Financial

accounting and
reporting
Topic 2:
The Accounting Equation and the Double Entry
System
 Objectives
At the end of the lecture, the student should be able to:
1. Describe the parts of an information system.
2. Define the elements of financial statements.
3. Understand the accounting equation and prove the validity of the “mirror image”
concept.
4. Explain how the double-entry system follows the rules of accounting equation.
5. Summarize the rules of debit and credit as applied to balance sheet and income
statement accounts.
6. Analyze the effects of business transactions on an entity’s assets, liabilities and
equity.

2
Accounting
information
system
3
INFORMATION SYSTEM
A collection of people, procedures, software,
hardware, and data which work together to
provide information essential to running an
organization.

4
PARTS OF AN INFORMATION
SYSTEM
People
- End users using hardware and software to solve
information-related or decision-making problems.

Procedures
- Manuals and guidelines that instruct end users on
how to use the software and hardware.

5
PARTS OF AN INFORMATION
SYSTEM
Software
- Another name for programs.
- Instructions that tell the computer how to process data

Types of Software
System software
- A background software that helps a computer manage its
internal resources (e.g. OS)
Application software
- performs work on general purpose-problems
6
PARTS OF AN INFORMATION
SYSTEM
Hardware
- Input devices, the system unit, secondary storage,
output devices and communication devices

Input devices
- Translate data and programs that humans can
understand into a form the computer can
process (ex.: keyboard, mouse, scanner, digital
camera, mic)
7
PARTS OF AN INFORMATION
SYSTEM
System Unit
- Electronic circuitry with CPU and Memory

Secondary Storage
- Stores data and programs. (ex.: flash drive, hard
disk)

Output devices
- Output processed information from the CPU (ex.:
monitor, printer
8
PARTS OF AN INFORMATION
SYSTEM Devices
Communications
- Send and receive data programs from one
computer to another

Data
- The raw material for data processing. It consists
of numbers, letters and symbols and relates to
facts, events and transactions.
9
ACCOUNTING INFORMATION
SYSTEM
An effective accounting information system should
achieve the following objectives:

1. To process the information efficiently at the least cost

(cost-benefit principle)

2. To protect the company’s assets, to ensure that data

are reliable, and to minimize wastes and the possibility
of theft or fraud (control principle)
10
ACCOUNTING INFORMATION
SYSTEM
3. To be in harmony with the entity’s organizational and
human factors (compatibility principle).

4. To be able to accommodate growth in the volume of

transactions and for organizational changes (flexibility
principle)

11
TYPES OF ACCOUNTING
INFORMATION
1. Manual systems
SYSTEMS
2. Computer based-transaction systems
3. Database systems

12
TYPES OF ACCOUNTING
INFORMATION
Manual systems SYSTEMS
● Utilize paper-based journals(general and special)
and ledgers (general and subsidiary)
● Rely on human processing
● Labor intensive

13
Example of manual system

14
TYPES OF ACCOUNTING
INFORMATION SYSTEMS
Computer-based Transaction Systems
● Compartmentalization of work
● Transactions can be quickly posted to the appropriate
accounts, bypassing the journalizing process.
● Detailed listings of transactions can be printed for review at
any time.
● Internal controls and edit checks can be used to prevent and
detect errors
● A wide variety of reports can be prepared.

15
Example of computer based
transaction system

16
TYPES OF ACCOUNTING
INFORMATION
Database Systems SYSTEMS
● Recognizes business rather than just accounting events
● Supports reduction in operating inefficiencies
● Eliminates redundant data

17
STAGES OF DATA PROCESSING

INPUT PROCESSING OUTPUT

Source documents: Accounting software Financial statements

Customer invoice Accounting cycle Accounting reports
Vendor invoice
Deposit slip
Check
Time card
18
Elements of financial statements
Financial Element Definition
statement
Financial Asset A present economic resource controlled by the entity as a result
position of past events. An economic resource is a right that has the
potential to produce economic benefits
Liability A present obligation of the entity to transfer an economic
resource as a result of past events.
Equity The residual interest in the assets of the entity after deducting all
its liabilities.
Financial Income Increases in assets, or decreases in liabilities, that result in
performance increases in equity, other than those relating to contributions
from holders of equity claims.
Expenses Decreases in assets, or increases in liabilities, that result in
decreases in equity, other than those relating to distributions to
holders of equity claims.
19
Financial position

20
asset
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.

Rights that have the potential to produce economic benefits are:

a) Rights that correspond to an obligation of another party
b) Rights that do not correspond to an obligation of another party

21
asset
An economic resource could produce economic benefits by
entitling an entity to:
a) Receive contractual cash flows or another economic resource
b) Exchange economic resources with another party on favorable
terms
c) Produce cash inflows or avoid cash outflows
d) Receive cash or other economic resources by selling the economic
resource
e) Extinguish liabilities by transferring the economic resource

22
asset
An entity controls an economic resource if it has the present
ability to direct the use of the economic resource and obtain the
economic benefits that may flow from it.
a) Present ability to prevent other parties from directing the use
of the economic resource and from obtaining the economic
benefits that may flow from it.

If one party controls an economic resource, no other party

controls that resource..
23
LIABILITY
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 an entity has no

practical ability to avoid.

Result of past events if:

 The entity has already obtained economic benefits or taken an action.
 The entity have to transfer an economic resource ot would not
otherwise have had to transfer.

24
equity
The residual interest in the assets of the enterprise after deducting all
its liabilities.
The claims against the entity that do not meet the definition of a liability.
● Sole proprietorship - capital account of the owner
● Partnership – one equity account for each partner
● Corporation - “stockholders’ equity” composed of share capital,
retained earnings, reserves representing appropriations of retained
earnings among others.

25
 Financial
performance
26
Income
increases in assets or decreases in liabilities,
that result in increases in equity, other than
those relating to contributions from holders of
equity claims.

27
Expenses
decreases in assets or increases in liabilities,
that result in decreases in equity, other than
those relating to distributions to holders of
equity claims.

28
The account

29
account
Refers to a detailed record of the increases, decreases and
balance of each element that appears in an entity’s financial
statements.

30
The accounting equation

Assets = Liabilities + Owner’s Equity

31
Double-entry system
Dual effects of a business transaction.
A debit side entry must have a corresponding credit
side entry.

32
Normal balance of accounts

* no negative balances
33
Types and effects of transactions
Transaction - a particular kind of activity that involves
the transfer of something of value between two
entities

1. Source of assets
2. Exchange of assets
3. Use of assets
4. Exchange of claims

34
ACCOUNT TITLES USED
ASSETS

Current asset
Non-current asset

35
Current assets
● Cash
● Cash equivalents
● Notes receivable
● Accounts receivable
● Inventories
● Prepaid expenses

36
Non-current assets
● Property, Plant and Equipment
○ Land, Building, Machinery and Equipment,
Furniture and fixtures, Motor Vehicle and
Equipment
● Accumulated Depreciation
● Intangible Assets

37
ACCOUNT TITLES USED
LIABILITIES

Current liabilities
Non-current liabilities

38
Current liabilities
● Accounts payable
● Notes payable
● Accrued liabilities
○ Salaries payable, utilities payable, interest
payable, taxes payable

● Unearned revenues
● Current portion of Long-term debt
39
Non-current liabilities
● Mortgage payable
● Bonds payable

40
equity
● Capital
● Withdrawals
● Income summary

41
income
● Service income/Service Revenue
● Sales

42
expenses
● Cost of sales
● Salaries and Wages
● Telecommunication, Electricity, Fuel and Water
Expenses
● Rent expense
● Supplies expense
● Insurance expense
● Depreciation expense
● Uncollectible accounts expense
● Interest expense
43
Illustrative
example
44
Del Mundo Graphics Design
Galicano del Mundo decided to establish a sole proprietorship business
and named it as Del Mundo Graphics Design. Del Mundo Graphics
Design can do the layout and production design of newspapers,
magazines, corporate reports, journals and other publications. The entity
can create promotional displays, marketing brochures for services and
products, packaging design, logos for businesses. Its initial revenue
stream comes from web designing.

45
Del Mundo Graphics Design
During March 2020, the first month of operations, various financial
transactions took place.

46
March 1. Del Mundo started his new business by depositing
P350,000 in a bank account in the name of Del Mundo
Graphics Design at BPI Poblacion Branch.

47
Del Mundo Graphics Design
March 5. Computer equipment costing P 145,000 is acquired on cash
basis.

48
Del Mundo Graphics Design
March 9. Computer supplies in the amount of P25,000 are purchased
on account

Accounts
Payable

49
Del Mundo Graphics Design
March 11. Del Mundo Graphics Design collected P88,000 in cash for designing
interactive web sites for two exporters based inside the Ortigas Ecozone.

Accounts
Payable

50
Del Mundo Graphics Design
March 16. Del Mundo paid P18,000 to Ceradoy Bills Express, a one-stop bills
payment service company, for the semi-monthly utilities.

Accounts
Payable

445,000 445,000
51
Del Mundo Graphics Design
March 17. The entity has service agreements with several Netpreneurs to maintain and
update their web sites weekly. Del Mundo billed these clients P35,000 for services
already rendered during the month.

Accounts
Payable

52
Del Mundo Graphics Design
March 19. Del Mundo made a partial payment of P17,000 for the March 9 purchase on
account.

Accounts
Payable

53
Del Mundo Graphics Design
March 20. Checks totaling P25,000 were received from clients for billings dated March
17.

Accounts
Payable

54
Del Mundo Graphics Design
March 21. Del Mundo withdrew P20,000 from the business for his personal use.

Accounts
Payable

443,000 443,000

55
Del Mundo Graphics Design
March 27. Warlito Blanche Publishing submitted a bill to Del Mundo for P8,000 worth
of newspaper advertisements for this month. Del Mundo will pay this bill next month.

Accounts
Payable

56
Del Mundo Graphics Design
March 31. Del Mundo paid his assistant designer salaries of P15,000 for the month.

Accounts
Payable

57
Use of t-accounts

58
Del Mundo Graphics Design
March 1. Del Mundo started his new business by depositing
P350,000 in a bank account in the name of Del Mundo
Graphics Design at BPI Poblacion Branch.
Asset (Increase) = Equity (Increase)

Cash Del Mundo, Capital

Debit Credit Debit Credit
+ - - +
3-1 350,0000 3-1 350,000

59
Del Mundo Graphics Design
March 5. Computer equipment costing P 145,000 is acquired on cash
basis.
Asset (Increase) = Asset (Decrease)

Computer Equipment Cash

Debit Credit Debit Credit
+ - + -
3-5 145,000 3-1 350,000 3-5 145,000

60
Del Mundo Graphics Design
March 9. Computer supplies in the amount of P25,000 are purchased
on account
Asset (Increase) = Liability (Increase)

Computer Supplies Accounts Payable

Debit Credit Debit Credit
+ - - +
3-9 25,000 3-9 25,000

61
Del Mundo Graphics Design
March 11. Del Mundo Graphics Design collected P88,000 in cash for designing
interactive web sites for two exporters based inside the Ortigas Ecozone.

Asset (Increase) = Income (Increase)

Effect:
Cash Design Revenues
Debit Credit Debit Credit
+ - - +
Increase in 3-5Owner’s
3-1 350,000 145,000 3-11 88,000
3-11
Equity
88,000
P 88,000
62
Del Mundo Graphics Design
March 16. Del Mundo paid P18,000 to Ceradoy Bills Express, a one-stop bills
payment service company, for the semi-monthly utilities.
Asset (Increase) = Expense (Decrease)

Effect:
Cash Utilities Expense
Debit Credit Debit Credit
+ - + -
Decrease in3-5Owner’s
3-1 350,000 145,000 3-16 18,000
3-11
Equity 18,000
88,000 3-16
P 18,000
63
Del Mundo Graphics Design
March 17. The entity has service agreements with several Netpreneurs to maintain and
update their web sites weekly. Del Mundo billed these clients P35,000 for services
already rendered during the month.
Asset (Increase) = Income (Increase)

Effect:
Accounts Receivable Design Revenues
Debit Credit Debit Credit
Increase
+ in Owner’s - - +
3-17
Equity
35,000 3-17 35,000

P 35,000
64
Del Mundo Graphics Design
March 19. Del Mundo made a partial payment of P17,000 for the March 9 purchase on
account.
Liability (Decrease) = Asset (Decrease)

Accounts Payable Cash

Debit Credit Debit Credit

- + + -
3-19 17,000 3-9 25,000 3-1 350,000 3-5 145,000
3-11 88,000 3-16 18,000
3-19
17,000
65
Del Mundo Graphics Design
March 20. Checks totaling P25,000 were received from clients for billings dated March
17.
Asset (Increase) = Asset (Decrease)

Cash Accounts Receivable

Debit Credit Debit Credit
+ - + -
3-1 350,000 3-5 145,000 3-20 25,000
3-11 88,000 3-16 18,000
3-20 3-19
25,000 17,000
66
Del Mundo Graphics Design
March 21. Del Mundo withdrew P20,000 from the business for his personal use.

Asset (Decrease) = Equity (Decrease)

Original
CashEntry Del Mundo, Capital
Debit Credit Debit Credit
Del Mundo, Drawing
+ 20,000 - - +
Cash 350,000 20,000
3-1 3-5 145,000 3-21 20,000
3-11 88,000 3-16 18,000
Del3-20
Mundo, Capital
25,00020,000
3-19
17,000
Del Mundo, Drawing 20,000
3-21 20,000
67
Del Mundo Graphics Design
March 27. Warlito Blanche Publishing submitted a bill to Del Mundo for P8,000 worth of
newspaper advertisements for this month. Del Mundo will pay this bill next month.

Liability (Increase) = Expense (Decrease)

Effect:
Accounts Payable Advertising Expense
Debit Credit Debit Credit
- + + -
Decrease in3-27Owner’s
8,000 3-27 8,000
Equity
P 8,000
68
Del Mundo Graphics Design
March 31. Del Mundo paid his assistant designer salaries of P15,000 for the month.

Asset (Decrease) = Expense (Increase)

Cash Salaries Expense

Debit Effect: Credit Debit Credit
+ - + -
3-1
Decrease
350,000in3-5 Owner’s
145,000 3-31 15,000
3-11
Equity
88,000 3-16 18,000
3-20
25,000 3-19 17,000
P 15,000
3-21 20,000
3-31
15,000
69
Distinction between revenues and
This Year
receipts Transaction Amount Cash Sales
Receipts Revenue
1. Cash sales made this year
P 200,000 200,000 200,000
2. Credit sales made last year, cash
300,000 300,000 0
received this year
3. Credit sales made this year, cash
400,000 400,000 400,000
received this year
4. Credit sales made this year, cash
100,000 0 100,000
to be received next year

70