HANDOUT 2 – INTRODUCTION TO ACCOUNTING EQUATION AND DOUBLE-ENTRY SYSTEM

By: REMAR ALLEN M. BAUTISTA, CPA

I. BOOKKEEPING SYSTEM. Bookkeeping is a systematic and chronological recording of transactions and events in books of
account. It is also known as the recording phase of accounting.
A. Systems of Bookkeeping
1. Double Entry Bookkeeping – a system of bookkeeping which views a transaction as having two-fold effect on
accounting values. The two underlying concepts of double-entry bookkeeping are duality and equilibrium.
2. Single Entry Bookkeeping – a system of bookkeeping whereby, as a general rule only cash and personal accounts
are recognized.
II. ACCOUNTING CYCLE – a series of well-defined steps leading to the communication of the effects of a business transaction.
The accounting cycle implements the accounting process from period to period.
A. Steps in Accounting Cycle
1. Identifying and Analyzing transactions and events to be recorded. Gathering of information from source documents
and determining the impact of the transaction or event on the financial position using the equation “Assets equals
Liabilities + Owners’ Equity”
 Assets - resources controlled by the entity as a result of past events and from which future economic benefits
are expected to flow to the entity.
 Liabilities - present obligations of the entity arising from past events, the settlement of which is expected to
result in an outflow from the entity of resources embodying economic benefits.
 Equity - the residual interest in the assets of the entity after deducting all its liabilities.
 Income - increases in economic benefits during the accounting period in the form of inflows or enhancements
of assets or decreases of liabilities that result in increases in equity, other than those relating to contributions
from equity participants.
 Expense - decreases in economic benefits during the accounting period in the form of outflows or depletions
of assets or incurrences of liabilities that result in decreases in equity, other than those relating to distributions
to equity participants.
 The dual-effect principle – each recorded event affects at least two items in the financial accounting record
 Chart of Accounts - s a listing of the names of the accounts that a company has identified and made available
for recording transactions in its general ledger.
 Rules of Debit and Credit
Debit Credit
ASSETS LIABILITIES
OWNERS’ EQUITY

EXPENSES INCOME

 The normal balance of an account (e.g. Debit for Assets) is also how you increase them (Debit Asset to Increase
it). Example:
o Cash is an Asset with a normal balance of debit. To increase cash, we debit it and to decrease, we credit it.
o Accounts Payable is a Liability with a normal balance of credit. To increase accounts payable we credit it
and we debit it for the decrease.
To Summarize:
Debit Credit
Increase Assets Decrease Assets
Decrease Liabilities Increase Liabilities
Decrease Owners’ Equity Increase Owners’ Equity
Increase Expenses Decrease Expenses
Decrease Income Increase Income
2. Journalizing the transactions and events. Act of recording transactions in the business forms to appropriate journals.
 Types of Journal Entries as to the time prepared
o Opening entry o Reversing entries
o Current entries o Correcting entries
o Adjusting entries o Reclassification entries
o Closing entries
  Types of Journal Entries as to form
o Simple Journal Entry
o Compound Journal Entry
 Journal - is a formal record or book of original entry where transactions are recorded for the first time
o Simple Journal – A book of original entry used to record all transactions
 General Journal – simple journal with two money columns
 Combination Journal – simple journal with several money columns
o Special Journal – multi-column cook to record transactions of a similar nature
 Cash Receipts Journal  Voucher Register
 Cash Disbursement  Check Register
Journal  Requisition Journal
 Sales Journal  Finished Goods Journal
 Purchase Journal  Factory Journal
3. Posting. Act of transferring peso amounts and other information from the journal to ledger.
 Ledger – systematic compilation of a group of accounts
o General Ledger – contains all accounts appearing in the financial statements
o Private Ledger – contains confidential information of accounts
o Subsidiary Ledger – a supporting ledger consisting of a group of accounts of similar nature the total
of which agrees with a controlling account in the general ledger
 Accounts Receivable  Finished Goods Ledger
Ledger  Factory Ledger
 Accounts Payable Ledger  Plant Ledger
 Work in Process Ledger  Expense Ledger
 Account – is used as the storage of unit of information in double-entry system
o Real/Permanent Accounts
o Nominal/Temporary Accounts
o Mixed Accounts
o Suspense Accounts
o Reciprocal Accounts (example: Home Office – Branch)
o Auxiliary Accounts
 Adjunct – similar/same balance as the principal (Bond Premium)
 Contra – has an opposite normal balance from the principal (Accumulated Depreciation)
o Clearing Accounts (Construction-in-Progress)
o Controlling Accounts (Accounts Receivable)
o Summary Accounts
4. Preparing unadjusted trial balance. Balance of the general ledger accounts are proved as to the equality of debits and
credits and to serve as a basis for adjusting entries.
 Types of Trial Balance
o As to Form
 Trial balance of balances  Trial balance of balances
 Trial balance of totals and totals
o As to Time of Preparation
 Periodic or Unadjusted – contains real, nominal and mixed accounts
 Adjusted – contains real and nominal accounts
 Post Closing – contains real accounts only
 Errors Revealed by Trial Balance
o Error of Transplacement (example 100 recorded as 1,000)
o Error of Transposition (example 73 recorded as 37)
o Error in Posting in one Side of an entry
o Omission in posting one side of an entry
 Errors Not Revealed by Trial Balance
o Wrong Computation
o Wrong Classification of Account
o Double-Posting both sides on an entry
 o Omission in posting both sides of an entry
o Omission in journalizing a transaction
5. Journalizing and posting the adjusting entries. To take up accruals, expiration of deferrals, estimations and other events
often not signaled by new source documents.
 Concepts Involved
o Accrual – revenue must be recognized when earned even cash is not yet received. Expenses must be
recorded when benefits are received even cash is not yet paid.
o Matching Principle – to have fair measurement of revenue in a any given period of time, all costs
and expenses incurred generating that revenue must be deducted therefrom
o Accounting Period (Periodicity)
 Purpose of Adjusting Entries
o To take up unrecorded income and expenses of the period
 Accrued expenses  Accrued Income
o To split mixed accounts into their real and nominal elements:
 Prepaid Expenses  Bad Debts
 Unearned or Pre-  Inventory
Collected Income  Depreciation
6. Preparing the adjusted trial balance. Checking the equality of debits and credits after adjustments and to facilitate the
preparation of financial statements.
 Worksheet is an analytical device used in accounting to facilitate the gathering of data for adjustment, the
preparation of financial statements, and closing entries.
7. Preparing the financial statements. The means by which the processed information is communicated to external
decision-makers.
 Financial Statements are the means by which the information accumulated and processed in financial
accounting is periodically communicated to the users.
 Components of Financial Statements (PAS 1)
o Statement of Financial Position (Balance Sheet)
o Statement of Comprehensive Income
o Statement of Changes in Equity
o Statement of Cash Flow
o Notes to Financial Statements
8. Closing the books. Involves journalizing and posting closing entries and ruling and balancing real accounts in the ledger.
 Closing Entries – are entries prepared at the end of the accounting period to “empty” all nominal accounts in
the ledger
 Steps in Preparing Closing Entries
a. Close all nominal accounts to income and expense summary accounts
b. Close income and expense summary to Capital (sole proprietorship and partnership) or Retained
Earnings (corporation)
c. Close Drawing to Capital. Applicable only to sole proprietorship and partnership.
9. Taking a post closing trial balance. This is done to prove equality of debits and credits in the ledger after the closing
process.
10. Preparing, entering and posting of reversing entries. This is done to facilitate the recording of certain transactions in
the succeeding accounting period.
 Reversing entries are entries made on the first day of the succeeding accounting period to reverse certain
adjusting entries done immediately preceding period.
 Purpose
o For convenience in recording accruals
o For consistency
 Adjustments requiring reversal
o Accrued expense
o Prepaid Expense (expense method)
o Unearned Income (income method)