2-1 CHAPTER 3 ACCOUNTING EQUATION AND DOUBLE ENTRY SYSTEM 2-2 LEARNING OBJECTIVES: At the end of the chapter, student will be able to: 1. Describe the account ( the simple T-Account) and its uses. 2. Discuss the double entry system and explain how it follows the rules of the accounting equation. 3. Define debits and credits. 2-3 Fundamental Accounting Equation ASSETS = LIABILITIES + OWNERS' EQUITY 2-4 Double Entry System Double-entry system is a method of recording transactions where for every business transaction, an entry is recorded in at least two accounts as a DEBIT and CREDIT. Account Name Debit Credit 2-5 The T-Account Increases to the T-account are recorded on one side of the T-account, and decreases are recorded on the other side. Account Name Debit Credit 2-6 What Are Debits and Credits? Tools used for recording transactions Debit (DR) Credit (CR) Debit refers to the LEFT and Credit to the RIGHT side of the T-Account. Debit and Credit are neutral terms and do not connote value judgments. Neither is “good” or “bad”! 2-7 What Are Debits and Credits? Tools used for recording transactions Debit (DR) Credit (CR) Debit refers to the LEFT and Credit to the RIGHT side of the T-Account Account Name LEFT Used as Adjectives: DEBIT SIDE RIGHT CREDIT SIDE 2-8 What Are Debits and Credits? Tools used for recording transactions Debit (DR) Credit (CR) Debit refers to the LEFT and Credit to the RIGHT side of the T-Account Account Name LEFT Used as Verbs: DEBIT RIGHT CREDIT Synonym for Debit? 2-9 Elements of Financial Statements Assets Liabilities Capital Income Expenses 2-10 Using Debits and Credits Again, debits and credits are used to increase or decrease account balances. Determining whether to use a debit or credit to record an increase or decrease depends on the type of account in question. The Balance Sheet equation is the basis for the determination. Balance Sheet Model (Revisited) A = L + C 2-11 2-12 Balance Sheet Model (Revisited) Assign a T-Account to each element of the Balance Sheet Model A = L + C Account Name Account Name Account Name Debit Debit Debit Credit Credit Credit 2-13 Balance Sheet Model (Revisited) Debits and credits affect the Balance Sheet Model as follows: A = L + C Account Name Account Name Account Name Debit Debit Debit Credit Credit Credit 2-14 Balance Sheet Model (Revisited) Debits and credits affect the Balance Sheet Model as follows: A = L + C ASSETS Debit Credit for for Increase Decrease Account Name Account Name Debit Debit Credit Credit 2-15 Balance Sheet Model (Revisited) Debits and credits affect the Balance Sheet Model as follows: A = L + C ASSETS LIABILITIES Debit Credit for for Increase Decrease Debit Credit for for Decrease Increase Account Name Debit Credit Balance Sheet Model (Revisited) 2-16 Debits and credits affect the Balance Sheet Model as follows: A = L + C ASSETS LIABILITIES EQUITIES Debit Credit for for Increase Decrease Debit Credit for for Decrease Increase Debit Credit for for Decrease Increase Capital A Closer Look Also, because Income accounts increase Capital, they are affected by debits and credits as follows: INCOME Debit Credit for for Decrease Increase 2-17 Capital A Closer Look And because Expense accounts decrease Capital, they are affected by debits and credits as follows: EXPENSES Debit Credit for for Increase Decrease 2-18 2-19 Normal Balances Each of the 5 account types also has a normal balance side. It is always the side which is used to record increases in the account. 2-20 Normal Balances The normal balances for each of the FIVE types of accounts are as follows: Account Name Debit Balance Assets Expenses Credit Balance Liabilities Capital Revenues Alternative Approach #2 Expanded Accounting Equation ASSETS + EXP. = LIAB. + C + REV. A + E =L+C+R Bal. Dr. Cr. Dr. Cr. + - - + Bal. 2-21 Alternative Approach #3 “A L O R E” Acronym Debit Credit A (ssets) + - L (iabilities) - + O (wners' equity) R (evenues) - + E (xpenses) - + + 2-22 2-23 SAMPLE PROBLEM 1 Genia Manapat, Capital P1,363,000 Cash in bank 250,000 Petty Cash Fund 10,000 Land 350,000 Accrued expenses 10,000 Accounts Receivable 90,000 Estimated Uncollectible Accounts 2,000 Prepaid Insurance 10,000 Building 1,000,000 Accrued interest income 15,000 Accounts payable 300,000 Notes payable 50,000 2-24 SAMPLE PROBLEM 2 Genia Manapat, Capital ? Cash on hand 150,000 Cash equivalents 10,000 Building 250,000 Accumulated depreciation 50,000 Accrued expenses 15,000 Accounts Receivable 80,000 Estimated Uncollectible Accounts 5,000 Office Supplies Expense 10,000 Unused Office Supplies 20,000 Repairs and Maintenance 15,000 Accounts payable 200,000 2-25 SAMPLE PROBLEM 3 Net profit ? Service Income 200,000 Rent Expense 10,000 Salaries Expense 25,000 Accrued rent expense 5,000 Accrued rent income 10,000 Interest income 10,000 Commission Income 5,000 Gas & Oil 7,000 Unused Office Supplies 10,000 Repairs and Maintenance 20,000 Unearned Interest income 25,000
