Acctg.

Ed 1 - Financial Accounting & Reporting

Unit 2

Application of Accounting Concepts & Principles

Module 5

Books of Accounts and Double Entry System

Acctg. Ed 1 - Financial Accounting & Reporting

Unit 2 – Application of Accounting Concepts & Principles

Unit 2 applies accounting concepts and principles into real business transactions. It will
cover deeper discussion on accounting equation, types of major accounts, books of accounts
and double entry system, business transactions and their analysis, posting to ledger and
adjusting entries.

Module 5– Books of Accounts and Double-entry System

This module covers topics like the basic accounting equation, the expanded accounting
equation and applications of the accounting equation.

Objectives

At the end of the module, you should be able to:

1. Identify the uses of the two books of accounts.

2. Explain the rules of debits and credits

The Books of Accounts

A business maintains two books of accounts, namely:
1. Journal; and
2. Ledger

JOURNAL
The journal, also called the ”book of original entries,” is the accounting record where business
transactions are first recorded. Business transactions are recorded in the journal through
journal entries. This recording process is called journalizing.

Types of Journals
Journals can be classified into the following:
1. Special Journal – is used to record transactions of a similar nature. Special journals
simplify the recording and retrieving of information.

Common examples of Special Journals

Types of Special Journal Uses

a. Sales Journal Is used to record sales on account
b. Purchase Journal Is used to record purchases of inventory on
account
c. Cash Receipts Journal Is used to record all transactions involving
receipts of cash
d. Cash Disbursements Journal Is used to record all transactions involving
payments of cash

A business may have other special journals to suit its needs. For example: “Purchase
returns journal,” “Sales returns journal,” etc.
Acctg. Ed 1 - Financial Accounting & Reporting

2. General Journal – All other transactions that cannot be recorded in the special
journals are recorded in the general journal. Examples of such transactions include
purchases of inventory in exchange for notes payable, adjusting entries, correcting
entries, reversing entries, and the like.

If a business does not utilize special journals, all its transactions are recorded in the
general journal.

Examples:
a. You sold barbecue to a customer who promised orally to pay the sale price next
week.

This transaction involves sale on account, therefore, it is recorded in the sales

journal.

b. You sold barbecue to a customer who immediately paid the sale price.

This transaction involves the receipt of cash; therefore, it is recorded in the cash
receipts journal.

c. You sold barbecue to a customer who promised in writing to pay the sale price next
week.

This transaction cannot be record in the special journals; therefore, it is recorded in

the general journal.

LEDGER
The ledger is a systematic compilation of a group of accounts. It is used to classify the effects
of business transactions on the accounts. The ledger is also called the “book of secondary
entries” or the “book of final entries” because it is used only after business transactions are
first recorded in the journals. The process of recording in the ledger is called “posting.”

Kinds of ledgers
Ledgers can be classified into the following:
a. General ledger – contains all the accounts appearing in the trial balance.
b. Subsidiary ledger – provides a breakdown of the balances of controlling accounts.

*A controlling account (or control account) is one which consists of a group of accounts with
similar nature. The balance of the controlling account is shown in the general ledger, while the
balances of the accounts that comprise the controlling account are shown in the subsidiary
ledger. Not all account in the general ledger though are controlling accounts. Only those whose
balances necessarily need a breakdown are considered controlling accounts.

Example:
You sell barbeque on credit. The balance of credit sales not yet collected is P100,000. This
information is shown in Accounts Receivable, which is a controlling account in the General
Ledger.
Acctg. Ed 1 - Financial Accounting & Reporting

However, knowing only the total balance is insufficient. You need a breakdown of this amount.
You need information on which customers owe you money and the amount each customer
owes you. This information is provided by the Subsidiary Ledgers.

Analyze the illustration below.

General Ledger Subsidiary Ledgers

Accounts Receivable from

Customer A , P20,000

Accounts Receivable, Accounts Receivable from

P100,000 Customer B , P30,000

Accounts Receivable from

Customer C , P50,000

Summary:
Books of Accounts Description Function
1. Journal - Book of original entries - Journalizing
a. General Journal (Initial Recording)
b. Special Journals
2. Ledger - Book of secondary entries - Posting (Classifying)
a. General Ledger
b. Subsidiary Ledgers

Formats of the Books of Accounts

Ledger and Subsidiary Ledgers

General Journal
A general journal can have the following format:
Acctg. Ed 1 - Financial Accounting & Reporting

Other columns may be included, such as “posting reference” (P.Ref.) which is used to cross-
reference journal entries to the ledger, and journal entry number (GJ No.) which is used to
number the journal entries.

Special Journal
A special journal can have the following format:

General Ledger & Subsidiary Ledgers

DOUBLE-ENTRY SYSTEM
All transactions are recorded in the accounting records using the “double-entry system.”
Under this system, each transaction is recorded in two parts – debit and credit.

No transaction is recorded by a debit alone or a credit alone. For each amount that is debited,
there must be a corresponding amount that is credited, and vice-versa. This is in order for the
accounting equation to be balanced at all times. If at any time and accounting equation does
not balance, there is an error.
Acctg. Ed 1 - Financial Accounting & Reporting

Recall from our previous discussions that debit (Dr.) simply refers to the left side of an account,
while credit (Cr.) refers to the right side of an account.

Concepts of Duality and Equilibrium

The double-entry system involves the use of the concepts of “duality” and “equilibrium.”
a. The concept of duality views each transaction as having a two-fold effect on values – a
value received and a value parted with, and each transaction is recorded using at least
two accounts.
b. The concept of equilibrium requires that each transaction is recorded in terms of equal
debits and credits. For every peso debited, there is a corresponding peso credited, and
vice versa.

Normal balances of accounts

The normal balance of an account is on the side where an increase in that account is recorded.
The following are the normal balances of accounts:

Type of Account Normal Balance

Asset Debit
Liability Credit
Capital |(Equity) Credit
Revenue (Income) Credit
Expense Debit

To help us remember the normal balances of accounts, let us recall the expanded basic
accounting equation:

ASSETS = LIABILITIES + CAPITAL + REVENUE - EXPENSES

Notes:
- Assets which is on the left side of the equation has a normal debit balance.
- Liabilities, Capital (Equity) and Revenue (Income) which are additions on the right side
of the question have normal credit balances.
- Expenses which is a deduction on the right side of the equation has a normal debit
balance.
- Revenue (Income) increases equity, thus, it has a normal credit balance (same with
Capital). Expense decreases equity, thus, it has a normal debit balance (opposite of that
of equity).
- Another way to depict the normal balances of the accounts is as follows:

DEBITS CREDITS
Assets + Expenses = Liabilities + Capital (Equity) + Revenue (Income)
Acctg. Ed 1 - Financial Accounting & Reporting

Rules of Debits and Credits

To debit an account with a normal debit balance means to increase that account. To credit it
means to decrease it.

To credit an account with a normal credit balance means to increase that account. To debit it
means to decrease it. Analyze the table below.

Type of account Normal balance Debit Credit

Asset Debit Increase Decrease
Liability Credit Decrease Increase
Capital (Equity) Credit Decrease Increase
Revenue (Income) Credit Decrease Increase
Expense Debit Increase Decrease

Assets + Expenses = Liabiltiies + Capital + Revenue

Debit Credit

Recall the following concepts:

- An account takes the form of a “T-account” which resembles the alphabetical letter “T.”
- The left side of all accounts is the debit side, while the right side of all accounts is the credit
side.
The normal balance of an account is the side where that account is increased.

Ending balance of an account

Debits to a specific asset or expense account should be greater than (or equal to) the credits
to that account. On the other hand, credits to a liability, capital (equity) or revenue (income)
account should be greater than (or equal to) the debits to that account.

The difference between the monetary totals of debits and credits to an account represents the
ending balance of that account. The minimum ending balance of an account is zero. This occurs
when the total debits equal total credits to an account.

If an asset or expense account results to an ending balance that is a credit, meaning the total
amount of debits is less than the total amount of credits, the account is said to have an abnormal
Acctg. Ed 1 - Financial Accounting & Reporting

balance. This means a recording error has been committed. A correction is needed to eliminate
the abnormal balance. This is also true when a liability, capital (equity), or revenue (income)
account results to an ending balance that is a debit.

Illustration: Rules of debits and credits

Cash #1: Asset account

At the beginning of the period, you have a cash balance of P2,000. During the period, you had
total cash collections amounting to P10,000 and made total cash payments of P8,000.

Requirement: Using “T-account” analysis, compute for the ending balance of your cash.

Solution:
Cash
Dr. Cr.
Beg. Balance 2,000
Cash collections 10,000 8,000 Cash payments
Ending balance 4,000
Notes:
- The beginning balance is placed on the debit side because “Cash” is an asset account
and assets have a normal debit balance.
- Cash collections increase the balance of cash; thus, they are placed on the debit side.
- Cash payments decrease the balance of cash; thus, they are placed on the credit side.
- The ending balance is the difference between the debit and credits in the account. IT
is computed as follows: 2,000 Dr. + 10,000 Dr. – 8,000 Cr. = 4,000 ending balance.
- The 2,000 and 10,000 amounts are added because they are both debits. The 8,000
amount is deducted because it is a credit.

Take note:
- “Debit and debit” results to addition. Same is true for “credit and credit.”
- “Debit” and “credit,” or vice-versa, results to deduction.

Cash #2: Liability account

At the beginning of the period, you have a note payable of P1,200. During the period, you
obtained an additional loan amounting to P800 and made total payments of P500.

Requirement: Using “T-account”, compute for the ending balance of your notes payable.

Solution:
Notes Payable
Dr. Cr.
1,200 Beg. Balance
Payments onloan 500 800 Additional loan
1,500 Ending balance
Acctg. Ed 1 - Financial Accounting & Reporting

Notes:
- The beginning balance is placed on the credit side because “Notes payable” is a
liability account and liabilities have normal credit balance.
- Additional loan increases the balance of notes payable; thus, it is placed on the credit
side.
- Payment of loan decreases the balance of notes payable; thus, it is placed on the debit
side.
- Then ending balance is the difference between the total credits and total debits in the
account. The ending balance is computed as follows: 1,200 Cr. + 800 Cr. – 500 Dr. =
1,500.
- The 1,200 and 800 amounts are added because they are both credits. The 500 amount
is deducted because it is a debit.

Contra and Adjunct accounts

Some accounts have related accounts to them. An account related to another account is
referred to as either a contra account or an adjunct account.

Contra accounts are presented in the financial statements as deduction to their related
accounts.

Adjunct accounts are presented in the financial statements as addition to their related
accounts.

Thus:
- If an account has a normal debit balance, its contra account has a normal credit
balance (the opposite). To credit a normal debit balance means to deduct.
- If an account has a normal debit balance, its adjunct account has a normal debit balance
(the same). To debit a normal debit balance means to add.

On the other hand:

- If an account has a normal credit balance, its contra account has a normal debit
balance (the opposite). To debit a normal credit balance means to deduct.
- If an account has a normal credit balance, its adjunct account has a normal credit
balance (the same). To credit a normal credit balance means to add.

A contra asset account has a normal credit balance, while an adjunct asset account has a
normal debit balance

Examples of accounts with contra accounts:

ACCOUNT RELATED ACCOUNT
Accounts receivable - Allowance for bad debts
- Type of account: CONTRA ACCOUNT
Building - Accumulated depreciation – Building
- Type of account: CONTRA ACCOUNT
Equipment - Accumulated depreciation – Equipment
- Type of account: CONTRA ACCOUNT
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The sum of the balances of an account and its related contra and adjunct account is called the
net carrying amount (or simply the “carrying amount”) of that account.

Example 1:
Your accounts receivable has a balance P100,000, while the related allowance for bad debts
account has a balance of P20,000. How much is the carrying amount of your accounts
receivable?

Solution:

Accounts receivable P100,000

Allowance for bad debts (20,000)
Accounts receivable - net P80,000

The “Allowance for bad debts” is deducted because it is a contra account to “Accounts
receivable.”

Example 1:
You have a building with a historical cost of P1,000,000 and an accumulated depreciation of
P300,000. How much is the carrying amount of your building?

Solution:

Building P1,000,000
Accumulated depreciation - Building (300,000)
Building - net P700,000

The “Allowance for bad debts” is deducted because it is a contra account to “Accounts
receivable.”
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SAQ # 1

Identify the following:

1. ______________________________________ is the basic accounting equation

2. __________ are economic resources you control that have resulted from past events
and can provide you with economic benefits.
3. ___________ are your present obligations that have resulted from past events and can
require you to give up economic resources when settling them.
4. _________ is assets minus liabilities
5. _________________________ Under this concept, some costs are initially recognized
as assets and charged as expenses only when the related revenue is recognized.
6. __________________________________________________________ the expanded
accounting equation.
7. _______ is increases in assets, or decreases in liabilities resulting to increases in capital,
excluding those relating to investments by the business owner.
8. _______________ are decreases in assets, or increase in liabilities, that result in
decreases in capital, excluding those relating to distributions to the business owner.
9. _________________ Revenue less expenses. If Revenue is greater than expenses,
there is ___________. If revenue is less than expense, there is ___________.
10. Revenue and profit _____________ Capital while expenses ___________ Capital

ASAQ # 1

Identify the following:

1. _ASSETS = LIABILITIES + CAPITAL__ is the basic accounting equation

2. __ASSETS___ are economic resources you control that have resulted from past events
and can provide you with economic benefits.
3. _LIABILITIES__ are your present obligations that have resulted from past events and
can require you to give up economic resources when settling them.
4. _CAPITAL__ is assets minus liabilities
5. ____MATCHING PRINCIPLE___ Under this concept, some costs are initially recognized
as assets and charged as expenses only when the related revenue is recognized.
6. ___ASSETS = LIABILITIES + CAPITAL + REVENUE – EXPENSES__ the expanded
accounting equation.
7. _REVENUE_ is increases in assets, or decreases in liabilities resulting to increases in
capital, excluding those relating to investments by the business owner.
8. __EXPENSES___ are decreases in assets, or increase in liabilities, that result in
decreases in capital, excluding those relating to distributions to the business owner.
9. __PROFIT OR LOSS__ Revenue less expenses. If Revenue is greater than expenses,
there is __PROFIT___. If revenue is less than expenses, there is __LOSS___.
10. Revenue and profit ____INCREASE___ Capital while expenses ___DECREASE__
Capital