Lecture 3

Accounting Principles 1
 Chapter Two
The Accounting Equation
and The Debit and Credit
Rule
 • The financial statements are reports prepared by
accountants as the final product of the
accounting system. The most widely used
statements are the income statement and the
statement of financial position.
The • The Income Statement.
• The Income statement is an important report
Financial prepared by accountants at the end of the
Statements accounting period to show the results of all
activities of the period. The income statement
includes the revenues and the cost of producing
these revenues (expenses). The difference
between revenues and expenses is called net
income or net loss. Accordingly, the income
statement contains the following items:
 1. Revenues
• Revenue is the price for selling products or goods to
customers, the price for rendering services to them
regardless of collecting these prices from customers or not
during the period. Service firms get fees or commissions for
their services while commercial or manufacturing firms get
sales revenues.
The income 2. Expenses

Statement. • Expenses are the cost of providing resources, and facilities

necessary to perform services or produce and sell products.
So, we call expenses the cost of producing revenues.
3. Gains and Losses
• Companies may sell some of its assets like equipment or
land either for its obsolesces or not needing them. If the sale
produces increase of equity. this increase is called gains. If
sale produces decrease in equity this decrease is called loss.
Thus, gains and losses are net change in equity from non-
central activities of the firm.
 • The income statement format
• The income statement includes revenues and gains on one
The income side and expenses and losses on the other side.
Statement • Net income or net loss is determined using the following
equation:
format • Net Income (Net Loss) = Revenues and Gains — Expenses
and Losses
• The income statement may be presented in one of two
formats, the report format, or the T-account format.
 1. The report format.
• In the report format, all revenues and gains are listed first
hen expenses and losses are subtracted and the difference is
net income or net loss as follows:
Revenues and Gains:
Fees and Commissions $80,000

The income Investment revenues

Gains of sale of assets
Total Revenues and Gains
2,000
10,000
$92,000
Statement Less:
Expenses and Losses:

format Salaries and wages

Rent expenses
Supplies
$25 000
2,000
1,000
Depreciation expenses 2,000
Accounting fees 5,000
Maintenance and repair 2,000
Interest expenses 4,000
Losses of sale of equipment 10,000
Income taxes 5,000
Total of expenses and Losses (56.000)
Net Income $36,000
 2. T-account format
• One side for revenues and Gains and the other side
for Expenses and losses as follows:
Expenses and Losses Revenues and Gains
Salaries and Wages $25 000 Fees and Commissions $80,000
Rent Expenses 2,000 Investment revenues 2,000

The income Supplies

Depreciation
Accounting fees
1,000
2,000
5,000
Gains of sale of assets 10,000

Statement Maintenance and repair

Interest expenses
2,000
4,000 Total Revenues and Gains $92,000

format Losses of sale of equipment

Income taxes
10,000
5,000

Total of expenses and Losses 56.000

Net Income $36,000

$92,000 $92,000

Note that: Since total revenues and gains is greater than total
expenses and losses, then the company achieved net income, and it
is computed as follows
Total revenues — Total expenses ($92,000 - $56,000 = $36,000)
 1. Periodicity Assumptions
• According to this assumption, the life of business is
Accounting divided into Equal periods, normally a calendar year,
assumptions which is called financial period or accounting period.
This assumption helps in measuring net income for
and each period instead of waiting to the end of the
business's life to know the real profit or loss for the
Principles business. This is done by relating revenues and
Related to expenses to each period.
• Normally, the accounting period is a year (12
the income months). It starts at any month, it may or may not
statement. coincide with the calendar year. The important thing
is that it should be 12 months. The entity may prepare
its financial statements for shorter periods (Quarterly,
semi-annually, or monthly)
 2. Revenue Recognition Principle
Accounting • This concept is related to the timing of recording
assumptions revenues in the accounting records. According to this
principle, revenues should be recorded when it is
and realized or realizable. Revenue is realized when the
Principles services are rendered, or the product is delivered to
customers, regardless of collecting its price. If the
Related to service is rendered to a customer in April but its price
is collected in May, it should be recorded in April and
the income not in May. As for expenses they are recorded in the
same period of revenues generated from them. We
statement. mentioned that expenses are the cost of producing
revenues.
 3. The Matching Principle
• This principle states that expenses are spent to
generate revenues, so, revenues of the period should
Accounting be matched with all expenses contributed to the
assumptions production of these revenues. Timing is a very
important factor in the application of the matching
and principle to match revenues and expenses. It needs a
great amount of estimation and professional
Principles judgment from accountants.
Related to • There are many expenditures that benefit more than
one accounting period and it is necessary to allocate
the income these expenditures to the periods benefit from them.
statement. This requires an estimation of the part allocated to
each period. Or what is called depreciation expense.
The real or true net income cannot be computed or
measured accurately until the end of the life of the
business.
 • The policy of recording revenues when realized or
expenses in the same period of its revenues,
regardless of its collection or payment is called
The Accrual Basis of Accounting. This basis aims at
measuring income for each period separately.
Accrual There is another basis of accounting called The
Basis of Cash Basis of Accounting in which revenues are
recorded when its values are collected, and
Accounting expenses are recorded when they are paid.
Regardless of realization or matching. The Cash
basis of accounting measures cash receipts and
cash payment and is not an accurate measure for
profit or loss., since it mixes revenues and
expenses of different periods.
 The Effect of • Revenues and expenses affect the accounting equation.
Revenues/Expe Revenues increase cash or accounts receivable and
increase owner's equity. Thus, revenues increase both
nses assets and owner's equity. Expenses decrease cash or
Transactions increase liabilities and decrease owner's equity.
on The • Cash revenues:
• Cash revenues increase cash and owner's equity. So,
Accounting revenues are another source of Increase in capital and is
Equation called earned capital, not invested capital.
 Example:
The Effect of • The following transactions took place in Ahmed company:
Revenues/Expenses (Continue of Example in lecture 2)
Transactions on The 13. Ahmed travel agency arranged a trip to Alexandria for a
Accounting Equation customer for $7,000 in cash.
Cash increases by $7,000 and owner's equity increase by $7,000. The
effect on the accounting equation is as follows:

Assets = Liabilities + Owner’s equity

Cash Buildings Comp. supplies A/R L/ P A/P N/P Rev/ Ahmed's
Exp. Capital
Previous 59,000 15,000 0 3000 0 15,000 5,000 2000 55,000
transactions

Services +7,000 +7,000

provided for
cash
Total 66,000 15,000 0 3000 0 15,000 5,000 2000 7,000 55,000
 The Effect of • Revenues to be collected in the future:
Revenues/Expenses 14. Ahmed travel agency arranged a trip to Luxor
Transactions on The for a customer for $5,000 on credit. The A/R
increases by $5,000 and revenues increase by
Accounting Equation $5,000. The effect of this transaction on the
equation is as follows:

Assets = Liabilities + Owner’s equity

Cash Buildings Comp. supplies A/R L/ P A/P N/P Rev/ Ahmed's
Exp. Capital
Previous 66,000 15,000 0 3000 0 15,000 5,000 2000 7,000 55,000
transactions

Services +5,000 +5,000

provided on
account
Total 66,000 15,000 0 3000 5,000 15,000 5,000 2000 12,000 55,000
 The Effect of 15. When the amount due from customers is
Revenues/Expenses collected.
Transactions on The
Accounting Equation cash increases, and A/R decreases. The
accounting equation remains balanced.

Assets = Liabilities + Owner’s equity

Cash Buildings Comp. supplies A/R L/ P A/P N/P Rev/ Ahmed's
Exp. Capital
Previous 66,000 15,000 0 3000 5,000 15,000 5,000 2000 12,000 55,000
transactions
Collecting A/R +5,000 -5,000
Total 71,000 15,000 0 3000 0 15,000 5,000 2000 12,000 60,000
 The Effect of Cash expenses:
Revenues/Expenses • Payment of expenses in cash decreases cash and owner's equity
(Revenues and Expenses).
Transactions on The 16. Ahmed paid $8,000 salaries expenses in cash. Cash is decreased
Accounting Equation by $8,000 and revenues and expenses decrease by $8,000. The effect
of this transaction on the equation is as follows:

Assets = Liabilities + Owner’s equity

Cash Buildings Comp. supplies A/R L/ P A/P N/P Rev/ Ahmed's
Exp. Capital
Previous 71,000 15,000 0 3000 0 15,000 5,000 2000 12,000 60,000
transactions
Expenses paid -8,000 -8,000
in cash
Total 63,000 15,000 0 3000 0 15,000 5,000 2000 4,000 60,000
 The Effect of • Expenses not paid in cash:
Revenues/Expenses • The company may not pay expenses when the service is
provided, there will be a liability with the value of the service
Transactions on The provided, to be paid later.
Accounting Equation 17. the company did not pay rent expense of $2,000 in cash, The
effect of this transaction on the equation is as follows:

Assets = Liabilities + Owner’s equity

Cash Build. Comp. supplies A/R L/ P A/P N/P R/P Rev/ Exp. Ahmed'
s
Capital
Previous 63,000 15,000 0 3000 0 15,000 5,000 2000 4,000 60,000
transactions
Rent +2,000 -2,000
Expenses
incurred
Total 63,000 15,000 0 3000 0 15,000 5,000 2000 2000 2,000 60,000
 The Effect of 18. The rent payable of $2,000 is paid. When
Revenues/Expenses the rent is paid later, cash is reduced, and rent
Transactions on The
Accounting Equation payable is reduced by $2,000. The effect on
the accounting equation will be:

Assets = Liabilities + Owner’s equity

Cash Build. Comp. supplies A/R L/ P A/P N/P R/P Rev/ Exp. Ahmed'
s
Capital
Previous 63,000 15,000 0 3000 0 15,000 5,000 2000 2000 2,000 60,000
transactions
Payment of -2,000 -2,000
Rent payable
Total 61,000 15,000 0 3000 0 15,000 5,000 2000 0 2,000 60,000
Example (Comprehensive example)
The cash in bank April 1, 2018 , was $80,000 deposited by Samer, the owner of a supermarket. The following
transactions occurred during April 2018:
1. On 3/4, purchased a truck for $35,000 in cash.
2. On 4/4, purchased furniture for $5,000 on credit.
3. On 5/4, rendered services to customers for $6,000 in cash.
4. On 6/4, borrowed $10,000 from a bank in cash
5. On 8/4, paid rent for $2,000 in cash.
6. On 12/4, paid $2,000 in cash as part of the amount due for furniture.
7. On 15/4, invested $20,000 as additional capital in cash.
8. On 18/4, rendered services $3,000 on credit.
9. On 20/4, repaid half of the loan to the bank.
10. On 22/4, sold some furniture with $1,000 cost for the same value in cash.
11. On 24/4, paid expenses for 500 in cash.
12. On 28/4, collected $ 1,000 from customers in cash.
13. On 30/4, rendered services to customers for $4,000, collected $1,500 in cash, and the remainder on credit.
Required: Show the effect of these transactions on the accounting equation.
 Solution
Assets = Liabilities + Owner’s equity
Cash Truck furniture A/R A/P L/ P Rev/ Exp. Samer’s
Capital
1/4 +80,000 +80,000
3/4 -35,000 +35,000
4/4 +5,000 +5,000
5/4 +6,000 +6,000
6/4 +10,000 +10,000
8/4 -2,000 -2,000
12/ 4 -2,000 -2,000
15 / 4 +20,000 +20,000
18 / 4 +3,000 +3,000
20 / 4 -5,000 -5,000
22 / 4 +1,000 -1,000
24 / 4 -500 -500
28/4 +1,000 -1,000
30/4 +1,500 +2,500 +4,000
Total 75,000 35,000 4,000 4,500 3,000 5,000 10,500 100,000
Thank you