DOUBLE ENTRY BOOKKEEPING SYSTEM AND

THE ACCOUNTING EQUATION

At the end of this module, the students should be able to:

 Describe how an accounting information system helps the

decision makers.
 Define the elements of financial statements.
 Describe the accounts and its uses.
 Understand the rationale behind the accounting equation.
 Explain the concept of double-entry system (Define Debits
and Credits).
 Apply the rules in debits and credits.
 Describe and analyze the nature of accounts used in
recording transactions.

ACCOUNTING INFORMATION SYSTEM

An accounting information system (AIS) is a system that businesses use to collect, store and
process financial and accounting data used by accountants, managers, chief financial officers
(CFOs), business analysts, managers, auditors, regulators, tax agencies and consultants.

It is a combination of personnel, records, and procedures that a business uses to meet its need
for financial information.

In order for an accounting information accounting system to be effective, it should achieve the
following objectives:

a. To be able to accommodate growth in the volume of transactions and for the

organizational changes.
b. To be in harmony with the entity’s organizational and human factors.
c. To protect entity’s assets, to ensure that data are reliable, and to minimize wastes and
the possibility of theft or fraud.
d. To process the information efficiently at the least cost.
ELEMENTS OF FINANCIAL STATEMENT
The elements of financial statements are the general groupings of line items contained within
the statements. These elements are as follows:

• Assets. A present economic resource controlled by the entity as a result of past events An
economic resource is a right that has the potential to produce economic benefits. Examples
are accounts receivable, inventory, and fixed assets.
• Liabilities. A present obligation of the entity to transfer an economic resource as a result
of past events. An obligation is a duty or responsibility that the entity has no practical ability
to avoid. Examples are accounts payable, taxes payable, and wages payable.
• Equity. In layman’s term, this is the amount invested in a business by its owners, plus
any remaining retained earnings. In accounting parlance, it is the residual interest in
the assets of the enterprise after deducting its all liabilities.
• Income. This is an increase in assets or decrease in liabilities caused by the provision
of services or products to customers. It is a quantification of the gross activity
generated by a business. Examples are product sales and service sales.
• Expenses. This is the reduction in value of an asset as it is used to generate revenue.
Examples are interest expense, compensation expense, and utilities expense.

THE ACCOUNT
Account – refers to the basic summary device of accounting. The simplest form of the account is
known as the “T” account because of its similarity to the letter T.

The account has three parts as follows:

ACCOUNT TITLE

Left Side Right Side

(DEBIT Side) (CREDIT Side)

THE ACCOUNTING EQUATION

Financial Statements tell us how a business is performing. They are the results of the accounting
process. More important question is how do we arrive at these items and amounts?

The most basic accounting tool is the ACCOUNTING EQUATION.

Assets = Liabilities + Owner’s Equity

This equation sets the foundation of double-entry accounting and highlights the structure of the
balance sheet. Double-entry accounting is a system where every transaction affects both sides of
the accounting equation. For every change to an asset account, there must be an equal change to
a related liability or shareholder’s equity account. It is important to keep the accounting equation
in mind when performing journal entries.

DEBITS & CREDITS: THE DOUBLE-ENTRY BOOKKEEPING 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.

For every debit, there should be a credit. The Abbreviation for debit and credit are Dr (from Latin
Debere) and Cr. (from the Latin Credere).

Debit
(Receive)
Double Entry
System
Credit (Give)

Accounting is based on a double-entry system which means that the dual effects of a business
transaction recorded.

A debit side entry must have a corresponding credit entry. For every transaction, there must be
one or more accounts debited and one or more accounts credited.

Note that the total debits for a transaction must always equal the total credits.
 ACCOUNTS

Debit Credit

Increases in Increases in
Assets Liabilities
Expenses Owner's Capital
Income

Decreases in Decreases in
Liabilities Assets
Owner's Capital Expenses
Income

,
NORMAL BALANCE OF AN ACCOUNT
This 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 account
and income accounts normally have credit balances. This result occurs because increases in an
account are usually greater than or equal to decreases.
 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. It is a transaction that is recognized in the financial
statements of an accounting entity.

- Events may be internal actions, such as the use of equipment for the production
of goods and services. It may also be an external event such as 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 assets from owner(s), borrowing

funds from creditors, and purchasing or selling goods and services.

TYPES OF TRANSACTIONS
1. Source of Asset (SA) – An asset account increases and a corresponding claim (liabilities
or owner’s equity) account increases.

- Examples:
Purchase of Supplies on account
Sold goods on cash on a delivery basis

2. Exchange of Assets (EA) – One asset account increases and another asset account
decreases.

- Example:
Acquired equipment for cash

3. Use of Assets (UA) – An asset account decreases and a corresponding claim (liabilities or
OE) account decreases.

- Examples:
Settled Accounts Payable
Paid Salaries of Employees

4. Exchange of claims (EC) -one claims account increases and another claims account
decreases.

- Examples:
Received utilities bill but the enterprise did not settle it yet.
EFFECTS OF TRANSACTIONS
1. Increase in assets = Increase in liabilities (SA)
2. Increase in assets = Increase in owner’s equity (SA)
3. Increase in one asset = Decrease in another assets (EA)
4. Decrease in assets = Decrease in Liabilities (UA)
5. Decrease in assets = Decrease in Owner’s equity (UA)
6. Increase in Liabilities = Decrease in Owner’s Equity (EC)
7. Increase in owner’s equity = Decrease in liabilities (EC)
8. Increase in one’s liability = Decrease in another liability (EC)
9. Increase in one Owner’s equity = Decrease in another owner’s equity (EC)

STATEMENT OF FINANCIAL POSITION

Statement of Financial Position also known as the Balance sheet gives the understanding to its users
about the financial status of the business at the particular point of time by showing the details of
the assets of the company along with its liabilities and owner’s capital.

It is one of the most important financial statements which reports the firm’s financial position at a
point in time. In other words, it summaries’ business financial position and acts as a snapshot of
events at one point in time. It comprises of three important elements namely:

a. Assets are the resources owned and controlled by the business. Assets are further classified
into Current Assets and Non-Current Assets.

Per revised Philippine accounting standards No. 1, an entity shall classify assets as
current when:

- It expects to realize the asset, or intends to sell or consume it in its normal

operating cycle.
- It holds the asset primarily for the purpose of trading.
- It expects to realize the asset within 12 months after the reporting period; or
- 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 12
months after the reporting period.

All other assets should be classified as non-current assets.

When we say “Operating cycle” it is the time between the acquisition of assets for
processing and their realization in cash or cash equivalents.

Current Assets

1. Cash

Cash is the most liquid asset of an entity and thus is important for the short-term
solvency of the company. The cash balance shown under current assets is the
balance available with the business. This cash can be promptly used to meet its day-
to-day expenses. It typically includes coins, currencies, funds on deposit with bank,
cheques and money orders.

2. Cash Equivalents

Cash equivalents are the result of cash invested by the companies in very short-
term, interest-earning financial instruments. These instruments are highly liquid,
secure and can be easily converted into cash usually within 90 days. Furthermore,
these securities include treasury bills, commercial paper and money market funds.
Also, these securities readily trade in the market and the value of such securities
can also be readily determined.

3. Accounts Receivable
 Accounts receivables are the amounts that a company’s customers owe to it for the
goods and services supplied by the company on credit. The accounts receivables are
presented in the balance sheet at net realizable value. These amounts are
determined after considering the bad debt expense.

4. Notes Receivable

Notes receivable is a balance sheet item, that records the value of promissory
notes that a business is owed and should receive payment for. A written promissory
note gives the holder, or bearer, the right to receive the amount outlined in the legal
agreement. Promissory notes are a written promise to pay cash to another party on
or before a specified future date.

If the note receivable is due within a year, then it is treated as a current asset on
the balance sheet.

5. Prepaid Expenses

Prepaid expenses refer to the operating costs of a business that have been paid in
advance. Thus, cash reduces in the balance sheet at the time when such expenses
are paid at the beginning of the accounting period. Simultaneously, a current asset
of the same amount is created in the balance sheet by the name of prepaid expenses.

6. Inventories, these are:

(a) 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.

Inventories are those assets of an entity which are sold in the normal course of
business. These are the finished goods which are ready for being sold. Assets which
are held for sale but are not traded in the normal course of business cannot be
classified as inventories.

Non-Current Assets

1. Property, plant, and equipment (PP&E)

These are long-term assets vital to business operations and not easily converted into
cash. Property, plant, and equipment are tangible assets, meaning they are physical
in nature or can be touched. The total value of PP&E can range from very low to
extremely high compared to total assets.

Accumulated depreciation is the total depreciation for a fixed asset that

has been charged to expense since that asset was acquired and made available for
use. The accumulated depreciation account is an asset account with a credit balance
(also known as a contra asset account); this means that it appears on the balance
sheet as a reduction from the gross amount of fixed assets reported.

2. Intangible asset

It is an asset that lacks physical substance; in contrast to physical assets, such

as machinery and buildings, and financial assets such as government securities.
An intangible asset is usually very hard to evaluate. Examples
are patents, copyright, franchises, goodwill, trademarks, and trade names.

b. Liabilities are the amount of business owed to its Lenders and Other Creditors. Liabilities are
further classified into Current Liabilities and Long Term Liabilities.

Current Liabilities
 1. Accounts Payable

It is a liability due to a particular creditor when it orders goods or services

without paying in cash up front, which means that you bought goods on credit.
Accounts Payable as a term is not limited to companies. Even individuals like
you and me have Accounts Payable.

2. Notes Payable

Notes Payable are written agreements (promissory notes) in which one party
agrees to pay the other party a certain amount of cash. Alternatively put, a note
payable is a loan between two parties.

3. Accrued Liabilities

An accrued liability is an expense that a business has incurred but has not yet
paid.

4. Unearned revenue

It is money received by an individual or company for a service or product that

has yet to be provided or delivered. It can be thought of as a "prepayment" for
goods or services that a person or company is expected to supply to the
purchaser at a later date.

5. Current Portion of the Long-term debt

The current portion of long-term debt (CPLTD) is the amount of unpaid principal
from long-term debt that has accrued in a company's normal operating cycle
(typically less than 12 months). It is considered a current liability because it has
to be paid within that period.

Non-current Liabilities

1. Mortgage Payable

A mortgage payable is the liability of a property owner to pay a loan that is

secured by property. From the perspective of the borrower, the mortgage is
considered a long-term liability.

2. Bonds Payable

A bond payable is just a promise to pay a series of payments over time (the
interest component) and a fixed amount at maturity (the face amount). Thus, it
is a blend of an annuity (the interest) and lump sum payment (the face).

c. Owner’s Equity which is the residual interest in the Net Assets of a business that remains after
deducting its liabilities.

1. Capital

It comes from the Latin word “capitalis”, meaning “property”. Capital refers to
the financial resources that businesses can use to fund their operations like cash,
machinery, equipment and other resources. These are the assets that allow the
business to produce a product or service to sell to customers
 2. Withdrawals

Withdrawals or owner withdrawals are payments from an owner’s share in a

company. In other words, its money the owner took out of the company to use
for personal expenses.

3. Income Summary

The income summary account is an account that receives all the temporary
accounts of a business upon closing them at the end of every accounting period.

INCOME STATEMENT

Income Statement is one of a company’s core financial statements that shows their profit and
loss over a period of time. The profit or loss is determined by taking all revenues and subtracting
all expenses from both operating and non-operating activities.

Income accounts

1. Service Income
2. Sales

Expense accounts

1. Cost of sales
2. Salaries or Wages Expense
3. Telecommunications, Electricity, Fuel and Water Expense
4. Rent Expense
5. Supplies Expense
6. Insurance Expense
7. Depreciation Expense
8. Uncollectible Account Expense
9. Interest Expense

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Reference: Ballada, Win. (2019). Basic Financial Accounting and Reporting: Domdane Publishers and
Made Easy Books

Additional video reference: https://www.youtube.com/watch?v=w6jOjZqPXD0

https://www.youtube.com/watch?v=A8o1X81f5HY

https://www.youtube.com/watch?v=RaA_GC3CFCs

“The sufferings of this present

time are not worth comparing
with the glory that is to be
revealed to us.”
—Romans 8:18