THE ACCOUNTING EQUATION

ACCOUNTING

A financial information system that involves three basic activities:

1. <<Identifying<<

• Identification of the economic events relevant to the business 
• Selecting the transactions which are financial or economic in nature
  • Applying the Entity Principle
• Personal transactions of the owner is not included 

1. <<Recording<<

• A long process
• Parts:
  • Preparing the journal entries (Journalizing)
  • Transferring the entries from the journal to the ledger (Posting)
  • Grouping assets, liabilities, revenues, expenses, and equities (Classifying)
  • Prepare the Trial Balance (Summarizing)

1. <<Communicating<<  

• By providing Financial Statements and Reports
• Analyzing and interpreting the data from these statements
• Income statement shows result of operation for the period 
  • Income statement accounts are just temporary accounts, because at the end of the year, it will go back to zero 
• Statement of Financial Position shows the financial status or condition

Users of Accounting Data

• Internal Users
  • Board of Directors, managers, etc. 
  • People who plan, regulate, and operate the business 
• External Users 
  • Creditors (suppliers and bankers), Investors, Government regulatory bodies (BIR)
  • Outside organizations and individuals who want financial information on the country

THE ACCOUNTING EQUATION

• Basic Accounting Equation
  • ASSETS = LIABILITIES + OWNER’S EQUITY
  • Debits → assets
  • Credits → liabilities and equity 
  • Expenses are debits, revenues are credits 
• Expanded Accounting Equation 
  • ASSETS = LIABILITIES + OWNER’S CAPITAL - OWNER’S DRAWING + REVENUE - EXPENSES

TRANSACTION ANALYSIS

Transaction 1: Cash Investment by Owner 

• Increase in cash and increase in owner’s equity 

Transaction 2: Purchase of equipment for cash

• Decrease in cash and increase in equipment 

Transaction 3: Purchase of supplies using credit

• Increase in supplies and increase in accounts payable

Transaction 4: Services performed for cash

• Increase in cash and increase in service revenue 

Transaction 5: Purchase of advertising expense on credit

• Increase in accounts payable and decrease in advertising expense 

Transaction 6: Services performed for cash and credit

• Increase in cash and an increase in accounts receivable and increase in service revenue 

Transaction 7: Payment of Expenses

• Decrease in Cash and increase in expenses 

Transaction 8: Payment of accounts payable

• Decrease in cash and decrease in accounts payable

Transaction 9: Receipt of cash on account

• Increase in cash and decrease in accounts receivable

Transaction 10: Cash withdrawal by owner

• Decrease in assets and decrease in owner’s equity