Webz Designs

AC 02
Learning Objectives

Distinguish between the asset, liability, capital,
revenue and expense accounts.

Demonstrate the use and application of the
accounting equations.

Apply the mechanism of double-entry and
journal entries in recording transactions for the
financial statements.
What’s the Problem?

You need to prepare an analysis showing the
relationship between the transactions that occur in the
1st month of operations.

The analysis should track the various resources used in
the business.

The relationship is known as the
Accounting Equation
Assets = Liabilities + Owner’s Equity
What is the Accounting
Equation?

The accounting equation represents the
resources of the business and the claims to
those resources.

The accounting equation consist of 3 main
elements – Assets, Liabilities and Owner’s
Equity.

Resources of the business are assets

Claims are liabilities and equity.
What is the Accounting
Equation?
A graphical representation of the accounting equation is
shown below:

Liabilities

Assets

Owner's
Equity
What are Assets?

Assets are the economic resources of a
business that are expected to produce a benefit
in the future.

Examples of assets are cash, inventory, land,
building, equipment, machinery, furniture, etc.
What are Liabilities and
Owner’s Equity?

Liabilities are “outsider claims”.

They are economic obligations payable to outsiders
(creditors).

Examples of liabilities are accounts payable, bank
loans, bonds payable, etc.

Owner’s equity are “insider claims”.

Equity means ownership so it is the owner’s interest
in the assets of the company.
Owner’s Equity Expanded

Owner’s Equity can be divided into 2 components,
Paid-up Capital and Retained Earnings:

Paid-up Capital is the amount invested in the

company by its owners.

Retained Earnings is the amount earned by the
activities of the company and kept for use in the
business.

The accounting equation can re-written as:

Assets = Liabilities + Capital + Retained Earnings
Retained Earnings Expanded

Retained Earnings can be divided into the following
components:

Prior Year’s Retained Earnings is amount earned by the
company excluding the current year

Net Profit/Loss in current year (derived from Revenue –
Expenses)

Revenue are increases in retained earnings derived from
profit generating activities such as selling goods,
performing services etc.

Expenses are decreases in retained earnings that are
the costs of doing business such as rent, salaries etc.

Dividends are distributions of the profits of the company to its
shareholders.

Retained earnings = Prior year retained earnings
– dividends + revenue - expenses
Accounting Equation Revisited

The accounting equation can re-written as:
l Assets = Liabilities + Capital + Prior Years Retained Earnings –
Dividends + Revenue – Expenses

Liabilities Capital

+ Prior Years
Retained Earnings

Assets - Dividends

Owner's + Revenue
Equity
- Expenses
What is Debit and Credit?

For Assets – an increase is represented by a debit and a
decrease is represented by a credit.

For Liabilities and Owner’s Equity – an increase is

represented by a credit and a decrease is represented
by a debit.

Point to wonder – what about Revenue and

Expenses?
Double Entry

All business transactions have two parts, one which
involves the giving of something and the receiving of
something – the duality of effects.

As such, every business transaction should affect
two accounts via a debit and a credit.

For example: Mary and Jane both invested $50,000

into the business.

The business recognises inflow of cash by debiting
the cash account by $50,000 and crediting the Paid-
up Capital $50,000 to recognise the claims that
Mary and Jane have on the business.
Journal Entries

A journal entry, in accounting, is a logging of
transcriptions into an accounting journal.

Each general journal entry lists

the date,

the account title(s) to be debited and the
corresponding amount(s) followed by

the account title(s) to be credited and the
corresponding amount(s), and

the description of the transaction.
Example of a journal entry

On June 1 2008, a company borrows $5,000
from its bank.

1 Jun 2008 Dr Cash $5,000

Cr Note Payable $5,000
(To record borrowing of $5,000 from a bank)
 Analysis of Webz Designs
Transaction 1 - Mary and Jane invested a total of $50,000 into business.

Cash account increased and Paid-up Capital account increased.

The company made a full payment of $12,000 for the purchase of

Transaction 2 -
computers for use.

Computers account increased and Cash account decreased.

The company made a partial payment of $5,000 for the purchase

Transaction 3 -
of furniture, which cost a total of $15,000.
Furniture account increased, Other Payables account increased, and
Cash account decreased.
The company made a full payment of $5,000 for the purchase of
Transaction 4 -
software for use.

Software account increased and Cash account decreased.

 Analysis of Webz Designs
The company completed its first job for services rendered to
Donutz Pte Ltd. Donutz paid $15,000 to Webz Designs on 25 Nov
Transaction 5 - 2008.

Service Revenue, and Cash account increased.

Transaction 6 - The company paid out $10,000 to its employees for Nov's payroll.

Salaries account increased and Cash account decreased.

Transaction 7 - The company paid out $4,000 for Nov's rental.

Rental expense account increased and Cash account decreased.

The company took up an interest free loan of $100,000 from one its
Transaction 8 - directors, to be repaid on 1 Dec 2010.

Loan payable account increased and Cash account increased.

Transaction 1 (“T1”)
The company is set up with a capital of $50,000 by the owners.
Account Category Impact on Category
Paid-up Capital Owners’ Equity Increase $50,000
Cash Assets Increase $50,000

Assets = Liabilities + Owner’s Equity

+50,000 +50,000

1 Nov 2008 Dr Cash $50,000

Cr Paid-up Capital $50,000
(To record investment of $50,000 by owners)
Transaction 2 (“T2”)
The company made a full payment of $12,000 for the purchase of
computers for use.
Account Category Impact on Category
Computers Assets Increase $12,000
Cash Assets Decrease $12,000

Assets = Liabilities + Owner’s Equity

+12,000
-12,000

5 Nov 2008 Dr Computers $12,000

Cr Cash $12,000
(To record the purchase of computers for $12,000)
Transaction 3 (“T3”)
The company made a partial payment of $5,000 for the purchase
of furniture, which cost a total of $15,000.
Account Category Impact on Category
Furniture Assets Increase $15,000
Cash Assets Decrease $5,000
Other Payables Liabilities Increase $10,000

Assets = Liabilities + Owner’s Equity

+15,000 +10,000
-5,000
8 Nov 2008 Dr Furniture $15,000
Cr Cash $5,000
Cr Other Payables $10,000
(To record the purchase of furniture for $15,000 with a
partial payment of $5,000)
Transaction 4 (“T4”)
The company made a full payment of $5,000 for the purchase of
software for use.
Account Category Impact on Category
Software Assets Increase $5,000
Cash Assets Decrease $5,000

Assets = Liabilities + Owner’s Equity

+5,000
-5,000

8 Nov 2008 Dr Software $5,000

Cr Cash $5,000
(To record the purchase of software for $5,000)
Transaction 5 (“T5”)
The company completed its first job for services rendered to
Donutz Pte Ltd. Donutz paid $15,000 to Webz Designs on 25 Nov
2008.
Account Category Impact on Category
Service Revenue Owners’ Equity Increase $15,000
Cash Assets Increase $15,000

Assets = Liabilities + Owner’s Equity

+15,000 +15,000

22 Nov 2008 Dr Accounts Receivable $15,000

Cr Service Revenue $15,000
(To record rendering of services worth $15,000 to Donutz)

25 Nov 2008 Dr Cash $15,000

Cr Accounts Receivable $15,000
(To record receipt of cash from Donutz)
Transaction 6 (“T6”)
The company paid out $10,000 to its employees for Nov's payroll.

Account Category Impact on Category

Salaries expense Owners’ Equity Decrease $10,000
Cash Assets Decrease $10,000

Assets = Liabilities + Owner’s Equity

-10,000 -10,000
30 Nov 2008 Dr Salaries expense $10,000
Cr Cash $10,000
(To record payment of salaries of $10,000 to
employees)

* Note that the November payroll affects the company profit and thus
has an impact on the retained earnings under owners’ equity.
Transaction 7 (“T7”)
The company paid out $4,000 for Nov's rental.

Account Category Impact on Category

Rental expense Owners’ Equity Decrease $4,000
Cash Assets Decrease $4,000

Assets = Liabilities + Owner’s Equity

-4,000 -4,000
30 Nov 2008 Dr Rental expense $4,000
Cr Cash $4,000
(To record payment of rental of $4,000)
Transaction 8 (“T8”)
The company took up an interest free loan of $100,000 from one
its directors, to be repaid on 1 Dec 2010.
Account Category Impact on Category
Loan Payable Liabilities Increase $100,000
Cash Assets Increase $100,000

Assets = Liabilities + Owner’s Equity

+100,000 +100,000

30 Nov 2008 Dr Cash $100,000

Cr Loan payable $100,000
(To record taking up of interest-free loan of $100,000)
 Analysis of Webz Designs
Assets Liabilities Owner's Equity

Other Paid up Retained

Transaction Cash Computer Furniture Software = Loan Payable Payables + capital Earnings Revenue - Expenses

1 +50,000 +50,000

2 -12,000 +12,000

3 -5,000 +15,000 +10,000

4 -5,000 +5,000

5 +15,000 +15,000 +10,000

6 -10,000 +4,000

7 -4,000

8 +100,000 +100,000

Total 129,000 12,000 15,000 5,000 100,000 10,000 50,000 15,000 14,000
Conclusion

Debits, Credits and journal entries are used to record the
changes that each business transaction have on the
accounting equation.

Every transaction affects at least two accounts (duality of
effects).

It is critical to identify correctly the accounts affected and
the direction of the effect (increase or decrease).

The accounting equation must remain in balance after
each transaction.

The total dollar value of the debits in the transaction
should equal the total dollar value of the credits.
Mindmap

Accounting Accounting
Journal Entries
Equation

Debits and credits Duality of effects

1. Assets
2. Liabilities
3. Owners’ Equity
4. Revenue
5. Expenses Nature of accounts
Resources
Textbooks

Walter Harrison, Charles Horngren, Zubaidah Bte Ismail, Chng Chee Kiong, Fazilah
Samad and Mak Yuen Teen; Financial Accounting in Singapore and Malaysia; Prentice
Hall; 2005; Chapters 1 and 2

Joel Lerner; Schaum’s Outline of Theory and Problems of Bookkeeping and Accounting
(4th Edition); Irwin/McGraw-Hill; 2007; Chapters 1 and 2.

Robert Libby, Patricia Libby and Daniel Short; Financial Accounting (5th Edition);
Irwin/McGraw-Hill; 2007; Chapters 1 and 2.

Websites

QuickMBA/Accounting/Equation, http://www.quickmba.com/accounting/fin/equation/,
Retrieved on 06 Apr 2009

Accountingcoach.com, http://www.accountingcoach.com/online-accounting-
course/14Xpg01.html, Retrieved on 06 Apr 2009

Expended Equation Review, http://www.bboinc.com/ExpandedEquation.htm, Retrieved on
06 Apr 2009

How to Prepare a Journal Entry, http://www.bellaonline.com/articles/art50073.asp,
Retrieved on 06 Apr 2009

Debits and Credits, http://www.accountingcoach.com/online-accounting-
course/07Xpg01.html, Retrieved on 06 Apr 2009

Journal – Book of Prime Entry, Journalising, http://www.futureaccountant.com/accounting-
process/study-notes/recording-transaction-journal.php, Retrieved on 06 Apr 2009