Chapter 2

DOUBLE ENTRY BOOK KEEPING

Introduction to Transaction Analysis

The entire concept of accounting is built upon the fundamental accounting equation:

Assets = Liabilities + Owner's Equity

• This equation must remain in balance and for that reason our modern
accounting system is called a dual-entry system.

• This means that every transaction that is recorded in accounting records must
have at least two entries; if it only has one entry the equation would necessarily
be unbalanced.
 Assets:

An asset is anything of value

that your company owns —
including cash.

Assets get recorded on the

balance sheet in terms of their
dollar values.

Types of assets

• Tangible Assets

• Intangible Assets

Tangible assets:

Are physical assets that we can see and touch and feel.

Tangible assets can be classified into:

 Current Assets (short term)

 Fixed assets (long term)

Current Assets: Are also called as short term assets because these assets will be with
the company for less than 12 months (1 year).
Example: Inventory

 Cash in hand/bank
 Debtors( receivables)

Non-current assets:

• Are also called as fixed assets or long term assets.

• These assets will remain with the company for more than 1 year.

• Example: Land, buildings, property, plant and equipment.

Intangible assets
Are those assets which do not have physical existence but are very
valuable to the company and they generate huge benefits for the
company.

Intelligence, ideas etc. are all valuable to the company, which we

cannot see, or touch or feel like physical objects.

Example: Good will, brand names, copyrights etc.

MicrobookPro’s Assets ($millions)

Balance Sheet

December 2003
Liabilities:

Liabilities is like loan, what we owe to others.

Liability accounts are broken into

• Current and

• Long-term liabilities.

Current liabilities include items such as accounts payable, wages payable, taxes
(various types) payable, and deposits from customers (for work not completed yet).

Once a bill is paid it is moved from accounts payable and counted as an expense.

This removes the money from the asset account it is paid from (e.g. a business’
checking account) and removes the amount from the accounts payable account.

Long-term liability accounts include loans (that have a term exceeding one year).
This can include liabilities for anything from equipment and vehicles to bank and land
loans.

Capital or owner’s Equity:

• Capital is the ownership of the assets of the

business by the proprietor.

• The owner (proprietor) in the beginning of the

business contributes assets to the business. These assets
may consist of cash, supplies or equipment.
 • Each asset is assigned a money value based on the cost of the asset to the
proprietor. Since the proprietor is also the owner of the business, the assets
contributed represent the proprietor’s ownership or equity in the business. A
record is set up by the accountant to represent the proprietor’s ownership in the
business. This record is called capital.

Business Transactions:

Business Transactions are events that have

a financial impact on the business (assign a
$$ amount) and can be measured reliably.

• Transactions will impact the Assets,

Liabilities, and Owners’ Equity of a firm

• To analyze, determine how this impacts

the accounting equation (Assets =
Liabilities + Owners’ Equity) of a firm

• Accounts are a summary device that record the changes that have occurred
during a period.

• Organizational system for businesses that allow them to analyze the

cumulative effects of transactions.

• Each account shows the effect of all of the increases and decreases
during a period.

• Accounts are organized via the basic accounting equation (Assets = Liabilities
+ Owners’ Equity.)

• Use a separate account for each particular:

• Asset

• Liability
 • Stockholders’ Equity (Owners’ Equity), that is involved in a
transaction.

• Each transaction will affect at least two accounts. This is reflective of the
double-entry system used in accounting, which keeps the accounting equation
in balance.

Working on accounting equation:

Example 1

On January 1, 2001, Chris begins a business that will be known as MicrobookPro.

1. Chris deposits $25,000 in a bank account in the name of MicrobookPro

2. MicrobookPro exchanged $20,000 for land.

3. During the month, MicrobookPro purchased supplies for $1,350 and agreed to pay
the supplier in the near future (on account).
4. MicrobookPro provided services to customers, earning fees of $7,500 and received
the amount in cash.

5. MicrobookPro paid the following expenses: wages, $2,125; rent, $800; utilities,
$450; and miscellaneous, $275
6. MicrobookPro paid $950 to creditors during the month.

6. At the end of the month, the cost of supplies on hand is $550, so $800 of
supplies were used.

7. At the end of the month, Chris withdrew $2,000 in cash from the business for
personal use.
Summary of the Accounting Process:

NOTE: Capital may be divided into two categories:

 Permanent Capital=Proprietor’s capital (Investment)

  Temporary Capital=Revenue, Expenses and withdrawals

Permanent capital represents the investment that the owner makes in the business.

Temporary capital represents revenue, expenses and withdrawals (“drawing”).

An account is an individual record of each item that a business owns and owes and of
permanent and temporary capital

All businesses exist for the purpose of earning a profit. An excess of revenue over
expenses represents a profit. If expenses exceed revenue, the result is known as a loss.
Resulting profit or loss will cause a change in the proprietor’s capital.

Debtors and Creditors

• Creditors are the people to whom we owe money for goods and services
supplied by them to us on credit.

• Debtors are the people who owe us money for goods or services we have
supplied to them. They are our debtors.

Collateral

Collateral is what we pledge to the bank in the event that you should have to default on
your bank loan. This asset is what will guarantee the repayment of your loan. If you
default, the bank has full power and authority to seize your collateral property to attempt
to make up the loss from the loan default.