Accounting Equation: Assets, Liabilities, and Equity

• Accounting Information System entails collecting and processing data, and communicating financial information to decision makers.
• Most businesses rely on an electronic data processing system (EDP) to handle all the accounting cycle steps.
• Transactions are economic events which require recording in financial statements.
• Assets, liabilities, or stockholders' equity items change because of an economic event, with a dual effect on the accounting equation.
• The accounting equation always remains in balance.
• The Basic Accounting Equation is Assets = Liabilities + Stockholders' Equity

Accounting Equation Expanded

• Assets = Liabilities + Stockholders' Equity
• Stockholders' Equity = Common Stock + Retained Earnings
• Retained Earnings = Revenues - Expenses - Dividends
• Assets + Expenses + Dividends = Liabilities + Common Stock + Retained Earnings + Revenue
• A+E+D = L+C+R

Events Affecting the Accounting Equation

• Paying rent decreases cash and increases rent expenses.
• Hiring an employee has no effect on the equation until the employee is paid.
• Purchasing supplies decreases cash and increases supplies.

Account and Debits/Credits

• An account records increases and decreases in specific assets, liabilities, equity, revenue, or expense items.
• An account has 3 parts: the balance, a debit (left) side, and a credit (right) side; a T account format is often used.
• Each transaction must affect two or more accounts to keep the basic accounting equation in balance (double-entry system).
• Accounting is done by debiting at least one account and crediting another; debits must equal credits.
• If debits are greater than credits, the account has a debit balance and vice versa.
• Assets, Expenses and Dividends should have debits greater than credits.
• Liabilities, Common Stock, Retained Earnings, and Revenues should have credits greater than debits.
• The normal balance is on the increase side.

Steps in the Recording Process

• Analyze transactions.
• Enter transactions in a journal (journalizing).
• Transfer journal entries to the ledger (posting).
• Source documents (sales slips, checks, bills, cash register tapes) provide transaction evidence.

The Journal

• The journal is the book of original entry where transactions are recorded chronologically.
• It discloses the complete effects of a transaction.
• It prevents or locates errors because debit and credit amounts are easily compared.
• When journalizing, using specific account titles from a company's chart of accounts is important.

The Ledger

• The ledger contains the entire group of accounts maintained by a company and their amounts.
• Posting transfers amounts from the journal to ledger accounts.
• Ledgers are also commonly shown in "T" format in manual systems.

The Trial Balance

• This is a list of accounts and their balances at a given time; it proves debits equal credits.
• A trial balance may still occur even if a transaction is not journalized, a correct journal entry isn't posted, a journal entry is posted twice, incorrect accounts are used, or offsetting errors are made.