The Accounting Equation

ASSETS = LIABILITIES + OWNER’S EQUITY

This means that the whole assets of the company

comes from the liability, or debt of the company, and
from the capital of the owner of the business, and the
income it generated from the business operations. This
reflects the double-entry bookkeeping, and shown in
the balance sheet

Double-entry bookkeeping tells us that if we add

something from the one side, which is asset, we must
add the same amount to the other side to keep them in
balance.
 There are also concept of normal balances, either a
debit normal balance or a credit normal balance, is the
side where a specific account increases.

Nominal Accounts
B. Expense Account – A source when not yet
used up for the current period, is considered an
Asset and will provide benefits at a future time. At
the end of each accounting period, expenses are
closed out to the Retained Earnings Account
which decreases the Owner’s Equity. Since
expenses decrease the Owner’s Equity, those
expense accounts carry a normal debit balance.
 Nominal Accounts

B. Revenue Accounts – These accounts reflect

the accumulation of potential additions to
retained earnings during the current accounting
period.
At the end of the accounting period
accumulation of revenues during the period are
closed to the Retained Earning Account which
increases Owner’s Equity.
Therefore, revenue accounts carry a normal
credit balance meaning the same balance as the
Retained Earnings Account.
 The Accounting Cycle
The Process:
Step 1: Analyze Business Transactions
A transaction is analyzed to find out if
it affects the company and if it needs
to be recorded.
Personal transactions of the owners
and managers that do not affect the
company should not be recorded.
A decision may have to be made to
identify if a transaction needs to be
recorded in special journals like sales
and purchases journal.
Remember:

Carefully read the description of the

transaction to determine whether an asset, a
liability, an owner’s equity, a revenue, an
expense, or a drawing account is affected.

For each account affected by the

transaction to determine whether increases
or decreases.

Determine whether each increase or

decrease should be recorded as a debit or
credit, following the rules of debit and credit.
Step 2: Record this in the Journal
Using the rule of debit and credit,
transactions are initially entered in a record
called a journal and the entry made is
called a Journal Entry.

The Journal serves as a record of when

transactions occurred and were recorded.

For repetitive transactions or high volume

transactions, Special Journals are made.
These special journals include Sales
Journal, Purchases Journal, Cash Receipt
Journal, and Cash Disbursements Journal.
The Source Document

It is the file or document that will provide a

basis or reason for a journal entry

i.e. official receipt, purchase order, invoice,

check voucher, contract
The Source Document
Sample Journal
Step 3: Post the Transactions on a Ledger

Periodically, the journal entries are transferred

to the accounts in the ledger.
The process of transferring the debits and the
credits from the journal entries to the accounts
is called Posting.
Ledger provides chronological details as to
how transactions affect individual accounts.
There are two types of Ledgers: General
Ledger and Subsidiary Ledger.
The General Ledger is a summary of the
different Subsidiary Ledgers and can serve as
control account.
Step 3: Post the Transactions on a Ledger

Posting in the subsidiary ledgers can be done

anytime and the balances are summarized at
the end of an accounting period. Posting in the
general ledger is done at the end of an
accounting period.
 Step 3: Post the Transactions on a Ledger

Posting in the subsidiary ledgers can be done

anytime and the balances are summarized at
the end of an accounting period. Posting in the
general ledger is done at the end of an
accounting period.

Step 4: Preparing an Unadjusted Trial Balance

Errors may occur in posting debits and credits

from the journal to the ledger. One way to
detect such errors is by preparing a trial
balance.
 Double-entry accounting requires that debits
must always equal credits. The trial balance
verifies this equality.
The steps in preparing Trial Balance:
List the name of the company, the title of trial
balance, and the date the trial balance is
prepared.

List the accounts from the ledger and enter their

debit or credit balance in the Debit or Credit
column of the trial balance.
Total the debit and credit columns of the trial
balance.
Verify that the total of the debit column equals
the total of the credit column.
Step 5: Make adjustments. Journalize
adjusting entries

At the end of accounting period, many of

the account balances in the ledger can
be reported in the financial statements
without change.
For example, the balances of the cash
and land accounts are normally the
amount reported on the balance sheet.
However, some accounts in the ledger
require updating.
This updating is required for the following
reasons:

Some expenses are not recorded

daily. For example, the daily use of
supplies would require many entries
with small amounts. Also, managers
usually do not need to know the
amount of supplies on hand on a
day-to-day basis.
Some revenues and expenses are
earned as time passes rather than a
separate transactions. For example,
rent received in advance (unearned
rent) expires and becomes revenue
with the passage of time. Likewise,
prepaid insurance expires and
becomes an expense with the
passage of time.
Some revenues and expenses may
be unrecorded. For example, a
company may have provided
services to customers that are have
not billed or recorded at the end of
the accounting period. Likewise, a
company may not pay its
employees until the next accounting
period even though the employees
have earned their wages in the
current period.
 The analysis and updating of
accounts at the end of the period
before the financial statements are
prepared is called the Adjusting
Process.

 The journal entries that bring the

accounts up to date at the end of
the accounting period are called
Adjusting Entries.
 The following are normally adjusted at the
end of a period:
Accruals. These include unpaid salaries
for the accounting period, unpaid interest
expense, or unpaid utility expenses.

Prepayments. If a company has prepaid

expenses such as prepaid rent or prepaid
insurance then the correct balances for
these accounts have to be established at
the end of each accounting period to reflect
their correct balances.
 Depreciation and amortization
expenses. Depreciation expenses are
recognized at the end of each
accounting period through adjusting
entries. If there are intangible assets
such as franchise, the allocation of
their costs which is called amortization
expense, is also recognized at the end
of each accounting period through
adjusting entries.
 Allowance for uncollectible
accounts. Bad debt expense from
accounts receivable is also recognized
through adjusting entries.
Step 6: Prepare an Adjusted Trial Balance

 An adjusted trial balance is

prepared after taking into
consideration the effects of the
adjusting entries. Again, this is to
ensure that the total debit balances
equal the credit balances after
posting and journalizing adjusting
entries made.
Sample Adjusted Trial Balance
Step 7: Prepare the financial statements.

From the adjusted trial balance, the

financial statements can then be
prepared. These are the statement of
financial position, statement of profit
or loss, and the statement of cash
flows.
Step 8: Make the closing entries.
In the discussion about accounts, it was
discussed that nominal accounts
(revenue and expense accounts) are
closed to retained earnings, or an
owner’s capital account because these
accounts refer only to a specific
accounting period. Actually, these
accounts to be closed are accounts
that can be seen in the income
statement.
 The balance of the Income Summary (net
income or net loss) is transferred to the
owner’s capital account.
 The balance of the owner’s drawing account
is transferred to the owner’s capital
account.
Step 9: Make a Post-Closing Trial Balance
 A Post-Closing Trial Balance shows the accounts
that are permanent or real. These are the
accounts that can be seen in your balance
sheet. The post-closing trial balance is prepared
to test if the debit balances equal the credit
balances after closing entries are considered.
 Basic Financial Statements.

A financial statement is basically a

summary of all transactions that are
carefully recorded and transformed into
meaningful information. It also shows the
company’s permanent and temporary
accounts.
Financial statements are comprised of the
following:
a. Income Statement
• These are also known as the
Profit/Loss Statement, Statement of
Comprehensive Income, or Statement
of Income.
• This is a summary of the revenue and
expenses of a business entity for a
specific period of time, such as a
month or a year.
Sample Income Statement
b. Statement of Owner’s Equity
 These are also known as the Statement of
Changes in Equity.
 This reports the changes in the owner’s equity over
a period of time.
 It is prepared after the income statement because
the net income or net loss for the period must be
reported in this statement.
 Similarly, it is prepared before the balance sheet
since the amount of owner’s equity at the end of
the period must be reported on the balance sheet.
 Because of this, the statement of owner’s equity is
often viewed as the connecting link between the
income statement and balance sheet.
Sample Statement of Changes in Owner’s Equity
c. Balance Sheet

 Formerly known as the Statement of Financial

Position.
 This provides information regarding the liquidity
position and capital structure of a company as of a
given date.
 It must be noted that the information found in this
report are only true as of a given date.
 It shows a list of the assets, liabilities, and owner’s
equity of a business entity as of a specific date,
usually at the close of the last day of a month or a
year.
d. Statement of Cash Flow

 The statement of cash flows reports a company’s

cash inflows and outflows for a period.

 This is used by managers in evaluating past

operations and in planning future investing and
financing activities.

 It is also used by external users such as investors

and creditors to assess a company’s profit potential
and ability to pay its debt and pay dividends.
Planning is an important
aspect of the firm’s operations
because it provides road
maps for guiding,
coordinating, and controlling
the firm’s actions to achieve
its objectives.
 Management planning is about
setting the goals of the
organization and identifying ways
on how to achieve them.
There are two phases of financial
planning. Financial planning starts
with long term plans which
would then translate to short term
plans.
Long-term financial plans
These are a set of goals that
lay out the overall direction of
the company.
A long-term financial plan is an
integrated strategy that takes
into account various
departments such as sales,
production, marketing,
and operations for the purpose
of guiding these departments
towards strategic goals.
Those long-term plans
consider proposed outlays for
fixed assets, research and
development activities,
marketing and
product development actions,
capital structure, and major
sources of financing.
Short-term financial plans
Part of short term financial plans
include setting the sales forecast
and other forms of operating and
financial data. This would then
translate into operating budgets,
the cash budget, and pro
forma financial statements
 Long-
Term Short-Term Planning
Planning
Top management is still involved
but there is more
More
participation from lower level
Pers participati managers (production,
ons on from
marketing, personnel, finance and
Invol top
plant facilities) because
ved managem
ent their inputs are crucial at this stage
since they are the ones who
implement these plans.
Time
2 to 10 years 1 year or less
Period

Level of
Less More
detail

Direction of the Everyday functioning of

Focus
company the company
Long term goals set the
direction of the company.

Short term goals are the

specific steps or actions that
will ultimately reach the
company’s long term goals.
Steps in planning:
A. Set goals or objectives.
B. Identify Resources.
C. Identify goal-related tasks.
Steps in planning:
D. Establish responsibility
centers for accountability and
timeline.
E. Establish the evaluation
system for monitoring and
controlling.
F. Determine contingency
plans.
Criteria may be used for effective
planning:
Criteria may be used for effective
planning:

Specific – target a specific area for

improvement.
Measurable – quantify or at least suggest
an indicator of progress.

Assignable – specify who will do it.

Criteria may be used for effective
planning:
Realistic – state what results can
realistically be achieved, given available
resources.
Time-related – specify when the result(s)
can be achieved.

There's a S.M.A.R.T. way to write

management's goals and objectives