CHAPTER TWO – NOTES
PART A: BASIC ACCOUNTING CONCEPTS
1. Business Entity Concept
Business is separate from the owner.
Owner’s personal transactions are not recorded in business books.
Example: If owner withdraws money → it is recorded as drawings.
2. Going Concern Concept
Assumes business will continue for long period.
Assets are recorded at cost, not liquidation value.
3. Money Measurement Concept
Only transactions measured in money are recorded.
Employee skill, honesty, reputation are not recorded.
4. Historical Cost Concept
Assets are recorded at original purchase price.
Not recorded at market value.
5. Dual Aspect Concept
Every transaction has two effects.
Based on accounting equation:
Assets = Liabilities + Owner’s Equity
Example:
If cash increases → either liability increases or equity increases.
6. Accounting Period Concept
Business life divided into accounting periods.
Usually 1 year.
7. Matching Principle
Expenses must be matched with related revenue.
Example: Salary expense of this year must be recorded in this year.
8. Revenue Recognition Principle
Revenue is recorded when earned.
Not when cash is received.
9. Consistency Principle
Same accounting method must be used every year.
10. Conservatism Principle
Do not overstate profit.
Record probable losses but not unrealized gains.
PART B: ACCOUNTING EQUATION
Accounting Equation:
Assets = Liabilities + Owner’s Equity
Where:
Assets = Resources owned
Liabilities = Debts
Equity = Owner’s claim
Expanded form:
Assets = Liabilities + Capital + Revenue – Expenses – Drawings
PART C: DOUBLE ENTRY SYSTEM
Every transaction affects at least two accounts.
One account is debited.
One account is credited.
Rule:
Total Debit = Total Credit
PART D: RULES OF DEBIT AND CREDIT
1. Personal Account
Debit the receiver
Credit the giver
2. Real Account
Debit what comes in
Credit what goes out
3. Nominal Account
Debit all expenses and losses
Credit all incomes and gains
PART E: TYPES OF ACCOUNTS
1. Assets
2. Liabilities
3. Capital
4. Revenue
5. Expenses
6. Drawings
SHORT QUESTIONS WITH ANSWERS
1. What is the accounting equation?
Assets = Liabilities + Owner’s Equity
2. What is dual aspect concept?
Every transaction has two effects in accounting.
3. What is double entry system?
Every transaction is recorded in at least two accounts with equal debit and credit.
4. Define going concern concept.
Business is assumed to continue operating in the future.
5. What is revenue recognition principle?
Revenue is recorded when earned, not when cash is received.
6. What is matching principle?
Expenses must be matched with related revenue.
7. What is historical cost concept?
Assets are recorded at original purchase price.
8. What is conservatism principle?
Record expected losses but not unrealized gains.
ESSAY QUESTIONS WITH FULL ANSWERS
1. Explain the Basic Accounting Concepts.
Answer:
Accounting concepts are basic assumptions used in preparing financial statements.
1. Business Entity Concept – Business and owner are separate.
2. Going Concern Concept – Business will continue.
3. Money Measurement Concept – Only monetary transactions are recorded.
4. Historical Cost Concept – Assets recorded at original cost.
5. Accounting Period Concept – Business life divided into periods.
6. Matching Principle – Expenses matched with revenue.
7. Revenue Recognition Principle – Revenue recorded when earned.
8. Conservatism Principle – Do not overstate profit.
9. Consistency Principle – Use same methods every year.
Conclusion:
These concepts ensure uniformity and reliability in accounting.
2. Explain Accounting Equation with Example.
Answer:
Accounting equation shows relationship between assets, liabilities, and owner’s equity.
Assets = Liabilities + Owner’s Equity
Example:
Owner invested 50,000 cash.
Assets = 50,000
Liabilities = 0
Equity = 50,000
If business borrows 20,000 from bank:
Assets = 70,000
Liabilities = 20,000
Equity = 50,000
Conclusion:
Every transaction keeps the equation balanced.
3. Explain Double Entry System and Rules of Debit and Credit.
Answer:
Double entry system means every transaction affects two accounts.
One account is debited and another is credited.
Rules:
Personal Account
Debit the receiver
Credit the giver
Real Account
Debit what comes in
Credit what goes out
Nominal Account
Debit expenses and losses
Credit income and gains
Example:
Paid salary 5,000 cash.
Salary Expense → Debit
Cash → Credit
Conclusion:
Double entry system maintains equality of debit and credit.
4. Explain the Importance of Accounting Principles.
Accounting principles:
Ensure accuracy
Maintain consistency
Prevent overstatement of profit
Help comparability
Provide reliable financial information
Without principles, financial reports would not be trustworthy.
PART 1: 30 PRACTICE PROBLEMS WITH SOLUTIONS
SECTION A: ACCOUNTING EQUATION PROBLEMS
1. Owner invested 100,000 cash.
Solution:
Assets (Cash) = 100,000
Equity (Capital) = 100,000
2. Purchased equipment 30,000 cash.
Solution:
Equipment ↑ 30,000
Cash ↓ 30,000
Total Assets unchanged
3. Borrowed 50,000 from bank.
Solution:
Cash ↑ 50,000
Liability (Loan) ↑ 50,000
4. Purchased goods on credit 20,000.
Solution:
Inventory ↑ 20,000
Accounts Payable ↑ 20,000
5. Paid salary 5,000 cash.
Solution:
Cash ↓ 5,000
Expense ↑ 5,000
Equity ↓ 5,000
6. Received service revenue 15,000 cash.
Solution:
Cash ↑ 15,000
Revenue ↑ 15,000
Equity ↑ 15,000
7. Owner withdrew 10,000.
Solution:
Cash ↓ 10,000
Equity ↓ 10,000
8. Paid creditor 8,000.
Solution:
Cash ↓ 8,000
Accounts Payable ↓ 8,000
9. Purchased furniture on credit 12,000.
Solution:
Furniture ↑ 12,000
Accounts Payable ↑ 12,000
10. Paid rent 3,000.
Solution:
Cash ↓ 3,000
Expense ↑ 3,000
Equity ↓ 3,000
SECTION B: IDENTIFY DEBIT & CREDIT
11. Paid electricity 2,000.
Debit: Electricity Expense
Credit: Cash
12. Received cash from debtor 7,000.
Debit: Cash
Credit: Accounts Receivable
13. Purchased goods cash 5,000.
Debit: Inventory
Credit: Cash
14. Borrowed from bank 25,000.
Debit: Cash
Credit: Bank Loan
15. Received commission income 4,000.
Debit: Cash
Credit: Commission Revenue
16. Paid insurance 3,500.
Debit: Insurance Expense
Credit: Cash
17. Sold goods on credit 6,000.
Debit: Accounts Receivable
Credit: Sales Revenue
18. Paid wages 8,000.
Debit: Wages Expense
Credit: Cash
19. Purchased land 40,000 cash.
Debit: Land
Credit: Cash
20. Owner invested equipment 15,000.
Debit: Equipment
Credit: Capital
SECTION C: APPLY ACCOUNTING PRINCIPLES
21. Revenue earned but not received.
Principle: Revenue Recognition
22. Expense paid for future period.
Principle: Matching
23. Asset recorded at purchase price.
Principle: Historical Cost
24. Business assumed to continue.
Principle: Going Concern
25. Only money transactions recorded.
Principle: Money Measurement
SECTION D: MIXED QUESTIONS
26. Define dual aspect concept.
Every transaction has two effects.
27. Define double entry system.
Each transaction has equal debit and credit.
28. What is accounting period?
Business life divided into time periods.
29. State accounting equation.
Assets = Liabilities + Equity
30. What is conservatism principle?
Record expected losses, not unrealized gains.
PART 2: TRIAL BALANCE PRACTICE
Question 1
Prepare Trial Balance from following:
Cash – 50,000
Capital – 100,000
Equipment – 30,000
Loan – 20,000
Salary Expense – 10,000
Revenue – 60,000
Solution:
Account Debit Credit
Cash 50,000
Equipment 30,000
Salary Expense 10,000
Capital 100,000
Loan 20,000
Revenue 60,000
Total 90,000 180,000 ❌
Not balanced → Missing entry (capital investment likely incomplete)
Question 2
Cash 120,000
Capital 120,000
Rent Expense 10,000
Revenue 50,000
Loan 20,000
Equipment 60,000
Trial Balance:
Account Debit Credit
Cash 120,000
Equipment 60,000
Rent Expense 10,000
Capital 120,000
Revenue 50,000
Account Debit Credit
Loan 20,000
Total 190,000 190,000 ✅
Balanced ✔
PART 3: JOURNAL ENTRY EXERCISES WITH ANSWERS
Exercise 1
Owner invested 200,000 cash.
Journal:
Debit Cash 200,000
Credit Capital 200,000
Exercise 2
Purchased furniture 50,000 cash.
Debit Furniture 50,000
Credit Cash 50,000
Exercise 3
Borrowed 30,000 from bank.
Debit Cash 30,000
Credit Bank Loan 30,000
Exercise 4
Paid salary 15,000.
Debit Salary Expense 15,000
Credit Cash 15,000
Exercise 5
Sold goods 25,000 cash.
Debit Cash 25,000
Credit Sales Revenue 25,000
Exercise 6
Purchased goods 10,000 on credit.
Debit Inventory 10,000
Credit Accounts Payable 10,000
Exercise 7
Received cash from customer 8,000.
Debit Cash 8,000
Credit Accounts Receivable 8,000
Exercise 8
Paid creditor 5,000.
Debit Accounts Payable 5,000
Credit Cash 5,000
Exercise 9
Owner withdrew 20,000.
Debit Drawings 20,000
Credit Cash 20,000
Exercise 10
Paid rent 6,000.
Debit Rent Expense 6,000
Credit Cash 6,000
🎯 FINAL EXAM TIP
For Chapter 2 practical:
Always remember accounting equation.
Assets increase → Debit
Liabilities increase → Credit
Expenses increase → Debit
Revenue increase → Credit
Capital increase → Credit
20 ADVANCED JOURNAL ENTRY PROBLEMS WITH SOLUTIONS
1. Owner invested 300,000 cash and equipment worth 50,000.
Journal Entry:
Debit Cash 300,000
Debit Equipment 50,000
Credit Capital 350,000
2. Purchased goods 40,000 cash and 60,000 on credit.
Debit Inventory 100,000
Credit Cash 40,000
Credit Accounts Payable 60,000
3. Sold goods 80,000 on credit.
Debit Accounts Receivable 80,000
Credit Sales Revenue 80,000
4. Customer paid 50,000 from previous credit sale.
Debit Cash 50,000
Credit Accounts Receivable 50,000
5. Paid salary 20,000, but 5,000 is unpaid.
Total salary expense = 25,000
Debit Salary Expense 25,000
Credit Cash 20,000
Credit Salary Payable 5,000
6. Paid 12,000 insurance for one year in advance.
Debit Prepaid Insurance 12,000
Credit Cash 12,000
(Adjustment at year-end if 3 months used = 3,000)
Debit Insurance Expense 3,000
Credit Prepaid Insurance 3,000
7. Received 30,000 advance from customer.
Debit Cash 30,000
Credit Unearned Revenue 30,000
8. Earned 18,000 from advance received earlier.
Debit Unearned Revenue 18,000
Credit Service Revenue 18,000
9. Purchased equipment 100,000, paid 40,000 cash, balance on credit.
Debit Equipment 100,000
Credit Cash 40,000
Credit Accounts Payable 60,000
10. Depreciation on equipment 10,000.
Debit Depreciation Expense 10,000
Credit Accumulated Depreciation 10,000
11. Interest accrued on loan 6,000 (not yet paid).
Debit Interest Expense 6,000
Credit Interest Payable 6,000
12. Paid interest 6,000.
Debit Interest Payable 6,000
Credit Cash 6,000
13. Rent expense 15,000, but 3,000 prepaid for next year.
Expense = 12,000
Debit Rent Expense 12,000
Debit Prepaid Rent 3,000
Credit Cash 15,000
14. Bad debt of 4,000 written off.
Debit Bad Debt Expense 4,000
Credit Accounts Receivable 4,000
15. Owner withdrew cash 25,000 for personal use.
Debit Drawings 25,000
Credit Cash 25,000
16. Purchased furniture 70,000 by issuing cheque.
Debit Furniture 70,000
Credit Bank 70,000
17. Accrued revenue 9,000 (earned but not received).
Debit Accounts Receivable 9,000
Credit Service Revenue 9,000
18. Paid electricity bill 5,000 for previous month (accrued earlier).
Debit Electricity Payable 5,000
Credit Cash 5,000
19. Purchased supplies 8,000 cash. At year-end, supplies used 3,000.
Purchase entry:
Debit Supplies 8,000
Credit Cash 8,000
Adjustment:
Debit Supplies Expense 3,000
Credit Supplies 3,000
20. Business borrowed 200,000 from bank at 10% annual interest.
Loan received:
Debit Cash 200,000
Credit Bank Loan 200,000
Year-end interest (10% of 200,000 = 20,000):
Debit Interest Expense 20,000
Credit Interest Payable 20,000
IMPORTANT EXAM REMINDER
Remember:
Assets ↑ → Debit
Assets ↓ → Credit
Liabilities ↑ → Credit
Liabilities ↓ → Debit
Expenses ↑ → Debit
Revenue ↑ → Credit
Capital ↑ → Credit
Drawings ↑ → Debit
20 ADJUSTING ENTRIES PROBLEMS WITH SOLUTIONS
1. Accrued Salary
Salary for December 8,000 has not been paid.
Adjusting Entry:
Debit Salary Expense 8,000
Credit Salary Payable 8,000
2. Accrued Interest
Interest of 5,000 on bank loan is unpaid.
Debit Interest Expense 5,000
Credit Interest Payable 5,000
3. Accrued Revenue
Service revenue 12,000 earned but not yet received.
Debit Accounts Receivable 12,000
Credit Service Revenue 12,000
4. Prepaid Insurance
Insurance 24,000 paid for 12 months. 4 months used.
Used = 8,000
Debit Insurance Expense 8,000
Credit Prepaid Insurance 8,000
5. Supplies Used
Supplies account shows 10,000. Physical count shows 3,000 remaining.
Used = 7,000
Debit Supplies Expense 7,000
Credit Supplies 7,000
6. Unearned Revenue Earned
Unearned revenue 20,000. 6,000 earned.
Debit Unearned Revenue 6,000
Credit Service Revenue 6,000
7. Depreciation on Equipment
Equipment depreciation 15,000.
Debit Depreciation Expense 15,000
Credit Accumulated Depreciation 15,000
8. Prepaid Rent
Rent 18,000 paid for 6 months. 2 months used.
Used = 6,000
Debit Rent Expense 6,000
Credit Prepaid Rent 6,000
9. Accrued Electricity Expense
Electricity bill 4,500 unpaid.
Debit Electricity Expense 4,500
Credit Electricity Payable 4,500
10. Bad Debt Expense
Accounts receivable 100,000. Estimate 5% uncollectible.
5% × 100,000 = 5,000
Debit Bad Debt Expense 5,000
Credit Allowance for Doubtful Accounts 5,000
11. Interest Revenue Accrued
Interest earned 3,000 not yet received.
Debit Interest Receivable 3,000
Credit Interest Revenue 3,000
12. Prepaid Advertising
Advertising 9,000 paid for 3 months. 1 month used.
Used = 3,000
Debit Advertising Expense 3,000
Credit Prepaid Advertising 3,000
13. Unearned Rent Earned
Received rent 24,000 in advance for 6 months. 2 months earned.
Earned = 8,000
Debit Unearned Rent 8,000
Credit Rent Revenue 8,000
14. Accrued Commission Expense
Commission 6,500 unpaid.
Debit Commission Expense 6,500
Credit Commission Payable 6,500
15. Supplies Adjustment (Alternative Method)
Supplies purchased 12,000 during year. Ending supplies 2,000.
Used = 10,000
Debit Supplies Expense 10,000
Credit Supplies 10,000
16. Depreciation on Building
Building depreciation 25,000.
Debit Depreciation Expense 25,000
Credit Accumulated Depreciation – Building 25,000
17. Prepaid Maintenance
Maintenance 6,000 prepaid. Half expired.
Expired = 3,000
Debit Maintenance Expense 3,000
Credit Prepaid Maintenance 3,000
18. Accrued Wage
Wages 9,000 unpaid.
Debit Wages Expense 9,000
Credit Wages Payable 9,000
19. Unearned Service Revenue Adjustment
Unearned revenue balance 50,000. 30% earned.
Earned = 15,000
Debit Unearned Revenue 15,000
Credit Service Revenue 15,000
20. Interest on Loan (Annual)
Loan 100,000 at 12%. Year-end interest unpaid.
Interest = 12,000
Debit Interest Expense 12,000
Credit Interest Payable 12,000
🎯 MOST IMPORTANT TYPES FOR EXAM
1. Accrued expenses
2. Accrued revenue
3. Prepaid expenses
4. Unearned revenue
5. Depreciation
6. Supplies adjustment
7. Allowance for doubtful accounts
🔥 MEMORY RULE FOR ADJUSTING ENTRIES
If expense happened but not paid → Debit Expense, Credit Payable
If revenue earned but not received → Debit Receivable, Credit Revenue
If prepaid used → Debit Expense, Credit Prepaid
If unearned earned → Debit Unearned, Credit Revenue
If asset depreciates → Debit Depreciation Expense, Credit Accumulated Depreciation