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LESSON 7 The Accounting Equation

The document discusses the accounting equation and key accounting concepts: 1) The accounting equation states that assets must equal liabilities plus owner's equity. 2) Accounts track increases and decreases to elements in financial statements, with debits and credits following set rules. 3) Transactions are recorded through double-entry bookkeeping, with equal debits and credits.

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174 views3 pages

LESSON 7 The Accounting Equation

The document discusses the accounting equation and key accounting concepts: 1) The accounting equation states that assets must equal liabilities plus owner's equity. 2) Accounts track increases and decreases to elements in financial statements, with debits and credits following set rules. 3) Transactions are recorded through double-entry bookkeeping, with equal debits and credits.

Uploaded by

Unamadable Unleomarable
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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LESSON 7: THE ACCOUNTING EQUATION

Learning Objectives

At the end of this lesson, the learners should be able to:

1. equate assets with liabilities and equity solve problems using the accounting
equation

The Account

The basic summary device of accounting is the account. A separate is maintained for
each element that appears in the balance sheets and in income statements. Thus an
account may be defined as a detailed record of the increases, decreases and balance of
each element that appears in an entity’s financial statements. The simplest form of the
account is known as the “T” account because of its similarity to the letter “T”.

Account Title

Left Side or Right Side or


Debit Side Credit Side
(Dr.) (Cr.)

The Accounting Equation

ASSET = LIABILITIES + OWNER”S EQUITY

Debits and Credits – the double-entry system

Accounting is based on the double-entry system which means that the dual effects of a
business transaction are recorded. A debit side entry must have a corresponding
credit side entry. For every transaction, there must be one or more accounts debited
and one or more accounts credited. Each transaction affects at least two accounts.
The total debits for a transaction must always equal the total credits.

An account is debited when an amount is entered on the left side of the account and
credited when an amount is entered on the right side. The abbreviations for debit and
credit are Dr. (from the Latin debere) and Cr. (from the Latin credere).

The account type determines how increases or decreases in it are recorded. Increases
in assets are recorded as debits while decreases in assets are recorded as credits.
Increases in liabilities and owner’s equity are recorded by credits and decreases are
entered as debits.

The rules of debit and credit for income and expense accounts are based on the
relationship of these accounts to owner’s equity. Income increases owner’s equity and
expense decreases owner’s equity. Increases in come are recorded as credits and
decreases as debits. Increases in expense are recorded as debits and decreases as
credits.
Balance Sheet Accounts

Assets Liabilities and Owner’s Equity

Debit Credit Debit Credit


(+) (-) (-) (+)
Increases Decreases Decreases Increases

Normal Balance Normal Balance

Income Statements
Accounts
Debit for decreases in owner’s equity Credit for increases in owner’s equity

Expense Income

Debit Credit Debit Credit


(+) (-) (-) (+)
Increases Decreases Decreases Increases

Normal Balance Normal Balance

Normal Balance of an Account


The normal balance of any account 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 and income accounts normally
have credit balance.

Increases Recorded by Normal Balance


Account Category Debit Credit Debit Credit
Assets √ √
Liabilities √ √
Owner’s Equity
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. Events may be internal actions, such as the use of
equipment for the production of goods or services.it can also be an external event,
such as the purchase of raw materials from a supplier. A transaction is a particular
kind event that involves the transfer of something of value between entities.

Types and effects of transactions

It will be beneficial in the long-term to be able to understand a classification approach


that emphasizes the effects of accounting events rather than the recording procedures
involved. This approach is quite pioneering. Although business entities engage in
numerous transactions, all transactions can be classified into one of four types:

1. Source of Assets (SA) – an assets account increases and corresponding claims


(liabilities or owner’s equity) an account increases. Ex. (1) Purchase of supplies
on account; (2) Sold goods on cash on delivery basis.
2. Exchange of Assets (EA) – one asset account increases and another asset
account decreases. Ex. Acquired equipment for cash.
3. Use of Assets (UA) – an asset account decreases and a corresponding claims
(liabilities or equity) account decreases. Ex. (1) Settled accounts payable; (2)
Paid salaries of employees.
4. Exchange of Claims (EC) – one claims (liabilities or owner’s equity) account
increases and another claims (liabilities or owner’s equity) account decreases.
Ex. Received utilities bill but did not pay.

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