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145 views28 pagesChapter 2 The Accounting Equation and Double Entry System
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Danika Kaye E. MolinaCopyright
© © All Rights Reserved
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Basic Financial Accounting & Reporting
The Accounting Equation and the Double-Entry System
Learning Objectives:
After studying this chapter, you should be able to:
1. Describe the parts of an information system.
Explain how an accounting information system helps the decision makers.
3. Define the elements of financial statements.
4. Describe the account (the simple T-Account) and its uses.
5. Understand what is meant by the accounting equation and prove the
validity of the "mirror image" concept.
6. Understand what is meant by the double-entry system.
7. Explain how the double-entry system follows the rules of the accounting
equation.
8. Define debits and credits.
9, Summarize the rules of debit and credit as applied to balance sheet and
income statement accounts.
10. Describe the nature of the typical account titles used in retording
transactions.
11. Analyze and state the effects of business transactions on an entity's assets,
liabilities and owner's equity and record these effects in accounting
equation form using the financial transaction worksheet and the T-
Accounts.
12. Distinguish between revenue and receipts.
Companies like Microsoft, the software giant and Deloitte & Touche, the big US accounting firm,
use Vervex's EnGage 2.0 to manage large projects that involve employees, subcontractors and
consultants worldwide. The software allows team members to report on their progress via the
corporate intranet, as well as generate invoices and timesheets that can be easily accessed by
corporate headquarters. Intranet is a version of the Internet internal to a specific company and
is privately controlled.
Vervex Technologies established in 1994 is owned by Price Givens. This Irvine, California-based
company develops database and corporate intranet applications that help project managers
keep track of offsite workers’ projects. Givens and his team of software developers started by
producing project management applications for accountants. But with Givens in Irvine and the
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1 Basic Financial Accounting and, porting by Prof. WIN Ballad
ue, Washington, geographic distance interfered with
itimate solution. Vervex’s news
r accountants, architects
10 find out
fs le
company’s software developers in Bell
rent intranet could be the ul
‘ficient collaboration. Givens knew a
time fas designed specifically £0
timekeeping software program, FSBTime, W one
and others who bill clients for their time. HOWeVEr, 27-year old Givens was SUrPT!
T auitors to Vervex’s Web site were actually other software companies. epee! our
eit software developers in India and all their managers in California,
ble to create a niche by addressing specific needs such that sales in
tions is US$2.5 million. Adapted from: Business Start-Ups, April
that mos
biggest customers has allt!
Givens said. Givens was a!
1998 was US$1.2 million. 1999 proje
1999.
Givens is helping business entities generate timely accounting information regarding
activities or events which are important to the continued existence of the business. His
software products ensure that his clients have the accurate and relevant data needed by
the system to be able to accumulate the information necessary for timely accounting
reports.
PARTS OF AN INFORMATION SYSTEM
‘An information system is a collection of people, procedures, software, hardware and
data which works together to provide information essential to running an organization.
People
People are competent end users working to increase their productivity. End users use
hardware and software to solve information-related or decision-making problems.
Procedures
Procedures are manuals and i son how to use the
guidelines that instruct end
software and hardware. ‘
Software
Software is another name for i
programs—instructions th:
process data. There are basically two kinds of softwar yi he compute Low to
System Software
System software is background
software that helps a ci
resources. An example is the operating system, aya ee
operating systems. Windows and Linux are popular
Application Software
Application software performs
useful work on
general-purpose
problems,
of appli i
types of applications software are basic applications and advanced appli The two
Basic applications include: a
+ Browsers—navigate, explore, find information on the
+ Word processor—prepare written documents, —
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‘he Accounting Equation and the Double Entry System | 2-3
+ Spreadsheet—analyze and summarize numerical
1 Database management system: merical data.
‘em—organize and
2 presentation graphies—c ‘manage data and information.
esentton raphies—conmunateaesiage or posune or peel
‘Advanced appliations include:
imedia—j
Multimedia—integrate video, music, voice, and graphics to create interactive presentations.
+ Web publishers—create interacti
active multi-media We
+ Graphics programs—create atenk dee, ,
Professional publications, d
raphies progr ications, draw, edit, and modify im:
~via eay crete reals thee dimenstarl sual ost crore
» arti igence— simulated human thought processes and actions
Wgers—plan projects, schedule, people, and control resources.
Hardware
Hardware consists of input device: -
3s, the system uinit, secondary st t devic
and communication devices, is y storage, output devices,
Input Devices
rm the
Input devices translate data ahd programs that humans can understand into a fo
digital
computer can process. The more common are the keyboard, mouse, scanner,
camera and microphone.
The System Unit
s of electronic circuitry with two parts:
The system unit con
«central processing unit (CPU}—controls and manipulates data to produce information
1 Memory (primary storage)—temporarily holds data, program instructions, and processed data.
Secondary Storage
secondary storage stores data and programs.
flash drive, hard disk and optical disk.
Three most common storage media are:
Output Devices
formation from the CPU. Two important output
Output devices output processed in
devices are: monitor and printer.
Communications Devices
programs from one computer to another. A device
‘a and
amodem.
These send and receive dat
ter to a telephone is
that connects a microcompu}
Data
ing. Data consists of numbers, letters and
i rial for data processing:
smb on rl hes facts, events and transactions, Data describes something and is
peal a od etectronically in afile, A file is a collection of characters organized as a
ly stored el
single unit, Common types of files are: ‘document, worksheet and database.
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4 | Basic Financial Accour
ACCOUNTING INFORMATION SYSTEM
ust have an accounting information system which will
the decision-makers in a timely
+ consider the anticipated users of
pected to make. The design of
Every business organization m
generate reliable financial information needed by
manner. The design and ‘operation of a system mus!
the information and the types of decisions they are ex poe
the system to meet the entity's information requirement depends on the firm’s size,
nature of operations, volume of transaction data, organizational structure, ‘form of
business and extent of government regulation. These will influence the way in which
information is accumulated and reported in the financial statements.
s the combination of personnel, records and
4d for financial information. Most firms
cies and procedures to be followed in
mation system. This manual
ints, and when and how the
‘An accounting information system is
procedures that a business uses to meet its nee
have an accounting manual that specifies the poli
accumulating information within the accounting inforr
details what events are to be recorded in the accou!
information is to be classified and accumulated.
The
Accounting
Process
Economic
Activities
Accounting
Information
Actions
(decisions)
Decision
Makers
An effective accounting informatio e the fol
n system should achieve the following objectives:
lowing i
jectives:
* Toprocess the information effici
efficiently at the k
a ae least cost (cost-benefit princi
To protects tys assets, to ensure that data are reliable, eS
possibility of theft or fraud (control principle). yo marine wracts tn
* To be in harmony with the en ,
principle).
* Tobe able to accommod
> fate growth
changes (flexibility principle), "
s
"Y's organizational and human factors (compatibility
tional
the volume of transactions and for orga
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ing di il
The precoding seat illustrates how economic activities flow into the accounting
process ey duces accountng information. This information is then used by
decision | in making economic decisions and taking specific actions; thus,
resulting in economic activities. The cycle goes on.
TYPES OF ACCOUNTING INFORMATION SYSTEMS
In general terms, companies use three types of accounting information systems to
record the results of transactions: manual systems, computer-based transaction
systems and database systems. All of these systems are designed to capture
information regarding accounting events to prepare financial statements. In a nutshell,
manual systems utilize paper-based journals (general and special) and ledgers (general
and subsidiary). Computer-based transaction systems replace paper records with
computer records. Database systems embed accounting data within the business event
data on which they are based.
Computer-Based Transaction Systems
Manual systems rely on human processing so they are labor intensive and may be
inefficient in today’s complex business environment. Because manual systems rely on ©
human processing, they may be prone to error. To overcome these deficiencies, many
companies have computerized their accounting processes.
m maintains accounting data separately from other
operating data. That is, the accounting records are kept separately from the records
required for the expenditure, revenue and conversion processes. Suffice it to say, at this
point, that there is a greater degree ‘of compartmentalization of work to preserve the
integrity of the accounting information system but not as ideal as the database system.
A computer-based transaction syste
This system treats information in the same manner 25 4 manual system. The user is
simply filling in a computer screen that looks and oftentimes acts like a source
document, Some of the advantages of this system are a5 follows:
transactions can be quickly posted to the appropriate accounts, bypassing the
.journalizing process.
* Detailed listings of trat
+ Internal controls and edit checks can bs
* Awide variety of reports can be prepared.
nsactions can be printed for review at any time.
ye used to prevent and detect errors.
sts of several modules. A module is a program which deals
business accounting system. A simple accounting package
‘odule, in which case itis called a stand-alone module. But
everal modules, in which case, it will then be called a suite.
and Peachtree.
Accounting packages cons!
with one particular part of
might consist of only one ™
more often it will consist of s
Examples include QuickBooks
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| Basic Financial Accountit
Database Systems
5 such as enterprise resource planning, (ERP) depart from the
f organ vee ERP systems such as SAP,
accounting equation” method of organizing dat these ERP 9¥ Gs uch a SA,
deere and. PeopleSoft capture data, both financial and ronsinanc and stor ta
information in a data warchouse. Database systems reduce ine and
redundancies that often exist in transaction-based systems.
Relational database system’
ation (like name, address,
d separately from customer account information,
ty customer's balance might inadvertently
ved that credit limit. Also, separate
hat when a database system is not
‘ecorded several times. Advantages
For example, in transaction-based! systems, customer inform
phone, credit limit) is often maintaine
Thus, a salesperson who does not know
encourage a customer to purchase items that exce'
departments have special information needs such t
used then the same customer information may be r
of database systems include:
©The system recognizes business rather than just accounting events.
'* The system supports reduction in operating inefficiencies.
© The system eliminates redundant data,
STAGES OF DATA PROCESSING
Processing of raw data into useful accounting information then finally into summarized
reports follows the usual input-processing-output progression. Each transaction
entered into the accounting system should be supported by source documents like
customer invoices, vendor invoices, deposit slips, checks, time cards and memos. These
documents serve as evidence that a particular transaction occurred. They also provide
the necessary details and supports. The computer, with the use of the accounting
software, then processes the inputs. As will be discussed later, the manual system of
journalizing, posting, preparing the trial balance and updating the accounts are done
almost instantaneously. When required, the financial statements and other accounting
reports can be viewed on the screen or printed as output documents.
In many situations, manual systems are inferior to computerized systems in terms of
productivity, speed, accessibility, quality of output, incidence of errors and bulk
ELEMENTS OF FINANCIAL STATEMENTS
The elements of financial statements defined in the M:
2 arch 2
for Financial Reporting (2018 Conceptual Framework) are: Saas eer amuewere
assets, liabilities and equity
= relate to a reporting e'
ni "
«income and expense: entity's financial position; and
$— relate to a reporting entity’s financial performance.
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