CHAPTER 1

Introduction and Double Entry

LEARNING OBJECTIVES
After studying this chapter, you should be able to:

explain the meaning of accounting distinguish between bookkeeping and accounting identify the users and uses of accounting state the basic accounting equation and explain the meaning of assets, liabilities and stockholders equity describe the effect of business transactions on the basic accounting equation

WHAT

IS

ACCOUNTING ?

Accounting is the process of identifying, recording and communicating the economic events of an organization (business or non business) to interested users of the information Identification select economic events (transactions) Recording record, classify and summarize Communication prepare and distribute accounting reports, analyze (ratios, %, charts) and interpret (explaining the uses, meaning and limitations of reported data) for users

WHAT IS BOOKKEEPING?
The recording of data

Users and Uses of Accounting

The major users and uses of accounting are: INTERNAL USERS 1) Management uses accounting information in planning, controlling and evaluating business operations 2) Owner(s) of the business

EXTERNAL USERS 1) Direct interest Investors (owners) judge the wisdom of buying, holding or selling their financial interests on the basic of accounting data Creditors (suppliers and bankers) evaluate the risks of granting credit or lending money to particular businesses on the basic of accounting information obtained about those businesses A prospective buyer/partner 2) Indirect interest other groups with an indirect interest are taxing authorities, regulatory agencies, customers, labour unions and economic planners

THE ACCOUNTING EQUATION

When a firm starts up, it needs resources, initially these are often supplied by the owner of the business.
RESOURCES IN THE BUSINESS = RESOURCES SUPPLIED BY OWNER

In accountancy terms these are known as: ASSETS = CAPITAL If, however, resources are supplied by others, as well as the owner, the equation becomes: ASSETS = CAPITAL + LIABILITIES

Resources : What they are = Resources : Who supplied them (Assets) = (Capital + Liabilities) This is expressed in a financial statement called Balance Sheet

ACCOUNTING EQUATION
Assets Assets Assets Accounts Accounts

Equity Equity Capital Accounts Accounts

THE ACCOUNT AND ITS ANALYSIS

Assets Assets Assets Accounts Accounts Accounts

Equity Equity Capital Accounts Accounts Accounts

THE ACCOUNT AND ITS ANALYSIS

Assets Assets Assets Accounts Accounts Accounts

Liability Liability Liability Accounts Accounts Accounts

Equity Equity Capital Accounts Accounts Accounts

ASSET ACCOUNTS
Cash Land Accounts Receivable

Buildings

Asset Accounts

Motor vehicles

Equipment

Prepaid Accounts

Stocks

LIABILITY ACCOUNTS
Accounts Payable Notes Payable

Liability Accounts
Accrued Liabilities Unearned Revenue

CAPITAL ACCOUNTS
Owners Capital Owners Withdrawals

Capital Accounts
Revenues Expenses

DOUBLE-ENTRY ACCOUNTING

Assets
ASSETS

Liabilities
LIABILITIES

Capital
Capital

Debit

Credit

Debit

Credit

Debit

Credit

EQUALITY OF ACCOUNTING EQUATION

The total of each side of the balance sheet should always be EQUAL to each other Every transaction affects TWO items in the balance sheet

THE DOUBLE ENTRY SYSTEM

STUDY OBJECTIVES
After studying this chapter, you should be able to:

See how the double entry system follows the rules of basic accounting equation Enter transactions using the double entry system

THE ACCOUNTS
a

FOR

DOUBLE ENTRY

system where each transaction is entered TWICE, once on the debit side and once on the credit side part of the double entry record, containing details of transactions for a specific item

Account

Credit

the right-hand side of the accounts in double entry the left-hand side of the accounts in double

Debit

entry

Accounts Assets (DR) Liabilities (CR) Capital (CR) Expenses (DR) Revenue or Income (CR)

To record an increase a decrease an increase a decrease an increase a decrease an increase a decrease an increase a decrease

Entry in the account Debit Credit Credit Debit Credit Debit Debit Credit Credit Debit

Assets = To increase each item To decrease each item Debit Credit

Liabilities + Credit Debit

Capital Credit Debit

BIG T
Asset Expenses Purchases Withdrawal/drawings Capital Liabilities Revenue/Income Sales

THE ASSET OF STOCK

MOVEMENT OF STOCK

separate accounts are kept for each different type of stock movement Purchases goods bought by the business for the purpose of selling them again Returns inwards goods returned to the business by its customers due to wrong merchandise, damage or poor quality Returns outwards goods returned by the business to its suppliers Sales goods sold by the business

Cash Purchases Debit purchases account Credit cash account

Credit Purchases 1. Debit purchases account Credit suppliers account 2. Debit suppliers account Credit cash account

Cash Sales Debit cash account Credit sales account

Credit Sales 1. Debit customers account Credit sales account 1. Debit Cash account Credit customers account

Returns inwards/sales returns Debit returns inwards account Credit customers account Returns outwards/purchases returns Debit suppliers account Credit returns outwards account

THE EFFECT OF PROFIT OR LOSS ON CAPITAL & THE DOUBLE ENTRY SYSTEM FOR EXPENSES AND REVENUES

STUDY OBJECTIVES
After studying this chapter, you should be able to:

Show the effects of P/L on capital Enter expenses on the correct side of the expense accounts Enter revenues on the correct side of the revenue accounts Enter the drawing in the accounting books

PROFIT OR LOSS ?

PROFIT
REVENUES > EXPENSES

PROFIT OR LOSS ?

LOSS
REVENUES < EXPENSES

THE NATURE OF PROFIT OR LOSS

Revenues: Sales value of goods and services

Expenses: Cost value of all assets that have been used up to obtain revenues

Profit: Revenues are greater than expenses

Loss: Expenses exceed revenues

THE ACCOUNT AND ITS ANALYSIS Assets

Liabilities

+
+

Capital

+
Owners Capital

Owners Withdrawals/ DRAWINGS

Expenses

Revenues

THE EFFECT OF PROFIT OR LOSS ON CAPITAL

Capital

+
Revenues

Expenses

Profit Loss

Capital Capital

DOUBLE-ENTRY ACCOUNTING

CAPITAL
Owners Capital

Owners Withdrawals

Revenues

_ Expenses
Expenses

Revenues

Debit Credit

Debit Credit

DOUBLE-ENTRY ACCOUNTING

CAPITAL
Owners Capital
Capital

Owners Withdrawals
Withdrawals

Revenues
Revenues

Expenses
Expenses

Debit Credit

Debit Credit

Debit Credit

Debit Credit

NORMAL ACCOUNT BALANCES

Assets Liabilities Capital Withdrawal Revenue Expenses Debit balance Credit balance Credit balance Debit balance Credit balance Debit balance

THE EFFECT OF PROFIT AND LOSS

Profit increases capital Losses reduce capital

ON

CAPITAL

ASSETS = [CAPITAL + PROFIT] + LIABILITIES OR ASSETS = [CAPITAL LOSS] + LIABILITIES

DOUBLE ENTRY FOR EXPENSES AND REVENUES

Expenses

every different type of expense will be shown in a separate account shown as DEBIT entries in the various expense accounts E.g. postage, stationery, motor expenses, discount allowed (cash discounts allowed by a firm to its customers when they pay their accounts quickly)

Revenues

shown as CREDIT entries in the various revenue accounts E.g. rent receivable, discount received (received by a firm from its suppliers when it pays their accounts quickly)

DRAWING

cash or goods taken out of a business by the owner for his private use
Effect Drawing Cash capital is decrease cash is decrease Action Debit drawing account Credit cash account

Drawing Goods capital is decrease cost of goods available for sale is reduced

Debit drawing account Credit purchases account