PRINCIPLES OF ACCOUNTING

The Accounting Process

Double Entry System and Accounting Equation:

Double entry bookkeeping is a generally accepted system. This system was first described by
Luca Pacioli in 1494. The system of double entry may be well compared to a scale, which must
have equal weight on both sides in order that the scale is balanced. Thus, if the weight on one
side of the scale is increased or decreased the same weight must be correspondingly added to,
or removed from, the other side. A more common expression of double entry book keeping is
the accounting equation.

The total assets of a firm are always equal to the total equities. This reflects the fundamental
accounting equation of:
A=E
Where A denotes ‘Assets’ and E denotes ‘Equities’

‘Assets’ are the goods and property, which the firm owns as well as claims against
outsiders that the firm has not yet collected.

‘Equities’ are the claims against the assets and indicate the sources of the assets. The sources
may be the owners themselves or outsiders. Due to the difference in the nature of these claims,
equities are divided into the claims of the creditors and claims of the owners. Hence the
fundamental equation can be explained as follows:
A=L + P
Where
A = Assets
L = Liabilities (Loan from outsiders i.e. Creditors)
P = Proprietorship or Capital or Owners Equity (Owners claims in the organization)

So the Accounting Equation is: A=L+P

Balance Sheet of an organization shows the financial position of an organization at a

certain period of time. Accounting equation equates the financial position i.e. all the assets of
an organization equals to the internal liabilities (Capital or Owners equity) and external
liabilities (Creditors) of an organization.

Now we will explain what assets, liabilities are and owner’s equity means:

Assets: Assets can generate income for an organization and the physical objects or services
that have financial worth.

Types of assets:
1. Physical /tangible assets: Land, building, cash, motorcar etc. that we can see and have
the physical existence.
2. Right for receiving payment: Accounts Receivable, Sundry Debtors, Notes
Receivable, advances to employees.
3. Right for receiving services: Prepaid insurances, unexpired rates etc.
4. Intangible assets: Goodwill, patents etc that has no physical existence.

In another sense assets can be classified into two groups:

 1. Long-term assets: Those assets that will give benefit more than one-year .For
example: Land, Equipment etc.
2. Short term assets /Current assets: Those assets that will be matured within one year.
For example: Cash, bank balance, Accounts receivable etc.

Liabilities:
-Claims in the assets by outsiders or creditors
-Obligation to pay for purchases

Liabilities can be classified into two groups:

1. Short term /current liabilities: Those liabilities that will have to pay with in one year.
For example: Notes payable, accounts payable, salaries payable etc.
2. Long team liabilities: Those liabilities that we can avail for more than one year. For
example: Debenture, Bond Payable, Mortgage payable etc.

Owner’s Equity (O.E):

- The claims of owners from to organizations assets
- It can be said ‘Residual Claim’ since at the time of termination of the organization the
creditors are firstly paid and the remaining amount paid to the owners.

The following Four types of transactions that changes the Capital or Owner’s Equity
(O.E):

Types of Transactions Capital or O.E.

1. Owners contribution (Any assets invested by the owners) +
2.Owner’s withdrawals (Any thing taken by owner’s from the -
organization)
3.Revenues/Income +
4.Cost/ Expenses -

Increases: Decreases:
-Owner’s contribution -Withdrawals by
-Revenue/Income owner
Owner’s Equity
-Expenses/Cost
Examples of Accounting Equation:

Transactions Assets =Liabilities Owner’s

+ Equity
Cash + Motor Car
1. Investment by owner tk. (+) 10,00,000 (+)
10,00,000 10,00,000

2.Purchase a car of tk. 5,00,000 (-) 5,00,000 (+) 5,00,000

3.Purchase another car on (+) 400,000 (+) 400,000

account tk. 400,000

4.Interest earned tk. 15,000 (+) 15,000 (+) 15,000

5. Staff salary paid tk. 20,000 (-) 20,000 (-) 20,000

Total 4,95,000 + 9,00,000 =4,00,000 + 9,95,000

=Tk. 13, 95,000 =Tk. 13, 95,000

Now we will explain the above transactions:

Transaction no. 1: Investment by the owner will increase cash taka for the
organization. As a result cash increase (+) and since the owners give the fund to the
organization, it will increase the capital or Owner’s equity (+).

Transaction no.2: The organization purchases a car. As a result cash will reduce (-)
and on the other hand the organization will have a motorcar of the same amount. So in the asset
column a new asset named ‘Motor Car’ will be added. Now the organization will have two
assets –One is cash and another is Motorcar.

Transaction no 3: Purchase another car on account or on credit of tk. 4, 00,000. The

organization will have a new asset (Motor car) and will be added with the Motorcar column in
the asset side. Since the organization did not paid cash for purchasing the car, the organization
will be liable to pay the amount to at a future date. As a result this will increase the
organizations liability and will be added with the liability column. So the liability will increase
(+).

Transaction no 4: Interest earned in cash taka. It will increase the cash of the
organization. So it will be added with cash (+) and on the other hand as it is revenue for the
organization it will increase the capital or Owner’s equity of the organization. So added with
the Owner’s equity (+)
Transaction no 5: Salary paid to the organizations staffs. As a result cash will be
reduced (-) .On the other hand since it is an expense for the organization, it will reduce the
capital of the organization. So owner’s equity reduced (-).
Continuation of Accounting Equation
Practical Problem: 1

The list below contains the transactions for the Joan Miller advertising agency during the month of January,
2003:
January 1: Joan Miller invested $10,000 in her own advertising agency
January 2: Rented an office, paying two months rent in advance $800
January 3: Hired a secretary and agreed to pay $600 every two weeks. The secretary
agreed to work extra hours to make up the time for the first two days of January.
January 4: Purchased art equipment for $4200
January 5: Purchased office equipment from Morgan Equipment for $3000. Paying $1500 in
cash and agreeing to pay the rest next month.
January 6: Purchased on credit art supplies for $1800 and office supplies for $800 from Taylor
Supply co.
January 8: Paid $480 for a one-year insurance policy with coverage effective, January 1.
January 9: Paid Taylor Supply Co. $1000 of the amount owed.
January 10:Performed a service by placing advertisements for an automobile dealer in the
Newspaper and collected a fee of $1400
January 12: Paid the secretary two weeks salary, $600
January 15: Accepted $1000 as an advance fee for artwork to be done for another agency,
Ziko Co.
January 19: Performed a service by placing several major advertisements for ward department
stores. The earned fees of $2800 will be collected next month.
January 25: Joan Miller withdrew $1400 from the business for personal living expenses.
January 26: Received (but did not pay) a telephone bill, $70.

You are requested to prepare a tabular analysis for Joan Miller advertising agency for the month
of January ‘2003.
Solution:
Joan Miller advertising agency
January ‘2003
(All figures are in Tk.)
Date Assets = Liabilities (+)

Accounts Payable
Jan. Prepaid Art Office Prepaid Morgan Taylor Ziko Accr O.E*
Cash rent equip equipme insuran A/R* Co. Co. Co. ued
ment nt ce T.B.
1 (+) (+) 10000
10000
2 (-) 800 (+) 800
3 - - - - - - - - - - -
4 (-) 4200 (+) 4200
5 (-) 1500 (+) 3000 (+) 1500
6 (+) 1800 (+) 800 (+) 2600
8 (-) 480 (+) 480
9 (-) 1000 (-) 1000
10 (+) 1400 (+) 1400
12 (-) 600 (-) 600
15 (+) 1000 (+) 1000
19 (+) 2800 (+) 2800
25 (-) 1400 (-) 1400
26 (+) 70 (-) 70
Total 2420 800 6000 3800 480 2800 1500 1600 1000 70 12130
16,300 16,300
Relative discussion: Now we will explain the above problem-

Jan. 1: The owner starts his own business .It will increase the cash for the business and on the
other hand will increase the capital for the business.
2: Rented an office for the business; paid in advance by the business. This will reduce the cash
for the business. On the other hand rent paid in advance (any ‘advance expense’ treated as an
‘asset’ in accounting) will increase asset of the business in the name ‘Prepaid rent’.
3:Hire a secretary is not any financial transaction for the organization. It will not be recorded
in the books of accounts.
4:Purchased-art equipment will increase an asset for the organization and also decrease cash
position for the organization.
5.Purchase-office equipment will increase asset for the organization .It will be recorded in the
asset side in the column ‘office equipment’. To purchase this 1500 cash is paid will reduce the
cash position of the organization. Remaining 1500 will be given later on .So it will increase
liability for the organization and will be recorded as Accounts payable (Morgan co.) in the
liability side.
6:Purchase art supplies will increase asset of the organization. This purchase is done on credit
.It will increase the liability.
8: Insurance is paid to cover the future risk. It is an advance payment. It is an asset for the
business. This will be recorded as ‘Prepaid insurance’ in the asset side. On the other hand it
will reduce the cash for the organization.
9: Payment is made to accounts payable (liability) will reduce the liability. On the other hand
will reduce the cash.
10: The business provides service to its clients. It is an income for the business and will increase
the owner’s equity. On the other hand it will also increase e the cash position of the
organization.
12:Payment is made in cash. It will reduce the cash position of the organization. Since it is an
expense it will reduce the owners equity.
15:The firm accept an advance payment from a client although it did not provide any service
to its clients. This will increase cash position as cash is increased. On the other hand this will
increase liability for the business as any advance receipt is treated as a liability in accounting.
19:The business provides services to its clients. It is an income for the organization and will
increase the owner’s equity. On the other hand the payment will be collected in the next month.
This will be recorded as an asset in the name ‘Accounts Receivable’ in the asset side.
25:The owner taken money from the business (Anything taken by the owner from the business
is considered as ‘Withdrawals or Drawings’ and is treated an expense for the business). This
will decrease the owner’s equity. On the other hand, cash will be decreased as the owner takes
cash.
26:It is an expense for the business and will reduce the owner’s equity. On the other hand cash
is not paid and it will increase the liability of the organization in the name of ‘Accrued
Telephone Bill’
 Practical Problem: 2
On the basis of the above problem, now try to solve the following problem.

Michelle Pfeiffer opened a law office, Michelle Pfeiffer, attorney at law, on July
1,2002. One July 31,2002, the balance sheet showed cash $4000, Account Receivables $1500,
Supplies $500, Office equipment $5000, Accounts Payable $4200 and Capital $6800.

During August the following transactions occured:

1. Collected $1400 of A/R
2. Paid $2700 cash on A/P
3. Earned revenue of $7500 of which $3000 s collected in cash and the balance is due in
September.
4. Purchased additional office equipment for $1000,paying$ 400 in cash and the balance on
account.
5. Paid salaries $2500; Rent for August $900 and advertise expenses $350
6. Withdrew $550 in cash for personal use.
7. Received $2000 from Standard Federal Bank-money borrowed on a note payable.
8. Incurred utility expenses for month on account $250.

Prepare a tabular analysis of the August transactions beginning with July 31 balances. The
column heading should be as follows:
Cash + A/R+ Supplies + Office Equipment = Notes payable +A/P+ Capital.

Now students are requested to practice more problems from the referred textbook.

The Accounting Cycle

1. Accounting cycle process
2. Identification and recording of transactions and other events-journal

Accounting Cycle: In the accounting process, the accounting activities rotate in a similar way or follows the same
procedure in each year .The sequence or process is maintained by the accounting activities can be entailed as ‘
accounting cycle’.

Step in account cycle:

The following steps are followed in the accounting cycle:
1. Source document collection and recording in Journal.
2. Classified posting into ‘general ledger’
3. Proving periodic arithmetical accuracy into ‘ trial balance’.
4. Adjusting ‘general ledger and preparation of work sheet.
5. Preparation of Final Financial Statement.

In every transaction the above-mentioned steps are followed. First the transactions are recorded in Journal book
and classified them and posting into the ledger account. The third step is to provide the arithmetical accuracy
through Trial Balance. In the fourth stage, adjusting entries are incorporated with the Trial Balance accounts and
worksheet is prepared. And finally, various financial statements are prepared i.e. Income Statement, Cash Flow
Statement, Retained Earnings Statements, and Balance Sheet etc. This entire process is called as the ‘Accounting
cycle’.
Step 1: Identification and recording of transaction and other events- Journal.

The first step in the Accounting cycle is to record the transactions in the books of accounts. This process
is called ‘to record’ into the journal books. The books are also called ‘Book of original Entry’ as transactions
occur they are recorded first in the journal.

Simply Journal can be defined as recordings of transactions in a set of books in a

systematic way according to days
Before starting to record the transactions into the journal book, we will discuss about the ‘Accounts.’

Accounts: An account is simply a place where similar transactions and events, which occur during a particular
period, are summarized and accumulated.

Classification of Accounts:
1. Personal account: Any person or organizations. Example: Mr. X’s a/c, Beximco co. ltd. a/c.
2. Real a/c: any assets i.e. cash, bank, machinery, motorcar etc.
3. Nominal a/c: Nominal accounts are of two types:
(a) Expense a/c: Any expenses i.e. salary paid, commission paid etc.
(b) Income a/c: Any earnings or revenues i.e. interest earned, commission earned etc.
Debit & Credit:
The term ‘Debit’ & ‘Credit’ gives an accounting explanation of the mathematical
changes in the individual accounts. There must be always equal increases and decreases so
that equality of the two sides of the accounting equation is maintained.
Journal rules:
1.In personal a/c: Receiver-------Dr
Donor------------Cr
Example: Mr. Hasan gives tk.100 to Mr. Jaman
Here Mr. Hasan and Mr. Jaman both are personal a/c and Jaman is the receiver. So Jaman’s a/c will be
debited. On the other hand Hasan is the donor and his a/c will be credited.
Journal entry: Mr. Jaman’s A/C Dr 100
Mr. Hasan’s A/c Cr 100

2.Real a/c: Asset increases------Dr

Asset decreases-------Cr

Example: Equipment purchased at a cost of tk. 1,00,000.

Equipment is an asset for the organization. So it will be debited. On the other hand cash is also an asset
for the organization. It will be decreased and will be credited.
Journal entry: Equipment A/c Dr 1,00,000
Cash A/c Cr 1,00,000
3.Nominal a/c:
(a) Expense a/c: Expenses increases----Dr

Expenses decreases ------Cr

(b) Income or revenue a/c: Income decreases-----Dr

Income increases-------Cr
Example 1: salaries paid tk. 10,000.
Salaries are an expense for the organization and it will be debited. On the other hand salary is
been paid in cash. Cash is an asset and it decreases so will be credited.
Journal would be: Salaries a/c Dr. 10,000
Cash a/c Cr. 10,000
Example 2: Interest income tk. 5000
Interest is an income for the organization and will be credited. On the other hand income is earned in
cash. So it will be debited.
Journal entry: Cash a/c Dr. 5000
Interest income Cr. 5000

4.Capital, reserve, and liabilities a/c: Any decreases -----Dr

Any increase -----Cr
Example: Mr. Hasan invested tk.100, 000 in the business. Here cash is increased and on the other hand
Capital is increased (Anything given by the owner’s to the business is the considered as the Capital of the
business). So it will be credited.
Journal entry: Cash a/c Dr.100, 000
Capital a/c Cr.100, 000

The specimen form of a General Journal is giver below:

General Journal Folio

No.............................
Date Particulars Ledger Debit Tk. Credit
Folio Tk.

Journal problem: 1
Ann Evans, CPA, completed the following transactions during August of this current year:

Aug. 1: Begin a public accounting practice by investing $1500 in cash and office
equipment having a $ 1200 fair value.
Aug. 1: Purchased office supplies $75 and office equipment $250, from Sierra Company
on credit.
Aug. 1: Paid three months rent in advance on suitable office space, $900.
Aug. 5: Completed accounting work for a client and collected $ 60 cash there for.
Aug. 11:Paid Sierra Co. $ 125 of the amount owed for the items purchased on August 1.
Aug. 12: Paid the premium on insurance policy, $375.
Aug. 15: Completed accounting work for Nevada Co. on credit, $ 350.
Aug. 20: Ann Evans withdrew $100 from the Accounting practice for personal expenses.
Aug. 23: Completed Accounting work for Donner co. on credit, $200.
Aug. 25: Received $ 350 from Nevada co. for the work completed on August 15.
Aug. 31: Paid the utility bills, $ 35

Required:
1.Prepare journal entries for the transactions
Solution:

Ann Evans, CPA

Journal Entries
Particulars LF Dr (Tk) Cr (Tk)
Date
2003
Aug 1 Cash A/C Dr 1500
Office equipment A/C Dr 1200
Capital A/C Cr 2700
Office Supplies A/C Dr
Aug 1 Office equipment A/C Dr 75
Accounts payable (Sierra Co) Cr 250 325
Prepaid Rent A/C Dr
Cash A/C Cr 900
Aug 1 Cash A/C Dr 900
Accounting Revenue Cr
Aug 5 Accounts payable (Sierra Co) Dr 60 60
Cash A/C Cr
Prepaid Insurance Dr 125 125
Aug 11 Cash A/C Cr
Accounts Receivable (Neveda Co) Dr
Aug 12 Accounting Revenue Cr 375 375
Withdrawals A/C Dr
Cash A/C Cr 350 350
Aug 15 Accounts Receivable (Donner Co) Dr
Accounting Revenue Cr
Aug 20 Cash A/C Dr 100 100
Accounts Receivable (Neveda Co) Cr
Utility Expense Dr 200 200
Aug 23
Cash A/C Cr
Aug 25 350 350

35 35
Aug 31 5,520 5,520

Questions: Students are requested to solve the following problems.

Problem no 1:
Dr. Wali Asahraf completed the following transactions in the practice of his profession during May of the

current year:

May 1. Paid office rent for May tk. 1400

2. Purchased X –ray film and other supplies on account tk. 680
4. Received cash on account from patient’s tk.8476
6. Purchased equipment on account tk.5100
6. Paid cash to creditors on account tk. 4810
8. Sold X-ray film to another doctor at cost, as an accommodation, receiving cash tk. 120
10. Paid invoice for laboratory analysis tk.280
11. Paid cash for renewal of property insurance policy tk. 560
20. Out of the items of equipment purchased on May 6 one was defective. It was returned with the permission
of the supplier who agreed to reduce the account for the amount charged for the item tk. 800
26. Paid cash from business bank account for personal and family expenses tk. 3500
31. Recorded the cash received in payment of services (on a cash basis) to patients during May tk.8350
31. Recorded fees charged to patients on account for May tk. 10,000
Requirement:
1.Pass journal entries for the above transactions.

Problem no 2:
Journalize the following entries:
1.Mr. Hasan starts his business. He invests TK 10,00,000; a motorcar of Tk 5,00,000; a machinery of Tk 1,00,000
and Tk 2,00,000 in the Standard Chartered Bank to operate the business.
2. Purchase goods at a cost of Tk 30,000
3. Purchase office equipment of Tk 50,000
4. Purchase goods from Beximco ltd. co on account at Tk 15,000
5. Sold goods for cash Tk 1,00,000
6. Sold goods on credit to Mr. Rafiq at Tk 50,.000
7. Goods returned to Beximco ltd. co Tk 1000
8. Goods returned from Rafiq at Tk 2000
9. Deposited cash into the Bank Tk 2,00,000
10. Paid carriage on sales of goods Tk 500
11. Salary paid by cheque Tk 20,000
12. Purchase of 10% Government Defense Certificate Tk 5,00,000
13. Bank charges Tk 100 for services. On the other hand we earned interest Tk 200 from them.
14. Insurance prepaid Tk 2500
15.Wages outstanding Tk 2000