The ACCOUNTING EQUATION and the DOUBLE-ENTRY BOOKKEEPING SYSTEM

FUNDAMENTALS in ACCOUNTING

THE ACCOUNTING EQUATION and

the DOUBLE-ENTRY BOOKKEEPING SYSTEM

Fundamentals of Accounting, Volume 1, Mercedes J. Hinayon, etal

 The ACCOUNTING EQUATION and the DOUBLE-ENTRY BOOKKEEPING SYSTEM

BUSINESS TRANSACTION. An exchange of values (expressed in terms of money) involving two parties (in the case of external
transactions) or within the enterprise (in the case of internal transactions).

 Internal Transactions. Include manufacture of goods for sale and incurrence of losses by the company resulting from fire or
flood.
 External Transactions. Include the sale of goods to customers or the provision of services to clients.

SOURCE DOCUMENTS. Original record of a business transaction.

 EXAMPLES
o Sales Invoice. Cash Sales Invoice and Charge (Credit) Sales Invoice are issued to evidence a sale.
o Delivery Receipt. Issued to evidence the acceptance of the goods delivered to the customer.
o Official Receipt. Issued to evidence the receipt of cash from other parties.
o Vendor’s Invoice. Sales Invoice issued by the supplier to the enterprise
o Purchase Requisition Forms. Issued to evidence an employee’s request for the purchase of needed goods or supplies.
o IOUs. A note acknowledging indebtedness to the enterprise.
o Promissory Notes. An unconditional promise in writing made by the maker to abother, signed, engaging to pay on
demand, or at a fixed or determinable future time, a sum certain in money to order or to bearer.
o Bank Statements. a summary of financial transactions occurring over a certain period (usually one month) on a bank
account.
o Minutes of meetings. Written record of meeting
o Business Letter. Business correspondence with government agencies, customers, suppliers, or other parties.
o Job Time Tickets. Forms containing information on time spent working at a particular customer order.
o Certificates of Stocks. Documents evidencing ownership of shares in a corporation.
o Time records/Time Sheets. Detailed record showing time-in and time-out of employees for a particular period of time.
o Check voucher. Form used to facilitate the authorization of cash disbursement transactions.
o Journal voucher. Document used for transactions and journal entries for which there is no other source document.

BASIC ACCOUNTING EQUATION.

 Entity Theory. The objective is geared toward proper income determination.

o ASSETS = LIABILITIES + OWNERS’ EQUITY
 Proprietary Theory. The objective is geared toward proper valuation of assets.
o ASSETS – LIABILITIES = OWNERS’ EQUITY
 Residual Equity Theory. The objective is also proper valuation of assets. This is applicable where there are two classes of
shareholders, namely ordinary and preference.
o ASSETS – LIABILITIES – PREFERENCE SHAREHOLDERS’ EQUITY = ORDINARY SHAREHOLDERS’ EQUITY
 Fund Theory. Objective is neither proper income determination nor proper valuation of assets but the custody and
administration of funds. Government accounting is an example of the application of this concept.
o CASH INFLOWS – CASH OUTFLOWS = FUND

BUSINESS TRANSACTIONS AND THE ACCOUNTING EQUATION

 Always consider the following:

o In every transaction, value received = value parted with.
o The basic accounting equation must always be maintained (Entity Theory)
 Possible Effects
o Increase in Assets = Increase in Liability
o Increase in Assets = Increase in Equity
o Increase in One Asset = Decrease in other Asset
o Decrease in Asset = Decrease in Liability
o Decrease in Assets = Decrease in Equity
o Increase in Liability = Decrease in Equity
o Increase in Equity = Decrease in Liability
o Increase in One Liability = Decrease in Other Liability
o Increase in One Equity = Decrease in Other Equity
The ACCOUNTING EQUATION and the DOUBLE-ENTRY BOOKKEEPING SYSTEM
 COMMON EXAMPLES OF ACCOUNT TITLES USED
o ASSET ACCOUNTS
 Cash. Medium of exchange for business transactions. Includes currency and coins, checks, money orders, bank
drafts and demand deposit accounts.
 Held for Trading Securities. Temporary investments of excess cash which are primarily held for short-term
gain. Also known as “investments at fair value through profits or loss”.
 Receivables
 Accounts Receivables. Claims which arise in the ordinary course of doing business
 Notes Receivables. Claims which arise in the ordinary course of doing business evident by receiving a
promissory note.
 Loans Receivables. Claims which arise in lending loans to other parties.
 Inventories. Assets which are (a) held for sale in the ordinary course of business; (b) in the process of
production for such sale; or (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.
 Long-term investments. Investment as an asset held by an enterprise for the accretion of wealth through
capital distribution such as interest, royalties, dividends and rentals, for capital appreciation or for other
benefits for the investing enterprise such as those obtained through trading relationships.
 Property, Plant and Equipment. Tangible assets held by an enterprise for use in the production or supply or
goods or services, or for rental to others, or for administrative purposes and which are expected to be used
during more than one accounting period. (Land, Building, Transportation and Delivery Vehicles, Furniture and
Fixtures, Machinery and Equipment.)
 Intangible Assets. These are identifiable, non-monetary assets without physical substance. These include
patents, copyrights, licenses, franchises and trademarks.
o CONTRA ASSET ACCOUNTS
 Allowance for Bad Debts. Account used to record a portion of Accounts Receivables assumed to be
uncollectible.
 Accumulated Depreciation. Account used to recognize the amount has been depreciated up until a single
point.
o LIABILITY ACCOUNTS
 Accounts Payable. Claims of another party from the enterprise which arise in the ordinary course of doing
business.
 Notes Payable. Claims of another party from the enterprise which arise in the ordinary course of doing
business evident by receiving a promissory note.
 Loans Payable. Claims of another party from the enterprise which arise from doing loans.
 Accrued Liabilities. Amounts owed to others for unpaid expenses.
 Advances from Customers. Advanced payments received from customers in relation to undelivered goods.
 Unearned Revenues. Advanced payments received from customers in relation to unrendered services.
 Mortgage Payable. Account used to record long-term debts(s) of an enterprise for which the company has
pledged certain assets as security for the debt.
 Bonds Payable. Claims of another party from the enterprise evident by Bond. Bond is a contract betweem the
issuer and the lender specifying the terms of repayment as well as the interest to be paid.
o EQUITY ACCOUNTS
 Capital. Used to record original and additional investments of the owner of the business entity. And in case of
permanent withdrawals, such transaction shall be directly recorded to the Capital Account.
 Income summary. Temporary account used to summarize all income and expenses for a given period. If total
income is greater than total expenses, a net income results, otherwise, a net loss was sustained by the business.
o CONTRA EQUITY ACCOUNT
 Withdrawal. Account used when an owner temporarily withdraws cash or non-cash assets for personal use.
o INCOME ACCOUNTS
 Service Income or Fees Income. Account used to record revenues earned by performing services for
customers
 Professional Income. Account used to record revenues earned by performing professional services.
 Sales. Account used to record a sale of merchandise.
 The ACCOUNTING EQUATION and the DOUBLE-ENTRY BOOKKEEPING SYSTEM

o EXPENSE ACCOUNTS
 Cost of Sales. Account used to record the cost merchandise sold to customers.
 Salaries and Wages Expense. Includes all payments as a result of an employer-emplyee relationship such as
salaries or wages, 13th month pay, and other related employee benefits.
 Utilities Expense. Account used to record expenses related to Telephone, Electricity, Fuel and Water Expenses.
 Rent Expense. Account used to record leased office space, equipment or other assets rented from others.
 Supplies Expense. Account used to record the used portion of supplies in the normal course of business.
 Insurance Expense. Account used to record the portion of premiums paid on insurance coverage.
 Depreciation Expense. Account used to record the portion of the cost of tangible assets charged as expense
during an accounting period.
 Bad debts expense. The amount of receivables estimated to be uncollectible and charged as expense during
and accounting period. (Also known as Uncollectible Accounts Expense or Impairment Loss on Receivables)
 Interest Expense. An expense related to use of borrowed funds.

NATURE OF ELEMENTS

 When there is an increase in Assets and Expenses, such transaction should be recorded to the DEBIT SIDE.
 When there is an increase in Liabilities, Owners’ Equity and Income, such transaction should be recorded to the CREDIT SIDE.
 Contra-accounts should be recorded in the abnormal nature of its corresponding element.
 The ACCOUNTING EQUATION and the DOUBLE-ENTRY BOOKKEEPING SYSTEM
ILLUSTRATION: Aaron Delos Reyes owned an advertising agency called DR Advertising. During May 2020, the company’s first month of
operations, the following transactions occurred:

May 1 Invested P500,000 in a bank account in the name of DR Advertising.

May 5 Purchased Computer Equipment for P356,000.

May 9 Purchased office supplies, P18,000 on account.

May 11 Collected P154,000 cash from various customers for advertising services rendered.

May 16 Paid P30,000 cash to ABC Utility Company for the semi-monthly utilities expense of DR Advertising

May 17 Rendered Advertising Services to customers on account amounting to P50,000

May 19 Paid P14,000 for the office supplies bought last May 9

May 20 Collected P42,000 from clients billed last May 17

May 21 Mr. Delos Reyes withdrew cash amounting to P20,000 for personal use

May 27 Received billing from Voltes Repairs, P1,000 for the repair of computer equipment.

May 31 Paid monthly salary of Inggo, Aaron’s Assistant, P15,000.

ANALYSIS

May 1 Invested P500,000 in a bank account in the name of DR Advertising.

Parties: Although the transaction involves the bank, still consider that the transaction transpired only between the Investor (Mr. Delos
Reyes) and the bank account holder (DR Advertising)

Economic Effect: Always take the perspective of the company, in this case, DR Advertising. In its perspective, there was an increase in
capital (OE) and increase in cash (A).

May 01 Cash 500,000.00

Aaron Delos Reyes, Capital 500,000.00
To record investment of Mr. Delos Reyes.

May 5 Purchased Computer Equipment for P356,000.

Parties: The transaction transpired between DR Advertising and the supplier the computer equipment.

Economic Effect: When a transaction is silent, assume that the transaction was conducted by paying cash. So in this case, since there
was a purchase of Computer Equipment, there is an increase in computer equipment (A) and a decrease in cash (A).

May 05 Computer Equipment 356,000.00

Cash 356,000.00
To record purchase of computer equipment

May 9 Purchased office supplies, P18,000 on account.

Parties: the transaction transpired between DR Advertising and the supplier of the office supplies.

Economic Effect: Since the purchase of office supplies was made “on account”, it means to say that this transaction is not made thru cash
but in the form of debt. So in this case, there is an increase in office supplies (A) and an increase in Accounts Payable (L).

May 09 Office Supplies 18,000.00

Accounts Payable 18,000.00
To record purchase of office supplies on account
 The ACCOUNTING EQUATION and the DOUBLE-ENTRY BOOKKEEPING SYSTEM
May 11 Collected P154,000 cash from various customers for advertising services rendered.

Parties: The transaction transpired between DR Advertising and is customers.

Economic Effect: Rendering of a service result to an increase in Service Income (I) of the company and since they collected cash for
this services, there was also an increase in cash (A) present to this transaction.

May 11 Cash 154,000.00

Service Income 154,000.00
To record services rendered.

May 16 Paid P30,000 cash to ABC Utility Company for the semi-monthly utilities expense of DR Advertising

Parties: The transaction transpired between DR Advertising and the Utility Company

Economic Effect: There is a recognition of expense already incurred that was paid in cash. So for this transaction, there was an Increase
in Utilities Expense (E) and a decrease in cash (A).

May 16 Utilities Expense 30,000.00

Cash 30,000.00
To record payment of Utilities

May 17 Rendered Advertising Services to customers on account amounting to P50,000

Parties: The transaction transpired between DR Advertising and its clients.

Economic Effects. Since there is rendering of services, there is an increase in Service Income (I); however, since the transaction was
conducted in account, this means that the client has debt from DR Advertising representing a claim arising from conduct of services.
Hence, there is an increase in Accounts Receivable (A).

May 17 Accounts Receivable 50,000.00

Service Income 50,000.00
To record services rendered on account

May 19 Paid P14,000 for the office supplies bought last May 9

Parties: The transaction transpired between DR Advertising and the same supplier involved last May 9.

Economic Effects. Since this transaction is in relation to May 9 transaction, it suggests that this transaction was meant to pay for the
debt it previously had for procuring the office supplies. Is there an increase to office supplies here? None. This transaction only describes
the payment of debt previously recorded last May 9. Hence, there is a decrease in Accounts Payable (L) and a decrease in Cash (A).

May 19 Accounts Payable 14,000.00

Cash 14,000.00
To record payment of accounts payable

May 20 Collected P42,000 from clients billed last May 17

Parties: The transaction transpired between DR Advertising and the same clients who owed DR Advertising last May 17.

Economic Effects: Since this transaction is in relation to May 17 transaction, it suggests that this transaction was meant to receive
payment from the client to whom the services on account was rendered last May 17. As a result, there has been an increase in cash (A)
and a decrease in Accounts Receivable (A) in this particular transaction.

May 20 Cash 14,000.00

Accounts Receiveable 14,000.00
To record collection of accounts receivable
 The ACCOUNTING EQUATION and the DOUBLE-ENTRY BOOKKEEPING SYSTEM
May 21 Mr. Delos Reyes withdrew cash amounting to P20,000 for personal use

Parties: This transaction transpired between the Owner and DR Advertising.

Economic Effects: Random Withdrawal for personal use during any month of the year is considered a permanent withdrawal. Hence,
this reflects an effect directly to the Capital Account and since this is a withdrawal, there was an outflow of cash from the company. For
this scenario, there was a decrease in Capital (OE) and a decrease in Cash (A).

May 21 Aaron Delos Reyes, Capital 20,000.00

Cash 20,000.00
To record withdrawal made by Mr. Delos Reyes

May 27 Received billing from Voltes Repairs, P1,000 for the repair of computer equipment.

Parties: This transaction transpired between DR Advertising and VOltes Repairs.

Economic Effect: Since this transaction involves a “Services Received” from Voltes Repairs, this transaction is considered “related to
ordinary trade or course of business”. But since, DR Advertising only received billing and no payment was made, this transaction gives
birth to an obligation on the part of DR Advertising. Hence, in this transaction, there was an increase in Repairs and Maintenance
Expense (E) and an increase in Accounts Payable (L).

May 27 Repairs and Maintenance Expense 1,000.00

Accounts Payable 1,000.00
To record unpaid expenses of DR Advertising

May 31 Paid monthly salary of Inggo, Aaron’s Assistant, P15,000.

Parties: This transaction transpired between DR Advertising and its employee, Inggo.

Economic Effect: the payment of P15,000 was made to compensate the work done by Inggo. In this case, there is an increase of
Salaries Expense (E) and a decrease in Cash (A).

May 31 Salaries Expense 15,000.00

Cash 15,000.00
To record payment of salaries to Inggo.
The ACCOUNTING EQUATION and the DOUBLE-ENTRY BOOKKEEPING SYSTEM
T-ACCOUNTS

CASH ACCOUNTS RECEIVABLE

05/01/20 500,000.00 356,000.00 05/05/20 05/17/20 50,000.00 42,000.00 05/20/20
05/11/20 154,000.00 30,000.00 05/16/20
05/20/20 42,000.00 14,000.00 05/19/20
20,000.00 05/21/20
15,000.00 05/31/20
696,000.00 435,000.00 50,000.00 42,000.00
05/31/20 261,000.00 05/31/20 8,000.00

OFFICE SUPPLIES COMPUTER EQUIPMENT

05/09/20 18,000.00 05/05/20 356,000.00

18,000.00 0.00 356,000.00 0.00

05/31/20 18,000.00 05/31/20 356,000.00

ACCOUNTS PAYABLE AARON DELOS REYES, CAPITAL

05/19/20 14,000.00 18,000.00 05/09/20 05/21/20 20,000.00 500,000.00 05/01/20
1,000.00 05/27/20

14,000.00 19,000.00 20,000.00 500,000.00

5,000.00 05/31/20 480,000.00 05/31/20

SERVICE INCOME UTILITIES EXPENSE

154,000.00 05/11/20 05/16/20 30,000.00
50,000.00 05/17/20

0.00 204,000.00 30,000.00 0.00

204,000.00 05/31/20 05/31/20 30,000.00

REPAIRS AND MAINTENANCE EXPENSE SALARIES EXPENSE

05/27/20 1,000.00 05/31/20 15,000.00

1,000.00 0.00 15,000.00 0.00

05/31/20 1,000.00 05/31/20 15,000.00
The ACCOUNTING EQUATION and the DOUBLE-ENTRY BOOKKEEPING SYSTEM

DR Advertising
Statement of Financial Performance
For the period May 31, 2020
Income
Advertising Income PHP 204,000.00
Less: Expenses
Salaries Expense PHP 15,000.00
Utilities Expense 30,000.00
Repairs and Maintenance Expense 1,000.00 46,000.00
Profit PHP 158,000.00

DR Advertising
Statement of Changes in Owner's Equity
For the Month Ended May 31, 2020

Original Investment PHP 500,000.00

Add: Profit 158,000.00
Total 658,000.00
Less: Withdrawal 20,000.00
Aaron Capital, May 31, 2020 PHP 638,000.00

DR Advertising
Statement of Cash Flows
For the Month Ended May 31, 2020

Cash Flows from operating activities

Cash collections from customers 196,000.00
Cash paid for operating expenses -59,000.00 PHP 137,000.00

Cash used in investing activities -356,000.00

Purchase of Equipment

Cash flows from financing activities

Investment of Aaron Delos Reyes 500,000.00
Withdrawals for persoal use -20,000.00 480,000.00
Net Increase in the cash balance PHP 261,000.00
Cash balance, May 1 0.00
Cash balance, May 31 PHP 261,000.00

DR Advertising
Statement of Financial Position
As of May 31, 2020

ASSETS LIABILITIES and OWNER'S EQUITY

Cash PHP 261,000.00 Liabilities
Accounts Receivable 8,000.00 Accounts Payable 5,000.00
Office Supplies 18,000.00 Owner's Equity
Computer Equipment 356,000.00 Aaron Delos Reyes, Capital 638,000.00
Total Assets PHP 643,000.00 Total Assets PHP 643,000.00