equity: credit to increasedebit to decrease

Rule 4 – Drawing: debit to increasecredit to decrease

Rule 5 – Income: credit to increasedebit to decrease

Rule 6 – Expenses: debit to increasecredit to decrease

NORMAL BALANCE OF THE ELEMENTS OF FINANCIAL STATEMENTS

DEBIT BALANCE CREDIT BALANCE

Assets

Income or Revenue

Owner’s Equity

Liabilities

Expenses

BASIC ACCOUNTING EQUATION

Assets = Liabilities + Capital

Income – Expenses = Net Income

EXPANDED ACCOUNTING EQUATION

PHASES OF ACCOUNTING

1. Identifying transactions and events – source documents

2. Journalizing transactions – the journal

3. Posting to the ledger – general ledger

4. Trial balance preparation

5. Adjusting journal entries

6. Preparing the worksheet

7. Preparing financial statements

8. Closing entries

9. Post-closing trial balance

10. Reversing entries

Profitability – How much is the increase in capital as a result of business operation?

Liquidity – Are there available funds to finance the business operation?

Solvency – Can the business pay its long-term obligations to others?

NOTE: Steps 1 to 10 is the ACCOUNTING

CYCLE.

PHASE 1 - RECORDING

1. Identifying transactions and events – source documents

Steps 1 of the ACCOUNTING CYCLE.

a) Identification of business transaction what transactions are considered as accountable and what are not.

RULE: Only transactions & events which are of financial character to the business are being recognized.

SOURCE DOCUMENTS or SUPPORTING BUSINESS DOCUMENTS the basis of identifying transactions.

b) Analysis of business transactions Business transactions are analyzed from the view point of the business. “Always consider yourself as the business” when making the analysis.

By analyzing, we have to ask: What is the value received and value parted with in this particular transactions?

c) Measuring of business transaction the peso is our financial denominator.

Example of Source Documents(under Servicing Activities)

1. Customers’ & suppliers’ sales invoices

2. Official receipts

3. Cash or Check Vouchers

4. Service Order Slip

PHASE 1 - RECORDING

2. Journalizing transactions – the journal

Steps 2 of the ACCOUNTING CYCLE.

RECORDING is the 1st phase of accounting. This involves the writing down of business transaction in a systematic manner and in order of their occurrence in the book of original entry called Journal.

JOURNALIZING is the process of recording the effects of economic transaction in the journal.

the act of recording business transactions in the journal.

JOURNAL ENTRY the accounting record written in the journal which consists of debit account and credit account with their respective values.

ANALYSIS OF BUSINESS TRANSACTION

Transaction: Bought a car for cash, P650,000.00.Questions guide:1. Identifying: Who bought the car? The

business.2. Analyzing: What is the value received? Car.

What is the value parted with? Cash.3. Measuring: What is the amount involved?

P650,000.00.4. Journalizing:

1. Debit, value received – car P650,000.002. Credit, value parted with – cash 650,000.00

To illustrate the analyzing process of accounting, consider the transactions of Valrox, a servicing business.

Cash on hand

Cash in bank

Accounts Receivable

Office equipment

Notes PayableValrox, Capital

SSS Premium Payable

Withholding tax payable

Supplies expense

Utility expenseBank charge expense

Service Income

Salaries expense

Owner’s drawing

Financial StatementsObjective: To provide financial information useful to the users.

The formal reports prepared by accountants The final products of the accounting

process.

The information that accumulated and processed in financial accounting

2. Income Statement

1. Statement of Financial Position

3. Statement of Changes in Equity

4. Cash Flow Statement

5. Notes to the Financial Statement

Shows the financial position of a business entity as of a particular date.

Shows the performance of the business entity for a given period.

Shows the movement or changes in owner’s capital or equity in a certain period.

Shows and explains the changes of cash during an accounting period.

Part of the financial statements in a parenthesis form, to achieve proper understanding of the financial reports.

Relationships Among the Financial Statements

Example of Income StatementExample of the Statement of

Owner’s Equity

Example of Statement of Financial Position

Account Form – in horizontal order

Report Form – in vertical order

Example of Statement of Cash Flows

Example of Notes to Financial Statement

ELEMENTS OF FINANCIAL STATEMENTS

1.Assets2.Liabilities

3.Owner’s Equity or Capital

4. Income or Revenue5. Expenses

• The elements of financial statements refer to the quantitative information shown in the statement.

Real accounts are not closed at the end of the accounting period.

Nominal accounts are temporary accounts that are closed or put to zero balance at the end of the accounting period.

ELEMENTS OF FINANCIAL STATEMENTS

1. Assets – are resources controlled by the entity as a result of past transactions or events and from which future economic benefits are expected to flow to the entity. Asset accounts have a normal debit balance.

1. Is a leased lot or rented machines considered an asset of the entity?

2. Is a machine that can not be repaired and owned by the entity considered an asset?

3. Is buying a machine in the future transactions considered an asset?

4. Is a machine bought by the entity for the personal use of the owner considered an asset?

ELEMENTS OF FINANCIAL STATEMENTS

2. Liabilities – are present obligations of the entity arising from past transactions or events the settlement of which is expected to result in an outflow from the entity of resources embodying economic benefits. Liability accounts have normal credit balance.

a. Is the debt of the owner considered a liability of the entity?

b. Is a bank loan in the future transaction, thus a future obligation considered a liability?

ELEMENTS OF FINANCIAL STATEMENTS

3. Equity – is the residual interest in the assets of the entity after deducting all of its liabilities (asset – liabilities = equity). Equity accounts have normal credit balance.

4. Income or Revenue – represents the earnings of the business from sales of goods or service rendered. Revenue accounts have a normal credit balance.

5. Expenses – are costs incurred in conducting the business activities. Expense accounts have normal debit balances.

ELEMENTS OF FINANCIAL STATEMENTS

RECOGNITION OF ELEMENTS MEASUREMENT OF ELEMENTS

Recognition means the process of reporting the elements of financial statements of an entity.

1. Probability of future benefit When the item has any future economic benefit that will flow to or from the entity.

2. Reliability of measurement When the item has a cost or value that can be measured with reliability.

Measurement is the process of determining the monetary amounts at which the elements of financial statements are recognized.

1. Historical cost

2. Current cost

3. Realizable value

4. Present value

MEASUREMENT OF ELEMENTS

1. Historical cost is the amount paid when an asset was acquired.

2. Current cost is the amount to be paid if the asset (already acquired) was acquired today.

3. Realizable value or settlement value is the amount to be received if the asset is to be sold.

4. Present value the amount that a future sum of money is worth today given a specified rate of return.

5 years from now P1,000.00 P620.00 10%

ACCOUNTING CONCEPTS & PRINCIPLES

• Accounting concepts are important assumptions or ideas which accountants observe in recording business transactions in the books of accounts.

• Accounting conventions are the means of implementing accounting principles. They are the rules, procedures & methods used in accounting practice. They comprise the large body of practices that prescribe definitely how to do the accounting process.

• Accounting principles refers to a doctrine which is the basis of accounting conventions.

• GAAP Generally Accepted Accounting Principles– Guide accountants in the accounting process of an enterprise.– Are developed based on experience, research, & careful study.– Become generally accepted by agreement among accounting

practitioners.– OBJECTIVE: to fairly present the financial statements…in conformity

with GAAP.

IMPLICIT ASSUMPTIONS

ACCOUNTING PRINCIPLES1. Entity concept

2. Periodicity concept

3. Stable monetary unit concept

1. Objectivity principle

2. Historical cost

3. Revenue recognition principle

4. Expense recognition principle

5. Adequate disclosure

6. Materiality

7. Consistency principle

1. Accrual basis

2. Going concern

UNDERLYING ASSUMPTIONS

Assignment: Give the description of each concepts & principles(except implicit assumptions).