PRINCIPLES OF ACCOUNTING

CHAPTER 2
RECORDING THE ECONOMICS TRANSACTIONS
 Chapter overview
Analyzing Accounting Transactions

➢ The Nature of a Transaction

➢ The Elements of a Transaction

➢ Debit and Credit

➢ Rules of Double-entry System

➢ Type of Account

Recording Basic Economic Transactions

➢ Analyze and Record Transactions for Merchandise.

➢ Analyze and Record Transactions for Services

 The nature of a transaction

In accounting, a transaction is any monetary

business event that impacts a business’s
financial statements
 The nature of a transaction

Events Items
Change

A transaction Account
Recorded
 Example of a transaction
Event

On July 11th, company A bought a truck at

$20,000. A truck had been already paid by
cash in bank.

Items are
changed
The elements of financial Statements

Financial Position Financial Performance

✓ Assets
✓ Income
✓ Liability
✓ Expense
✓ Equity
 Assets
Asset = a present economic resource controlled by the
entity as a result of past events from which future
economic benefits are expected to flow to the entity

Non-Current Asset
Current Asset
(Fixed Asset)
= some assets are held and = some assets are held and
used for only a short time. used for only a long time.
<12 months >12 months
 Assets
• Land and buildings: Factories, office buildings, storage and
distribution centers (warehouses)
• Moto vehicles
• Plant and machinery
• Fixtures and fittings: Computer equipment, office furniture
and shelving
• Cash: in a bank account or held as notes and coins
• Inventory: goods held in store awaiting sale to customers, and
raw materials and components held in store by a manufacturing
business for use in production
• Receivables (or debtors): amounts owed by customers and
others to the entity
 Trade Receivable

Type of current asset

If the business makes credit sales, that customer is a Trade

Receivable
 Liability
Liability = a present obligation of the entity to transfer
an economic resource as a result of past events

Current Liability Non-Current Liability

= Current liabilities are a = Current liabilities are a

company's debts or obligations company's debts or obligations
that are due within one year or that does not come due for
within a normal operating cycle payment within one year or more.
 Liability
• A bank loan or overdraft: The liability is the amount
eventually repaid to the bank

• Payables (or creditors): amount owed to suppliers for

goods purchased but not yet paid for (purchases ‘on credit’).

• Taxation owed to the government. A business pays tax on

its profits but there is a gap in time between when a
business declares its profits (and becomes liable to pay tax)
and the payment date.
 Trade Payable

Type of liability

If the company buys goods on credit, it becomes a Trade

Payable of the company to which it owes money
 Equity
Equity = the residual interest in the assets of the entity
after deducting all its liabilities

Owner’s Contributions Retained Earning

Note: The owner of a sole trader ship does not get paid a wage; they
“draw out” or appropriate some of their capital as drawings.
Drawings: Money and goods taken out of a business by its owner
 Expense vs Income

Expense Income
= decreases in assets or = increases in assets or
increases in liabilities resulting decreases in liabilities resulting
in decreases in equity, other in increases in equity, other
than distributions to equity than contributions from equity
holders holders
 Business Expenses
➢ Distribution cost: Expenses associated with selling and
delivering goods to customers. They include the following:
o Salaries, wages and sales commission of employees
o Marketing costs (ag advertising and sales promotion
expense
o The costs of running and maintaining delivery vans,
including depreciation on these and any losses on their
disposal
➢ Financial costs: These include:
o Interest on loan
o Bank overdraft interest
 Business Expenses
➢ Administrative costs: Expenses of providing management and
administration for the business:
o Management and office staff salaries
o Rent and local business or property taxes
o Insurance
o Telephone and postage
o Printing and stationery
o Heating and lighting
o Discounts allowed to customers for early payment of their debt.
o Irrecoverable debts written off
o The cost of running and maintaining other non-current assets such
as office building, plus depreciation and losses on disposal of these.
 Revenue
❖The price of goods sold & services rendered
during a given accounting period.
❖Represents actual or expected cash inflows.
❖Causes owner’s wealth to increase.
 Accounting Equation

Liabilities
Assets + Equity

Assets = Liabilities + Capital

Statement of financial position

Assets
(itemized) xxx
Total assets $A

Liabilities
(itemized) xxx
Total liabilities xxx

Owner's equity xxx

Total liabilities & onwers' equity $A
Example 3
EXAMPLE

He began the venture with £40 of his own money, in cash.

paper for £40 and sold three-quarters of it for £45 cash.

Statement of financial position as at July 31

Assets
Cash (closing balance) 45
Inventories of goods for resales (1/4 of £40) 10
Total assets £ 55
Liabilities 0
Owner's equity £ 55
Total liabilities & onwers' equity £ 55
Accounting
Equation !
Analysing transactions using accounting
equations

Any business transaction has twofold impact on

the Accounting Equation.

Assets Liabilities Equity

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Or/And
Analysing transactions using accounting
equations

Assets Liabilities Equity

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Or/And
Analysing transactions using accounting
equations

Assets Liabilities Equity

i n cr ea se d ecr ea se
Analysing transactions using accounting
equations

Assets Liabilities Equity

i n cr ea se d ecr ea se
Analysing transactions using accounting
equations

Assets Liabilities Equity

i n cr ea se d ecr ea se
Analysing transactions using accounting
equations

Assets Liabilities Equity

d ecr ea se i n cr ea se
Expanded accounting equation

Assets Liabilities Equity

Share Retained
capital earnings

Revenues Expenses Dividends

 Double-entry system

Double entry bookkeeping is based on the idea that each transaction has
an equal but opposite effect. Every accounting event must be entered in
ledger account both as debit and as credit. Every transaction has two
effects ➔ dual effect

You own car worth

$10,000
purchase car for
$10,000 cash

Your cash less

$10,000

What is the “dual effect” ?

 You own car worth
$10,000
borrow bank for purchase
car
You owe bank
$10,000

You have $500 cash

less
If you pay $500 for
repair car
You incurred repair
expense of $500
 Rules of Double-entry system

➢This is a method of recording all transactions

➢The items in the transaction must be changed
➢Every transaction gives impacts on two sides:
debit and credit.
➢Debit must have an equal and opposite to
credit
➢Which account receives the credit entry and
which receives the debit depends on the
nature of the transaction.
 Quick Quiz…

Why is the Double-entry system called ‘double’???

✓Always at least two accounts affected by every

transaction
✓All transactions would result in two sides: Debit
side and Credit side
The double-entry system could record at more
than two item accounts. But there is at least
one at debit and one at credit.
EXAMPLE 1 Example: Asset = Capital

• The business began by owning the cash that Liza has put
into it, $2.500.
• → The business entity concept: The business is a separate
entity in accounting terms and so it owes the money to Liza
as capital.
• When Liza sets up her business: $
Cash at bank 2,500
Capital investment 2,500
We can express Liza’s initial accounting equation as follows:
Assets = Capital + Liabilities
$2.500 = $2,500 + $0
 EXAMPLE 1
WORK IN GROUP: 10 MINUTES

Liza purchases a market stall from Len Turnip for

$1,800
She also purchases some flowers from a trader in the
wholesale market, at a cost of $650.
This leaves $50 in cash, after paying for the stall
and goods for resale, out of the original $2,500. Liza
keeps $30 in the bank and holds $20 in small change
for trading.
She is now ready for her first day of market trading
on 3 July 20x6

Please express Liza’s initial accounting equation?

 Answer
The assets and liabilities of the business have now altered, and at 3
July, before trading begins, the statement of her business is as
follows:

Assets = Captial + Liabilities

Stall $1,800 = $2,500 + $0
Flowers $650
Cash at Bank $30
Cash in Hand $20
 EXAMPLE 1
Discussing
Example: Asset = Capital + Profit

• On 3 July Liza sells all her flowers for $900 cash.

• Since Liza has sold goods costing $650 to earn income of $900, we can
say that she has earned a profit of $250 on the day’s trading.
• Profits are added to the owner’s capital. In this case, the $250 belongs
to Liza. However, so long as the business retains the profits and does not
pay anything out to its owner, the retained profits are accounted for as
an additional to the owner’s capital.
We can express Liza’s initial accounting equation as follows:
Assets = Capital + Liabilities
Stall $1,800 = Original investment $2,500 + $0
Flowers $0
Cash at Bank Retained profit
$250 + $0
and in hand $950 (900-650)
(30 + 20 + 900)
 EXAMPLE 1
Discussing
Example: Asset = Capital - Drawing
• Business owners, like everyone else, need income for living expenses.
Liza therefore decides to pay herself $180 in wages.
• The payment of $180 is regarded by Liza as a fair reward for her day’s
work and she might think of the sum as wages. However, the $180 she
draws is not an expense to be deducted in arriving at the figure of net
profit because any amounts paid by a business to its owner are treated by
accountants as withdrawals or appropriations of profit and not as
expenses incurred by the business. In the case of Liza’s business, the
true position is:
Assets = Captial + Liabilities
Stall $1,800 = Original investment $2,500 + $0
Flowers $0
Retained profit
Cash $70 + $0
$770 (250-180)
(950 -180)
REMINDER
 INVOICE
BALANCE SHEET
Credit
PROFIT & LOSS Note,
ACCOUNT Cheques
TRADING Transaction occurs Analysis of
ACCOUNT
transaction

Preparation of Accounting Cycle

final accounts
Recording of
transactions
TRIAL BALANCE
DR CR

Adjustment of Posting to
balances ledger
Preparation of trial balance account
 Stages of Recording
Accounting Transactions

DEBIT CREDIT
1. Books of First
2. Ledger Accounts 3. Trail Balance 4. Final Account
Entry

Balance Sheet Income Statement Trading Account

 Measurement Issues

Once accountants have determined a transaction has

occurred, they must decide:

1 2 3
Recognition issue Valuation issue Classification issue

When should What dollar Which

the amount accounts are
transaction be should be affected?
recorded? recorded?
 Measurement Issues
1 2 3
Recognition issue Valuation issue Classification issue

When should the What dollar Which

transaction be amount should accounts are
recorded? be recorded? affected?

Business Transaction
Are Not Transactions Are Transactions
Customer inquires about a Customer buys a service
service
Ordering products from Receiving products previously
suppliers ordered
Hiring new employees Paying employees for work
performed
 Measurement Issues

1 2 3
Recognition issue Valuation issue Classification issue

When should the What dollar Which

transaction be amount should accounts are
recorded? be recorded? affected?

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Transactions should be recorded at their original cost (historical cost).

• The fair value is the exchange price, which results from an
agreement between the buyer and seller that can be verified by
evidence at the time of the transaction.
• Assets are valued at the initial fair value or cost unless there is
evidence that the fair value has changed and an adjustment
must be made.
 Measurement Issues
1 2 3
Recognition issue Valuation issue Classification issue

When should the What dollar Which

transaction be amount should accounts are
recorded? be recorded? affected?

• Classification is the process of assigning

transactions to the appropriate accounts
• Proper classification depends on
– Correctly analyzing the effect of each
transaction on the business
– Maintaining a system of accounts that
reflects that effect
 Account
❖Accounts are the basic storage units for accounting data and are
used to accumulate amounts from similar transactions.

❖Separate account used for each

o Asset
o Liability
o Component of owner’s equity (includes revenues and
expenses)
 T- Account
❖A T account (the simplest form of an account) has three parts.
o A title expressing the name of the asset, liability, etc.
o A debit (left) side
o A credit (right) side

Title of Account
Nợ
Debit Credit Có

(left) side (right) side

 Debit and Credit
To illustrate fully the working of the accounts, a manual system is being used.
It is referred to as T-accounts because:

Useful tool to record

every transaction Top

TITLE OF ACCOUNT

DEBIT $ CREDIT $

Left-hand Right-hand
side side

(Source: ACCA text book, F3 level, P.62)

 Account
▪ Plant and machinery at cost (NA) ▪ Total trade payables (CL)
▪ Motor vehicles at cost (NA) ▪ Wages and salaries (expense)
▪ Plant and machinery, provision for ▪ Rent and local taxes (expense)
accumulated depreciation ▪ Advertising expenses (expense)
(deduction from NA) ▪ Bank charges (expense)
▪ Motor vehicles, provision for ▪ Motor expenses (expense)
accumulated depreciation ▪ Telephone expenses (expense)
(deduction from NA) ▪ Sales (income)
▪ Owner's capital (capital) ▪ Total cash/bank overdraft (current
▪ Inventories – raw materials (CA) asset/liability)
▪ Inventories – finished goods (CA)
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▪ Total trade receivables (CA)
 Account
➢ Account title should describe what is recorded in the
account
➢ An account name can be analyzed to understand its
purpose
✓ Identify account’s classification as asset, liability,
owner's equity, revenue, or expense
✓ Identify the type of transaction that gave rise to the
account
➢ Different companies may use different account names
for the same account
 Account
❑ Footings and the Account Balance
➢ Footings
o Working totals of columns
o Calculated at end of each month
➢ Account balance
o Difference between total debit footing and total
credit footing
o Also simply called the balance
o Debit balance recorded on left side of T account
o Credit balance recorded on right side of T account
 Account
Total the debit side of Total the credit side of
the T account Cash the T account

(1) 50,000 (2) 35,000

(5) 1,500 (4) 200
(7) 1,000 (8) 1,000
(9) 400
(11) 600
Total Total Credit
52,500 37,200
Debit Footing
Footing Bal. 15,300

Debit Account Balance

($52,500 - $37,200)
 General Ledger
❖ Group of company accounts
❖ Sometimes simply referred to as the ledger
❖ Two types of systems
o Manual system
✓ Each account on separate page or card
✓ Pages or cards placed together in book or file
❖ Computerized system
o Accounts maintained on magnetic tapes or disks
 Chart of Accounts
❖ List of account numbers with corresponding
account names
❖ Helps identify accounts in the ledger
❖ First digit in account number refers to major
financial statement classification

o Assets o Revenues
o Liabilities o Expenses
o Owner's equity
Example: Chart of Accounts
 CHART OF ACCOUNTS

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Exercise
 Accounting Equation

Liabilities
Assets + Equity

Assets = Liabilities + Capital

 The Duality Concept

The corresponding due to Duality Concept:

3 Increase in
Increase in Asset
Liability/Capital

1 2

Decrease in
Decrease Asset
4 Liability/Capital
 The Duality Concept

❖Double entry system states that every transactions

affects at least two accounts.
❖Therefore: If an asset account increases
(decreases), because of duality concept there must be
a corresponding:
1. Increase(decrease) in a specific liability account
2. Or a decrease(increase) in a another asset account
3. Or an increase(decrease) in owners' equity account.
 Example

On July 11th, company A bought a

truck at $20,000. A truck had been
already paid by cash in bank.

ASSET

ASSET
 please compare …

DEBIT Truck a/c (↑): $20,000 DEBIT Truck a/c (↑): $20,000
CREDIT Cash in bank a/c (↓): $20,000 CREDIT Cash in bank a/c (↓): $15,000
CREDIT Payable a/c (↑): $5,000

Both of them:
Double –entry system
The Duality Concept
Table 1: Normal Account Balances
of Major Account Categories
 Table 1: Normal Account Balances
of Major Account Categories
Liability/
Debit Asset Acc Credit Debit Capital Acc Credit

Opening Balance Opening Balance

Closing Balance Closing Balance

Debit Revenue Credit Debit Expense Credit – Increases in assets are debited.
– Decreases in assets are credited.
– Increases in liabilities and
stockholders’ equity are credited.
– Decreases in liabilities and
stockholders’ equity are debited.
– Increases in revenues are credited.
NONE Closing Balance
– Increases in expenses are debited.
 Normal Account Balances and the
Accounting Equation

Recall the basic accounting equation:

Assets = Liabilities + Owner's Equity
Debit Credit Debit Credit Debit Credit
(+) (–) (–) (+) (–) (+)

• Assets are increased by debits

• Liabilities and owner's equity are
increased by credits
 Normal Account Balances and the
Accounting Equation

However, when the basic accounting equation

is expanded to include all the components of
owner's equity,

Assets = Liabilities + Capital – Withdrawals + Revenues – Expenses

+ – – + – + + – – + + –

We see that Withdrawals and expense

accounts reduce owner's equity
 Normal Account Balances and the
Accounting Equation

Withdrawals and expenses can be moved to

the left side of the equation so that

Assets + Withdrawals + Expenses = Liabilities + Capital + Revenues

+ – + – + – – + – + – +

Accounts increased by Accounts increased by

debits credits

Accounts with a Accounts with a

normal debit balance normal credit balance
Illustrated by T-account

ASSET LIABILITY + CAPITAL

Debit Credit
Debit Credit

EXPENSE INCOME

Debit Credit Debit Credit

Source: ACCA text book, F3 Level, P.70

Table 1: Normal Account Balances
of Major Account Categories
 Example continued…
On July 11th, company A bought a truck at $20,000. A
truck had been already paid by cash in bank.

Cash in bank account

Cash is paid – Cash
reduces – Credit side
$20,000

2 sides of
transaction
Truck (Asset) account
Assets – truck – increase
by $20,000 – Debit side
$20,000
 Example continued…
Recording transaction

On July 11th, company A bought a truck at $20,000. A truck

had been already paid by cash in bank.

Paid by cash in bank => CASH

decreased by $20,000 Note ‘Cash’ in
Cash: ‘Asset’ Credit account
2 sides of
transaction
Bought a truck => increased by
Note ‘Truck’ in Debit
$20,000
account
Truck: ‘Asset’

Following up to the Rule of

Double-entry system:
 On July 11th, company A bought a truck at $20,000. A truck
had been already paid by cash in bank.

DEBIT Truck a/c (↑): $20,000

CREDIT Cash in bank a/c (↓): $20,000

CASH IN BANK

$20,000
Described by
the T-account
TRUCK

$20,000
 Recording

Dr. Truck 20,000

Cr. Cash in bank 20,000

 Business Transaction Analysis
1. Analyze the transaction
Analyze the transaction to determine which
Five-step process for analyzing

accounts are affected and how (increased or Step 1

decreased).
and applying transactions

2. Apply the rules of double entry

Apply the rules of double-entry accounting using
Step 2
T accounts to show how the transaction affects
the accounting equation.
3. Record the entry
Show the transaction in journal form.
Step 3

4. Post the entry

Transfer dates and amounts from journal to
proper accounts in ledger
Step 4

5. Prepare the trial balance

Confirms that accounts are still in balance
Step 5
 Practice Questions
Work in Group:

See if you can identify the debit and

credit entries in the following
transactions :

Paid D (a credit supplier) $300

Bought a machine on a credit from A, cost $8,000

Paid wages to the employee $4,000

(Source: ACCA text book, F3 level)

 MINI
How to record a transaction ?
GAME…

Apply rule of Double –entry system

Put changed items in the correct account

categories
2

Record the transactions

3

Identify the items change

4
Do the exercises 1 to 9

Exercise