PART 3

The Accounting Equation and the

Double-Entry System
PARTS OF AN INFORMATION
SYSTEM
• People
• Procedures
• Software
 System Software
 Application Software
• Hardware
PARTS OF AN INFORMATION
SYSTEM - continuation
• Input Devices
• The System Unit
• Secondary Storage
• Output Devices
• Communications Devices
• Data
 ACCOUNTING INFORMATION SYSTEM
Every business organization must have an accounting information system
which will generate reliable financial information needed by the decision-
makers in a timely manner. The design and operation of a system must
consider the anticipated users of the information and the types of decisions
they are expected to make. The design of the system to meet the entity’s
information requirement depends on the firm’s size, nature of operations,
volume of transaction data, organizational structure, form of business and
extent of government regulation. These will influence the way in which
information is accumulated and reported in the financial statements.

An accounting information system is the combination of personnel,

records and procedures that a business uses to meet its need for financial
information. Most firms have an accounting manual that specifies the
policies and procedures to be followed in accumulating information within
the accounting information system. This manual details what events are to
be recorded in the accounts, and when and how the information is to be
classified and accumulated.
 ACCOUNTING INFORMATION SYSTEM

An effective accounting information system should achieve the following

objectives:
• To process the information efficiently at the least cost (cost-benefit
principle).
• To protect entity’s assets, to ensure that data are reliable, and to
minimize wastes and the possibility of theft or fraud (control principle).
• To be in harmony with the entity’s organizational and human factors
(compatibility principle)
• To be able to accommodate growth in the volume of transactions and
for organizational changes (flexibility principle)
ACCOUNTING INFORMATION SYSTEM

The Accounting
Process

Economic Accounting
Activities Information

Decision Makers
 TYPES OF ACCOUNTING INFORMATION
SYSTEMS
In general terms, companies use three types of
accounting information systems to record the results
of transactions: manual systems, computer-based
transaction systems and database systems. All of
these systems are designed to capture information
regarding accounting events to prepare financial
statements.
TYPES OF ACCOUNTING INFORMATION
SYSTEMS
In a nutshell, manual systems utilize paper-based
journals (general and special) and ledgers (general and
subsidiary). Computer-based transaction systems
replace paper records with computer records. Database
systems embed accounting data within the business
event data on which they are based.
TYPES OF ACCOUNTING INFORMATION
SYSTEMS
Computer-Based Transaction Systems
Manual systems rely on human processing so they are
labor intensive and may be inefficient in today’s
complex business environment. Because manual
systems rely on human processing, they may be prone
to error. To overcome these deficiencies, many
companies have computerized their accounting
processes.
TYPES OF ACCOUNTING INFORMATION
SYSTEMS
Database Systems
Relational database systems such as enterprise
resource planning (ERP) depart from the simple
“accounting equation” method of organizing data.
These ERP systems such as SAP, Oracle and Peoplesoft
capture data, both financial and non-financial, and
store that information in a data warehouse. Database
systems reduce inefficiencies that often exist in
transaction-based systems.
THE FINANCIAL STATEMENTS
 Users of Accounting information

• Investors
 Employees
 Lenders
 Suppliers and other trade creditors
 Customers
 Government and their agencies
 Public
ELEMENTS OF FINANCIAL STATEMENTS
Financial Position

In simple terms, assets are valuable resources owned by the

entity. Per Framework, asset is 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.
• “Controlled by the enterprise”
• “Past events”
• “Future economic benefits”
ELEMENTS OF FINANCIAL STATEMENTS
Financial Position

Liabilities are obligations of the entity to outside parties who

have furnished resources. Per Framework, liability is 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.
• “Obligations”
• “Transfer economic benefits”
• “Past transactions or events”
• “Complementary nature of assets and liabilities”
ELEMENTS OF FINANCIAL STATEMENTS
Financial Position
Equity is the residual interest in the assets of the enterprise
after deducting all its liabilities. Equity may pertain to any
of the following depending on the form of business
organization:
• In a sole proprietorship , there is only one owner’s equity
account because there is only one owner.
• In a partnership, an owner’s equity account exists for
each partner.
• In a corporation, owner’s equity or stockholder’s equity
consists of share capital, retained earnings and reserves
representing appropriations of retained earnings among
others.
ELEMENTS OF FINANCIAL STATEMENTS
Performance
Income is increases in economic benefits during the
accounting period in the form of inflows or
enhancements of assets or decreases of liabilities that
results 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 and is referred to by a variety of different
names including sales, fees, interest, dividends, royalties,
and rent.
Gains represents 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

Performance
Expenses are decreases in economic benefits during the
accounting period in the form of outflows or depletions
of assets or incurrences of liabilities that result in
decreases in equity, other than those relating to
distributions to equity participants.
Losses represent other items that meet the definition of
expense and may or may not, arise in the course of the
ordinary activities of an enterprise.
THE ACCOUNT
The basic summary device of accounting is the account. A
separate account is maintained for each element that
appears in the balance sheet and income statement. Thus,
an account may be defined as a detailed record of the
increases, decreases and balance of each element that
appears in an entity’s financial statements. The simplest
form of the account is known as the “T” account because of
its similarity to the letter “T”.
THE ACCOUNTING EQUATION
The most basic tool of accounting is the accounting equation.
This equation presents the resources controlled by the
enterprise, the present obligations of the enterprise and the
residual interest in the assets. It states that assets must
always equal liabilities and owner’s equity.

Assets = Liabilities + Owner’s Equity

The logic of debiting and crediting is related to the accounting

equation. Transactions may require additions to both sides (left
and right sides), subtractions from both sides (left and right
sides), or an addition and subtraction on the same side (left and
right side), but in all cases the equality must be maintained.
THE ACCOUNTING EQUATION

Assets = Liabilities + Owner’s Equity

So:
A = L + OE
Some use A = L + C, it’s the same :D
Samples:

A. If A = 1,000 and L = 500, what is C? C = 500

B. If A = 1,000 and L = 200, what is C? C = 800
C. If L = 200 and C=2,000, what is A? A = 2,200
D. If C = 1,500 and A = 5,000, what is L? L = 3,500
THE ACCOUNTING EQUATION
ASSETS LIABILITY
Cash = P690,000 Owner obtains
loan from the
bank =
P1,000,000
Office Supplies=
P10,000 Liability= P1,000,000

Delivery Van = OWNER’S EQUITY

P700,000
Owner invests
P500,000
Prepaid store
rental =
P100,000
Owner’s Equity = P500,000

A = P1,500,000 L + OE = P1,500,000
 Complete:
No. A L C
1 10,000 2,000 ?
2 ? 2,000 8,750
3 10,000,000 4,875,000 ?
4 100,000 ? 80,000
5 ? 700,000 700,000
6 1 Billion ? 200 Million
7 8,759,265 2,542,172 ?
8 525,000 25,000 ?
9 ? 777,777 222,223
10 325,000 ? 175,000
2 minutes
 Answers:
No. A L C
1 10,000 2,000 8,000
2 10,750 2,000 8,750
3 10,000,000 4,875,000 5,125,000
4 100,000 20,000 80,000
5 1,400,000 700,000 700,000
6 1 Billion 800 Million 200 Million
7 8,759,265 2,542,172 6,217,093
8 525,000 25,000 500,000
9 1,000,000 777,777 222,223
10 325,000 150,000 175,000
THE DOUBLE-ENTRY SYSTEM AND THE
ACCOUNTS
DEBITS AND CREDITS – THE DOUBLE
ENTRY SYSTEM
Balance Sheet Accounts

Assets Liabilities and Owner’s Equity

Debit Credit Debit Credit

(+) (-) (-) (+)
Increases Decreases Decreases Increases

Normal Balance Normal Balance

DEBITS AND CREDITS – THE DOUBLE
ENTRY SYSTEM
Income Statement Accounts
Debit for decreases in owner’s equity Credit for increases in owner’s equity
Expenses Income
Debit Credit Debit Credit
(+) (-) (-) (+)
Increases Decreases Decreases Increases

Normal Balance Normal Balance

DEBITS AND CREDITS – THE DOUBLE
ENTRY SYSTEM
Accounts

Debit Credit
Increases in
Increases in
Liabilities
Assets
Owner’s Capital
Expenses
Income

Decreases in
Decreases in
Liabilities
Assets
Owner’s Capital
Expenses
Income
NORMAL BALANCE OF AN
ACCOUNT
The normal balance of any account refers to the side of the account – debit or
credit – where increases are recorded. Asset, owner’s withdrawal and expense
accounts normally have debit balances; liability, owner’s equity and income
accounts normally have credit balances. This result occurs because increases in an
account are usually greater than or equal to decreases.
NORMAL BALANCE OF AN
ACCOUNT
Increases Recorded by Normal Balance

Account Category Debit Credit Debit Credit

Assets ✔ ✔
Liabilities ✔ ✔
Owner’s Equity:
Owner’s Capital ✔ ✔
Withdrawals ✔ ✔
Income ✔ ✔
Expenses ✔ ✔
ACCOUNTING EVENTS AND
TRANSACTIONS
An accounting event is an economic occurrence that causes changes in an
enterprise’s assets, liabilities, and/or equity. Events may be internal actions,
such as the use of equipment for the production of goods or services. It can
also be an external event, such as the purchase of raw materials from a
supplier.

A transaction is a particular kind of event that involves the transfer of

something of value between two entities. Examples of transactions include
acquiring assts from owner(s), borrowing funds from creditors, and
purchasing or selling goods and services.
TYPICAL ACCOUNT TITLES USED
STATEMENT OF FINANCIAL POSITION

Assets
Current Assets
Cash. Cash is any medium of exchange that a bank will accept for
deposit at face value.

Cash Equivalents. These are short-term, highly liquid investments that

are readily convertible to known amounts of cash.

Notes Receivable. It is a written pledge that the customer will pay the
business a fixed amount of money on a certain date.

Accounts Receivable. These are claims against customers arising from

sale of services or goods on credit.
TYPICAL ACCOUNT TITLES USED
STATEMENT OF FINANCIAL POSITION

Inventories. These are assets which are (a) held for sale in the ordinary
course of business; (b) in the process of production for such sales; or (c)
in the form of materials or supplies to be consumed in the production
process or in the rendering of services.

Prepaid Expenses. These are expenses paid for by the business in

advance.
TYPICAL ACCOUNT TITLES USED
STATEMENT OF FINANCIAL POSITION

Assets
Non-current Assets
Property, Plant and Equipment. These are tangible assets that are held
by an enterprise for use in the production or supply of goods and
services, or for rental to others, or for administrative purposes and
which are expected to be used during more than one period.

Accumulated Depreciation. It is a contra account that contains the sum

of the periodic depreciation charges.

Intangible Assets. These are identifiable, nonmonetary assets without

physical substance held for use in the production or supply of goods
and services, for rental to others, or for administrative purposes.
TYPICAL ACCOUNT TITLES USED
STATEMENT OF FINANCIAL POSITION
Liabilities
Current Liabilities
Accounts Payable. This account represents the reverse relationship of
the accounts receivable.
Notes Payable. The business 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.
Unearned Revenues. When the business entity receives payment
before providing it customers with goods or services, the amounts
received are recorded in the unearned revenue account.
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
STATEMENT OF FINANCIAL POSITION

Liabilities
Non-current Liabilities
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.

Bonds Payable. Business organizations often obtain substantial sums of

money from lenders to finance the acquisition of equipment and other
needed assets.
TYPICAL ACCOUNT TITLES USED
STATEMENT OF FINANCIAL POSITION

Owner’s Equity
Capital. This account is used to record the original and additional
investments of the owner of the business entity.

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.

Income Summary. It is a temporary account used at the end of the

accounting period to close income and expenses.
TYPICAL ACCOUNT TITLES USED
INCOME STATEMENT

Income

Service Income. Revenues earned by performing services for a

customer or client.

Sales. Revenues earned as a result of sale of merchandise.

TYPICAL ACCOUNT TITLES USED
INCOME STATEMENT
Expenses
Cost of Sales. The cost incurred to purchase or produce the products
sold to customers during the period.

Salaries or Wages Expense. Includes all payments as a result of an

employer-employee relationship.

Telecommunications, Electricity, Fuel and Water Expenses. Expenses

related to use of telecommunications facilities, consumption of
electricity, fuel and water.

Rent Expense. Expense for space, equipment or other asset rentals.

Supplies Expense. Expense of using supplies in the conduct of daily

business.
TYPICAL ACCOUNT TITLES USED
INCOME STATEMENT

Expenses
Insurance Expense. Portion of premiums paid on insurance coverage
which has expired.

Depreciation Expense. The portion of the cost of a tangible asset

allocated or charged as expense during an accounting period.

Uncollectible Account 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 use of borrowed funds.

-End-