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ACCTG 101 – FUNDAMENTALS OF ACCOUNTING PARTS 1 & 2

MODULE

LESSON 2
THE ACCOUNTING EQUATION AND THE DOUBLE-ENTRY SYSTEM

Learning Outcomes
 Describe and differentiate the types a of accounting information system.
 Illustrate and interpret the basic accounting equation.
 Discuss and apply the principles of double entry bookkeeping system.
 Explain the rules of debit and credit in recording business transactions.
 Enumerate typical account titles used in recording transactions and develop chart of
accounts.
 Record business transactions in financial transaction worksheet and T-accounts

Introduction
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. This lesson will give
the learners an overview of accounting information system (AIS), including the types of
AIS that are commonly used today. A thorough discussion on the basic accounting
equation as well as the use of Fra Luca Pacioli’s Double Entry Bookkeeping will be the
main focus of this lesson.

Lecture Notes / Lesson Content

Accounting Information System

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.
According to accountingedu.org, accounting information systems have three basic
functions:
1. The first function of an AIS is the efficient and effective collection and storage of
data concerning an organization’s financial activities, including getting the
transaction data from source documents, recording the transactions in journals, and
posting data from journals to ledgers.
2. The second function of an AIS is to supply information useful for making decisions,
including producing managerial reports and financial statements.
3. The third function of an AIS is to make sure controls are in place to accurately record
and process data.
In general terms, companies uses 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.
1. A manual system is a bookkeeping system where records are maintained by hand,
without using a computer system. Instead, transactions are written in journals, from
which the information is manually rolled up into a set of financial statements. These
systems suffer from a high error rate, and are much slower than computerized
systems. Manual systems are most commonly found in small enterprises that have
few transactions. (accountingtools.com)

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2. A computer-based transaction system maintains accounting data separately from

other operating data. This system treats information in the same manner as a manual
system. The user is simply filling in a computer screen that looks and oftentimes acts
like a source document.
3. Database systems embed accounting data within the business event data on which
they are based. Systems such as enterprise resource planning (ERP) depart from the
acccounting equation method of organizing data.

The Accounting Equation

An accounting transaction is a business activity or event that causes a measurable
change in the accounting equation. An exchange of cash for merchandise is a transaction.
Merely placing an order for goods is not a recordable transaction because no exchange
has taken place. In the coming sections, you will learn more about the different kinds of
financial statements accountants generate for businesses.
Specific types of accounts that business activities fall into, namely:
a) Assets (what it owns)
b) Liabilities (what it owes to others)
c) Equity (the difference between assets and liabilities or what it owes to the owners)
These are the building blocks of the basic accounting equation. The accounting equation
is:
ASSETS = LIABILITIES + EQUITY

Types of Accounts
1. Assets are the resources owned and controlled by the firm.
a) Current Assets are assets that can be realized (collected, sold, used up) one year
after year-end date. Examples include Cash, Accounts Receivable, Merchandise
Inventory, Prepaid Expense, etc.
i. Cash is money on hand, or in banks, and other items considered as medium
of exchange in business transactions.
ii. Accounts Receivable are amounts due from customers arising from credit
sales or credit services.
iii. Notes Receivable are amounts due from clients supported by promissory
notes.
iv. Inventories are assets held for resale
v. Supplies are items purchased by an enterprise which are unused as of the
reporting date.
vi. Prepaid Expenses are expenses paid in advance. They are assets at the time
of payment and become expenses through the passage of time.
vii. Accrued Income is revenue earned but not yet collected
viii. Short term investments are the investments made by the company that are
intended to be sold immediately
b) Non-current Assets are assets that cannot be realized (collected, sold, used up)
one year after year-end date. Examples include Property, Plant and Equipment
(equipment, furniture, building, land), long term investments, etc.
i. Property, Plant and Equipment are long-lived assets which have been
acquired for use in operations.
ii. Long term Investments are the investments made by the company for long-
term purposes
iii. Intangible Assets are assets without a physical substance. Examples include
franchise and copyright.
2. Liabilities are obligations of the firm arising from past events which are to be settled
in the future.

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a) Current Liabilities. Liabilities that fall due (paid, recognized as revenue) within
one year after year-end date. Examples include Accounts Payable, Utilities
Payable and Unearned Income.
i. Accounts Payable are amounts due, or payable to, suppliers for goods
purchased on account or for services received on account.
ii. Notes Payable are amounts due to third parties supported by promissory
notes.
iii. Accrued Expenses are expenses that are incurred but not yet paid (examples:
salaries payable, taxes payable)l
iv. Unearned Income is cash collected in advance; the liability is the services to
be performed or goods to be delivered in the future.
b) Non-current Liabilities are liabilities that do not fall due (paid, recognized as
revenue) within one year after year-end date. Examples include Notes Payable,
Loans Payable, Mortgage Payable, etc.
3. Equity or Owner’s Equity are the owner’s claims in the business. It is the residual
interest in the assets of the enterprise after deducting all its liabilities.
a) Capital is the value of cash and other assets invested in the business by the
owner of the business.
b) Drawing is an account debited for assets withdrawn by the owner for personal
use from the business.
4. Income is the increase in economic benefits during the accounting period in the form
of inflows of cash or other assets or decreases of liabilities that result in increase in
equity. Income includes revenue and gains.
5. Expenses are decreases in economic benefits during the accounting period in the
form of outflows of assets or incidences of liabilities that result in decreases in equity.

Debits and Credits - The Double-Entry System

The double-entry system of accounting or bookkeeping means that for every
business transaction, amounts must be recorded in a minimum of two accounts. The
double-entry system also requires that for all transactions, the amounts entered as debits
must be equal to the amounts entered as credits. Double entry also means that the
accounting equation (assets = liabilities + owner's equity) will always be in balance.
Debits and credits are terms used in accounting and bookkeeping systems for the
past five centuries. They are part of the double entry system which results in every
business transaction affecting at least two accounts. At least one of the accounts will
receive a debit entry and at least one other account will receive a credit entry. Further, the
amounts entered as debits must be equal to the amounts entered as credits.
You should think of a debit as an entry on the left side of an account, and a credit
as an entry on the right side of another account. Accountants often use T-accounts to
visualize the debit and credit effects on the accounts' balances.
It may take some time to learn which general ledger accounts will be debited and
credited, but here are some general rules:
a) Expense accounts generally have debit entries and have debit balances
b) Revenue accounts generally have credit entries and have credit balances
c) Assets generally have both debit and credit entries, but usually have debit balances
d) Liabilities generally have debit and credit entries, but usually have credit balances
e) Owner’s equity accounts could have debit and credit entries, but profitable
businesses usually have credit balances

Rules on Debit and Credit

To debit an account means to enter an amount on the left side of the account. To
credit an account means to enter an amount on the right side of an account.
Generally these types of accounts are increased with a debit:
Dividends (Draws)

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Expenses
Assets
Losses
You might think of D - E - A - L when recalling the accounts that are increased with a
debit.

Generally the following types of accounts are increased with a credit:

Gains
Income
Revenues
Liabilities
Stockholders' (Owner's) Equity
You might think of G - I - R - L - S when recalling the accounts that are increased with a
credit.

To decrease an account you do the opposite of what was done to increase the account.
For example, an asset account is increased with a debit. Therefore it is decreased with a
credit.

The abbreviation for debit is dr. and the abbreviation for credit is cr.

Accounting Events and Transactions

An accounting event is an economic occurrence that causes changes in an
enterprise’s assets, liabilities, and/or equity. A transaction is a particular kind of event
that involves the transfer of something of value between two entities. The main difference
between transaction and event is when an event brings change to account balances, it is
classified as a transaction and recorded in the books.

Difference between Event and Transaction

Event Transaction

(1) All events are not transactions. (1) All transactions are events.

(2) An event may or may not bring change in the (2) An event must bring financial change.
financial position of a person, family, or
organization.

(3) Financial changes caused by events may or (3) The financial changes caused by
may not be measurable in terms of money. transactions must be measurable in terms of
For example, the death of a skilled employee money.
may bring heavy loss to a business, but this loss
is not measurable in terms of money.

(4) Events are used in a wider sense. (4) Transactions are used comparatively in a
It may or may not require two parties for the narrow sense.
occurrence of an event. In the case of transaction two parties are
must.

(5) Transfer of goods or services may or may (5) As a consequence of transactions transfer
not occur for an event. of goods or service is a must.
Of course, in some cases, there is an
exception. For example, burning of goods,
fixed asset depreciation etc.

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(6) It is. not necessary that every event will be (6) Every transaction must be recorded in the
recorded in the books of accounts. books of accounts; otherwise accurate results
It is needless to record any event in the books of cannot be ascertained from the books of
accounts if it is not measurable in terms of accounts.
money.

(7) Transaction relating event is settled for cash. (7) Financial transactions may be settled in
Cash or are made on credit.

(8) As per accounting principle of events— (8) In the accounting process of the
(a) Cash statement. transaction in the first phase journalizing, in
(b) Separate statements for receipts and the second phase posting in the ledger and in
payments head wise and, the third phase financial statement is
(c) Final statement of receipts and payments are prepared.
made.

(9) The scope of the event is very wide. (9) The scope of the transaction is limited.

(10) The scope of the event is very wide. (10) The scope of the transaction is limited.

(11) Transactions related to events are not (11) Business transactions must be supported
always supported by evidence. by evidence.
So you can say that Transactions are events that;
(i) cause an immediate change in the financial resources or obligations of the business.
(ii) can be measured objectively in monetary terms.

Types and Effects of transactions

1. Asset Exchange Transaction
a) A transaction, such as the purpose of land with cash, that decreases one asset and
increases another asset; total assets remain unchanged
2. Asset Source Transaction
a) A transaction that increases both an asset and a claim on assets; the three types
of asset source transactions are acquisitions from owners (equity), borrowing
from creditors (liabilities), or earnings from operations (revenues)
3. Asset Use Transaction
a) A transaction that decreases both an asset and a claim on an assets; the three
types of asset use transactions are distributions (transfers to owners), liability
payments (to creditors), or expenses (costs incurred to operate the business)
4. Claims Exchange Transaction
a) A transaction that decreases one claim and increases another claim; total claims
remain unchanged. For example, accruing interest expense is a claims exchange
transaction; liabilities increase, and the expense recognition decreases retained
earnings

Accounting for business transactions

Accountants observe many events that they identify and measure in financial
terms. A business transaction is the occurrence of an event or a condition that affects
financial position and can be reliably recorded.
Every financial transaction can be analyzed or expressed in terms of its effects on
the accounting equation. The financial transactions will be analyzed by means of a
financial transaction worksheet which is a form used to analyze increases and decreases
in the assets, liabilities or owner’s equity of a business entity.

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Illustration of how to make financial transaction worksheet.

What is a T-Account?
A T-account is an informal term for a set of financial records that uses double-
entry bookkeeping. The term describes the appearance of the bookkeeping entries. First, a
large letter T is drawn on a page. The title of the account is then entered just above the
top horizontal line, while underneath debits are listed on the left and credits are recorded
on the right, separated by the vertical line of the letter T. A T-account is also called a
ledger account.
In double-entry bookkeeping, a widespread accounting method, all financial
transactions are considered to affect at least two of a company's accounts. One account
will get a debit entry, while the second will get a credit entry to record each transaction
that occurs.
The credits and debits are recorded in a general ledger, where all account balances
must match. The visual appearance of the ledger journal of individual accounts resembles
a T-shape, hence why a ledger account is also called a T-account.
A T-account is the graphical representation of a general ledger that records a
business’ transactions. It consists of the following:

An account title at the top horizontal line of the T

A debit side on the left
A credit side on the right

Summary
 An accounting information system (AIS) is a structure that a business uses to collect,
store, manage, process, retrieve, and report its financial data so it can be used by
accountants, consultants, business analysts, managers, chief financial officers (CFOs),
auditors, regulators, and tax agencies.(Investopedia)
 The accounting equation is considered to be the foundation of the double-entry
accounting system.

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Contact No. (043) 402-1450

 The accounting equation shows on a company's balance sheet where the total of all
the company's assets equals the sum of the company's liabilities and shareholders'
equity.
 Assets represent the valuable resources controlled by the company.
 The liabilities represent their obligations.
 Both liabilities and shareholders' equity represent how the assets of a company are
financed.
 Financing through debt shows as a liability, and financing through issuing equity
shares appears in shareholders' equity.
 Elements of financial statements (Assets, Liabilities, Owner’s Equity, Income &
Expenses) use different account titles depending on the type of business.
 A T-account is an informal term for a set of financial records that use double-entry
bookkeeping.
 It is called a T-account because the bookkeeping entries are laid out in a way that
resembles a T-shape.
 The account title appears just above the T. Underneath, debits are listed on the left
and credits are recorded on the right, separated by a line.
 The T-account guides accountants on what to enter in a ledger to get an adjusting
balance so that revenues equal expenses.

References

Book Reference
 Ballada, W., &; Ballada, S. (n.d.). Basic Accounting (20th ed.). DomDane.

Website Links
 What are Accounting Information Systems? (n.d.). Retrieved July 31, 2020, from
https://www.accountingedu.org/accounting-information-systems/
 Financial Accounting. (n.d.). Retrieved July 31, 2020, from
https://courses.lumenlearning.com/sac-finaccounting/chapter/the-basic-accounting-
equation/
 What is the double-entry system?: AccountingCoach. (n.d.). Retrieved July 31, 2020,
from https://www.accountingcoach.com/blog/what-is-the-double-entry-system
 Differences between Transaction and Event in Accounting. (2018, June 21).
Retrieved July 31, 2020, from https://www.iedunote.com/transactions-events-
difference
 Liberto, D. (2020, January 29). T-Account Definition. Retrieved July 31, 2020, from
https://www.investopedia.com/terms/t/t-account.asp

Youtube Channels
 Filipino Accounting Tutorial
 COB Channel
 Accounting Stuff

Prepared by:

Ms. Maria Corazon C. Castillo, CPA, MBA

Contact No.: 09171620148
Email Address: [email protected]