ACC 101 FINANCIAL ACCOUNTING AND REPORTING 1

___________________________________________________________________________

Module 2 THE ACCOUNTING INFORMATION SYSTEM, ACCOUNTING EQUATION AND

DOUBLE-ENTRY BOOKKEEPING SYSTEM Week 2 to 4

Introduction
The practice of accounting entails following accounting concepts, principles, procedures
and standards applied uniformly in the preparation of financial reports of all types of
businesses. In Module I, students were introduced to Accounting and its environment.
This module will expose students to the broader aspect of the accounting information
system, identify various accounting elements and how to analyze business transactions
using the accounting equation and acquire basic knowledge of the doubleentry system of
bookkeeping.

Learning Objectives:

After studying this chapter, students should be able to:

1. describe the accounting information system in a broader perspective.
2. differentiate the types of accounting information system: manual system,
computer-based system and data-based system.
3. explain how the accounting information system generates timely and accurate
financial information through various stages, which helps the stakeholders in
making important decisions.
4. identify and understand the nature of the accounting elements and its uses.
5. recognize how the elements affect the accounting equation as applied to all types
of businesses.
6. analyze business transactions from source documents using the accounting
equation and financial transaction worksheet.
7. apply knowledge of the accounting equation to better understand the rules of
debits and credits for recording purposes.

ACCOUNTING INFORMATION SYSTEMS

• With the employment of technology brought about by business globalization,
providing and processing of financia⁰l information becomes a “click of a finger”.
Though the effectiveness of the system largely depends on the nature, size of the
business and volume of data to process, yet accounting information systems made
businesses cope up with the fast demands of accounting information and
transactions. While accounting information involves planning, recording, analyzing
and interpreting data, it needs to gather and process it and then distributes this
information to interested end-users.

• Accounting information system is the planned process for the collection, storage and
processing of financial accounting data to provide reliable information that can be
used by the management and other stakeholders (Valencia 2016).
25

Classification: Public
 ACC 101 FINANCIAL ACCOUNTING AND REPORTING 1
___________________________________________________________________________
• It refers to a whole range of records and special accounting procedures use by the
business in achieving the objectives of financial accounting, preparation and
communication of financial reports (Valencia, 2016).
• A collection of people, procedures, software, hardware and data which work together
to provide information necessary to running an organization (Ballada, 2018)
• It is a device or an organization of planned procedures designed to transform
economic information and other data into meaningful reports (Valencia, 2016)

Figure 1.1 Accounting information Cycle

Importance of accounting information system

1. Business record-keeping is required by law.

For how long does a company have to store its accounting books and records?

Under RR 17-2013 and RR05-2014, all books, registers, records, vouchers and other
supporting papers and documents prescribed by the BIR must be kept by a business
for a period of 10 years, a sufficient time to maintain records for audit examination
and income tax purposes.

2. It helps prevent unnecessary cost.

A good accounting information in place means a company maintains proper
business records while a weak or poor accounting information system poses greater
risk to business.

3. It facilitates decision-making.
Accounting information system generally guides managers to facilitate in
providing financial information and reports in order to make sound economic
decisions.

26

Classification: Public
 ACC 101 FINANCIAL ACCOUNTING AND REPORTING 1
___________________________________________________________________________

Figure 1. 2 Stages of Accounting Information System

The accounting information system comprises of three (3) stages as follows:

Stage 1 – Inputs
The collection of raw data, acquired from internal and external sources,
evidenced by source documents such as invoices, receipts, contracts,
etc.

Stage 2 – Process
Refers to data processing which includes sorting , classifying and
summarizing function into their respective files and
categories, storing them in their respective records.

Stage 3 - Outputs
The generation of financial reports and communication of the needed
information to the decision makers or end-users.

Types of accounting information system

27

Classification: Public
 ACC 101 FINANCIAL ACCOUNTING AND REPORTING 1
___________________________________________________________________________
1. Manual accounting system – utilize paper-based journals and ledgers, the whole
process is done manually. This is labor intensive and dependent on human
processing.

2. Computer-based system – uses modern information technology resources and

transactions are coded and can be quickly posted bypassing the journalizing process.
It replaced paper records with computer records.

3. Database system – it embeds accounting data within the business event data on
which they are based. It reduces inefficiencies and redundancies that often exist in a
transaction -based systems. The computer, with the use of accounting software
processes the inputs. This system recognizes and capture both financial and non-
financial data and store it in a data warehouse.

In many situations, manual systems are inferior to computerized systems in

terms of productivity, speed, accessibility, quality of output, incidence of errors and
volume of data.

ELEMENTS OF FINANCIAL STATEMENTS

There are hundreds or even thousands of transactions that a business undertakes

during the accounting period. These transactions and events are grouped into broad
classes according to economic characteristics or attributes in the financial statements.
The broad classification of business transactions in the financial statements are called
accounting elements.

As defined in March 2018 Conceptual Framework for Financial Reporting, these elements
of financial statements are:
1. Assets
2. Liabilities
3. Equity
4. Income
5. Expenses

Assets • The term “assets” refers to the resources controlled by the entity as a result of
past events and from which future economic benefits are expected to flow to the entity.
• In simple terms, assets are properties owned and controlled by the business.
• An economic resource is a right that has potential to produce economic benefits
for the entity which has the sole control or ability to prevent other parties to direct
the use of that economic resource.

Examples: right to own land, building, equipment, machinery, furniture and fixtures,
etc., right to receive cash, right to receive goods or services

28

Classification: Public
 ACC 101 FINANCIAL ACCOUNTING AND REPORTING 1
___________________________________________________________________________
Liabilities • The term “liabilities” refers to the present obligations of an entity arising from
past events, the settlement of which is expected to result in an outflow from the entity
of resources embodying economic benefits.
• Simply stated, liabilities are the debts incurred by the business for the transfer of
an economic resource as a result of past events. • An obligation of the entity, owed
to another party

Examples: unpaid expenses, unpaid salaries, purchases made on account, etc.

Equity
• The term “equity” refers to the residual interest in the assets of the entity after
deducting all its liabilities.
• Equity represents owner’s capital and what is left to the owner after deducting the
entity’s debts or obligation.
• It represents claim of the owner/s over the assets of the business in the form of
capital.

Examples: R & B Service Business has total assets of P1,000,000 and total
liabilities of P450,000, therefore, the equity of the owner is P550,000.

NOTE: Assets, liabilities and equity – relate to a reporting entity’s financial position (shown
in the Statement of Financial Position or Balance Sheet)

Income
• The term “income” refers to the increase in economic benefits during the
accounting period in the form of inflow or enhancement of assets or decrease of
liabilities resulting in an increase in equity other than those relating to equity claims
from equity participants or equity contributors.
• The basic accounting principle is that income increases the equity of the owners
while loss decreases the owner’s equity.

Examples: R & B Service Business profited from its business as a result of its
operating activities in the amount of P50,000. From the previous example, its equity
amount is P550,000 , but due to income generated, the equity amount of R & B will
now be P600,000. However, if it incurs a loss of P50,000, R & B’s owners’ equity
will decrease to P500,000.

Expenses
• The term “expenses” refers to decreases in economic benefits during the accounting
period in the form of outflow or depletion of assets or incurrence of liabilities that result
in decreases in equity other than those relating to equity claims from equity participants
or equity contributors.
• The basic accounting principle is that expenses decrease the equity of the owners.

29

Classification: Public
 ACC 101 FINANCIAL ACCOUNTING AND REPORTING 1
___________________________________________________________________________
Examples: rent expense, salaries expense, supplies expense, etc.

NOTE: Income and expenses – relate to a reporting entity’s financial performance (shown
in the Statement of Comprehensive Income or Income Statement).

ACCOUNTING EQUATION

The most basic tool of accounting is the accounting equation. This equation
presents the resources controlled by the enterprise, the present obligation of the
enterprise, and the residual interest in the assets as shown in this model.

Figure 1.3 Basic Accounting Model

Account
• The basic summary device of accounting is the account.
• It is an accounting record in which the effects of similar business
transactions are grouped or classified.
• It records the increases or decreases of specific asset, liability, owner’s
equity, revenue and expense.
• The account is separately labeled with a specific name to identify one
element from the other.
• The name designated to the account is called account title. Ex. Cash,
Accounts Receivable, Office Supplies, Land, Accounts Payable, Notes
Payable, Service Income, Salaries Expense, Rent Expense, etc.
• The account titles used to record accounting transactions for a particular
business should be uniformly listed and arranged chronologically in a chart
called Chart of Accounts.
• Each accounting element is composed of several accounts which describe
the related transactions and events as provided by the source documents.

Books of Accounts
The books of accounts commonly used in recording economic transactions and
events are as follows:

30

Classification: Public
 ACC 101 FINANCIAL ACCOUNTING AND REPORTING 1
___________________________________________________________________________
General Journal – called as the “book of original entry”, is an accounting record
that is used to initially record business transactions known as journal entry.

General Ledger – called as the “book ⁰of final entry” where the accounts and
their related amounts previously recorded in the journal are posted and
summarized periodically.

DOUBLE-ENTRY SYSTEM

The double-entry system of accounting is based on the dual aspect concept

that for every transaction, there would always be a two-sided effect to the extent of the
same amount as recorded in the accounting books. It shows that for every “value
received”, there is a corresponding “value parted with”. In accounting, value received
is the debit and value parted with is the credit.

This system is the basis of modern accounting theory. It is known as the most
acceptable accounting system in recording accountable transactions due to the
following reasons:
1. It results in more accurate accounting records and financial reports.
2. It allows a more convenient means of recording business transactions and events.
3. It provides numerous ways to safeguard and check errors and misstatements committed.

In analyzing transactions, the accounting equation is used where the rules of

debits and credits apply. Business transactions are recorded with a debit entry (value
received) and a credit entry (value parted with), to show the dual effects of each event.
The recording process requires that the value of debits must equal the value of credits
for each transaction entry or simply put, both debits and credits are in balance.

Debit (Dr.) The place of debit is the left-hand side of the accounting equation therefore an
account is debited when it is entered in the left side of the T-Account.
Credit (Cr.) The place of credit is on the right-hand side of the accounting equation
therefore the account is credited when it is entered on the right side.

To better understand the debits and credits, a T-Account is used. It is called such
because it resembles a big letter T, used to summarize and determine account
balances without the need for the formal ledger. The T-Account has three (3) parts: the
account title, the debit and the credit side.

31

Classification: Public
 ACC 101 FINANCIAL ACCOUNTING AND REPORTING 1
___________________________________________________________________________

Figure 1.4 The T-Account

Rules of Debits and Credits

The rules of debits and credits depend on the account type and how increases or
decreases in it are recorded. This increase-decrease effect should be expressed in
the technical parlance of accounting which is to debit and to credit as it affects all
the accounting elements.

A. For the elements of financial position (Assets, Liabilities, Owner’s Equity), the
following rules apply:
• Increases in assets are recorded as debits (left side), while decreases in
assets are recorded as credits (right side).
• Increases in liabilities and owner’s equity are recorded as credits (right side)
decreases are entered as debits (left side)

B. For the elements of financial performance (Income and Expenses), the rules of
debits and credits are based on the relationship of these accounts to owner’s equity.
Income increases owner’s equity and expense decreases owner’s equity.
• Hence, increases in income are recorded as credits (right side) and
decreases are recorded as debits (left side).
• Increases in expenses are recorded as debits (left side) and decreases are
recorded as credits (right side)

Figure 1.5 summarizes the rules of debits and credits. It shows the effects of
transactions to the elements of financial statements in terms of increases and
decreases.

32

Classification: Public
 ACC 101 FINANCIAL ACCOUNTING AND REPORTING 1
___________________________________________________________________________

Figure 1.5 Rules of Debits and Credits Statement of Financial Position or

Balance Sheet Accounts

The Normal Balance of an Account

The normal balance of an account refers to the side of the account, debit or credit, where
increases are recorded.
• Assets, Owner’s withdrawals and Expenses increases on the debit side
therefore the normal balance of these accounts is a debit. • Liability, Owner’s
Capital and Income accounts increases on the credit side therefore the normal
balance of these accounts is a credit.

Accounting Events and Transactions

33

Classification: Public
 ACC 101 FINANCIAL ACCOUNTING AND REPORTING 1
___________________________________________________________________________
An accounting event is an economic occurrence that causes changes in an
entity’s assets, liabilities, and/or equity. It can be an internal event such as the use of
equipment for the production of goods or services or an external event such as the
purchase of raw materials from a supplier. A business transaction is a particular kind of
event that involves the transfer of something of value between two parties such as
purchasing and selling of goods or services and borrowing funds from creditors and that
it can be reliably recorded.
It is beneficial in the recording process that transactions are analyzed relative to
their effects to the different accounting elements rather than the recording involved. We
call this classification approach. All business transactions can be classified into one of
four types namely:

1. Source of Assets (SA). An asset account increases and a corresponding claim

(liabilities or owner’s equity) account increases.
• Examples: Purchase supplies on account.
Sold goods on cash on delivery basis.

2. Exchange of Assets (EA). One asset account increase and another asset account
decrease.
Example: Acquired equipment for cash.

3. Use of Assets (UA). An asset account decreases and corresponding claims

(liabilities or equity) account decreases.
Examples: Settled accounts payable.
Paid salaries of employees.

4. Exchange of Claims (EC). One claim (liabilities or owner’s equity) account

increases and another claims (liabilities or owner’s equity) account decreases.
Examples: Received utilities bill but did not pay.

Financial Transaction Worksheet

It is a form used to analyze increases and decreases in the assets, liabilities and
owner’s equity. A financial transaction is listed in the worksheet using the appropriate
accounts.

34

Classification: Public
 ACC 101 FINANCIAL ACCOUNTING AND REPORTING 1
___________________________________________________________________________

Table 1 Sample Financial Transaction Worksheet

ASSETS LIABILITIES OWNER’S EQUITY

TRANSACTION Cash Accts. Accounts Notes Owner’s Owner’s

Receivable Payable Payable Withdrawal Capital
(Dr) (Dr) (Cr ( (Dr) (Cr)
) Cr)
1. Owner invested P50,000 P50,000
P50,000 to the
business
2. Rendered P15,000 15,000
services on credit,
15,000
3.Received P3,000 (3,000)
Meralco bill,
P3,000
4. Borrowed money
from P50,000 P50,000
ACR Bank and
issued promissory
note P50,000
5. Withdrew cash
for personal use, (30,000) P30,000
P30,000
P70,000 P15,000 P3,000 50,000 P30,000 P62,000

TOTAL P85,000 P53,000 P32,000

Assets P85,000 = Liabilities P53,000 + Owner’s Equity P32,000

Analysis:

Transaction No. 1. The owner invested cash to the business, Cash increases an asset
account and the equity of the business also increases.

Transaction No.2. When the entity renders services on credit, it creates an account
receivable which is an asset account and a revenue account which increases owner’s
equity.

Transaction No. 3. When an electric bill is received, an expense account is created, but
it was not paid, therefore, the incurrence of an expense decreases the owner’s equity
account and increases the liability account due to non – payment.

Transaction No. 4. Borrowings increase the asset account Cash and the Notes Payable
due to issuance of promissory note which is a liability account.

35

Classification: Public
 ACC 101 FINANCIAL ACCOUNTING AND REPORTING 1
___________________________________________________________________________

Transaction No.5. The owner withdraws cash for personal use, therefore asset cash
decreases and a withdrawal account is created which is a contra-equity account. Owner’s
equity account has a normal balance of “credit”, the withdrawal account is a contra
account and has a normal balance of “debit”.

TYPICAL ACCOUNT TITLES USED

Statement of Financial Position (briefly discuss)

Assets. As per revised Philippine Accounting Standards (PAS) No. 1, assets should be
classified only in two (2): Current and Non-Current Assets. Assets are considered current
when:

a. it expects to realize, consumes or intends to sell it within the normal operating cycle
of the business
b. it holds the asset primarily for the purpose of trading
c. it expects to realize the asset within twelve (12) months after the reporting period
d. the asset is cash or cash equivalent (as defined in PAS No.7), unless the asset is
restricted from being exchanged or used to settle a liability for at least twelve
months after the reporting period.

Operating Cycle is the time between the acquisition of assets for processing and their
realization in cash or cash equivalents. When the entity’s normal operating cycle is
not clearly identifiable, it is assumed to be twelve (12) months. The entity uses an
accounting period that covers certain accounting functions which can be either a
calendar or fiscal year.

Calendar year means the accounting operations of the business covers one year from
January and ends in December.

Fiscal year or period means any 12-month period covering the accounting operations
of the business.
Example: May 2019 to May 2020 is one fiscal period.

Current Assets
Cash. It refers to any medium of exchange that a bank will accept for deposit at face
value including coins, currency, checks, money orders, bank deposits and drafts.

Cash Equivalents. Per PAS No. 7, these are short-term , highly liquid investments that
are readily convertible to known amount of cash and which are subject to
insignificant risk of changes in value

Notes Receivable. A written pledge that the customer will pay the business a fixed
amount of money on a certain date.
36

Classification: Public
 ACC 101 FINANCIAL ACCOUNTING AND REPORTING 1
___________________________________________________________________________

Accounts Receivable. These are claims against customers arising from sale of
services or goods on credit. This type of receivable offers less security than a
promissory note.

Allowance for Uncollectible accounts /Bad debts. A contra-asst account which

provides for possible losses from uncollected accounts receivable. The amount
provided for this is only an estimate.

Inventories. Per PAS No. 2, these are assets (a) which are 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. These are expenses paid for by the business in advance. It is
classified as an asset because the business avoids having to pay cash in the
future for a specific expense.

Noncurrent Assets
Property, Plant & Equipment. Per PAS No. 16, these are tangible assets that are held
by an enterprise for use in the production or supply of goods or services, or for
rental to others, or for administrative purposes and which are expected to be
used during more than one period.
Examples: Land, Machinery, Equipment, furniture and fixtures.

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

depreciation charges. The balance from this account is deducted from th cost of
the related asset – equipment or building – to obtain book value.

Intangible Assets: Per PAS No. 38, these are identifiable non-monetary assets without
physical substance held for use in the production or supply of goods or services,
for rental to others, or for administrative purposes.
Examples: Goodwill, patents, copyrights, licenses, franchises, trademarks,
brand names, secret processes, subscription lists and on-competitive
agreements.

Liabilities
Current Liabilities. As per revised PAS No 1, an entity shall classify liability as current
when
a. it expects to settle the liability in its normal operating cycle.
b. it holds the liability primarily for the purpose of trading.
c. the liability is due to be settled within twelve (12) months after the reporting period.
d. the entity does not have an unconditional right to defer settlement of the liability for at least
twelve months after the reporting period.

37

Classification: Public
 ACC 101 FINANCIAL ACCOUNTING AND REPORTING 1
___________________________________________________________________________
Accounts Payable. It denotes obligations or debts of the business arising from services
received, merchandise, supplies or property, plant and equipment acquired on
account. It is an “open account” obligation because it is not supported by a
promissory note.

Notes Payable. The treatment is similar to accounts payable however, this account is
supported with a promissory note executed by the debtor in favor of the creditor.

Accrued liabilities. Amounts owed to others for unpaid expenses. This account includes
salaries payable, utilities payable, interest payable and taxes payable.

Unearned Revenues. The business entity receives payment before providing the
customers with goods or services, the amount received is reorder to unearned
revenue account. When the goods or services are provided to the customer, the
unearned revenue account is reduced and income is recognized.

Current Portion of Long-term Debt. These are portion of mortgage notes, bonds and
other long-term indebtedness which are to be paid within one year from the
balance sheet date.

Noncurrent liabilities
Mortgage Payable. This account is used to record long-term debt that is supported or
backed up by a collateral or has pledged certain assets as security to the
creditor.

Bonds Payable. Is a contract between the issuer and the lender specifying the terms
and conditions of repayment and the amount of interest to be charged. It is a
long-term obligation evidenced by certificate of indebtedness. Business obtain
funds to finance acquisition of equipment and other needed assets by issuing
bonds.

Equity. The equity represents what is left to the business after the liabilities are fully paid.

Capital. This account is used to record the original and additional investments of the
owner of the business. It is increased by the amount of profit earned during the
year or decreased by a loss or by cash or other assets that the owner may
withdraw from the business. This account bears the name of the owner.
Example: if the owner of the business is Mr. Landicho, therefore, the capital
account of the business will be Landicho, Capital.

Withdrawals. When the owner of a business entity withdraws cash or other assets for
personal use, such is recorded in the withdrawal account rather than directly
reducing the owner’s equity account.

38

Classification: Public
 ACC 101 FINANCIAL ACCOUNTING AND REPORTING 1
___________________________________________________________________________
Income Summary. Is a temporary account used at the end of accounting period to
close income and expenses.This account shows the profit or loss for the period
before closing to the capital account.

Statement of Comprehensive Income

Income. Increases in economic benefits during the accounting period in the form of
inflows and enhancement of assets. The definition of income encompasses both
revenue and gains. Though these terms are almost similar,, however, there is a distinct
technical difference between them.

Service Income. Revenues earned by performing services for a customer or client.

Example: accounting services by a CPA, laundry services by a laundry shop.

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

Example: sale of hardware materials by a hardware company
sale of medicines by a pharmaceutical company

Expenses. A decrease in economic benefits during the accounting period as a result of

outflows or depletion of assets.

Cost of Sales. The cost incurred to purchase or produce the products sold to the
customers during the period. It is also known as the cost of goods sold.

Salaries and Wages Expense. All payments that arise from services from workers/
employees in an employee-employer relationship. It includes salaries and wages,
13 month pay, cost of living allowances and other related benefits.
th

Rent Expense. Expense for renting a space, equipment or other asset rental.

Supplies expense. Expense of using supplies like office supplies, in the conduct of daily
business.

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

Depreciation Expense. That portion of the cost of tangible asset (e.g. buildings and
equipment) allotted or charged to expense during the accounting period. All
tangible assets depreciate except Land.

Uncollectible Accounts or Bad Debts Expense. It is the amount of receivables

estimated to be doubtful of collection and charged to expense during the
accounting period.

39

Classification: Public
 ACC 101 FINANCIAL ACCOUNTING AND REPORTING 1
___________________________________________________________________________
The list of accounts mentioned and discussed are typical accounts used in introductory
accounting. As you move to higher accounting subjects, new account titles will be
introduced.

ASSESSMENTS

Exercise No.1
Understanding the Accounting Equation

Case Assets Liabilities Owner’s Equity

1 P ? P 990,000 P500,000
2 110,000 60,000 ?
3 5,180,000 ? 2,180,000
4 ? 225,000 (25%) ?
5 ? ? 560,000 (2/3)
6 671,200 ? 246,000
7 784,000 ? (1/2) ?

Required: Fill-in the amount of the missing element of the Statement of Financial Position

40

Classification: Public