CHAPTER 1

Cotrugli – first accounting book

Fr. Luca Pacioli – Italian mathematician who earned the title of “Father of Accounting”

Business – is an economic unit that controls resources and engages in buying and selling of goods or
services.

Profit – is obtained when the amount you receive is more than the amount you paid for the goods or
services you sold.

Entrepreneur – is one who takes the risk of putting up a business to produce and sell goods or services.

Business Risk – An endeavor, like a business, has always an element of uncertainty.

FORMS OF BUSINESS ORGANIZATION

A. Sole Proprietorship – is a business organized by one person who usually acts as manager.
B. Partnership – is a business owned by two or more individuals who contribute money, property,
and talent.
C. Corporation – is a business organized as a separate legal entity from the owners.
Shareholder/Stockholder - investor whose right over the business is expressed in the number
of shares bought and is evidenced by a certificate of stock.
Board of Directors - elected by the shareholders from among themselves.

TYPES OF BUSINESS OPERATIONS

A. Service Business - is one which provides services, for a fee, to client or customers.
B. Merchandising Business - is one which buys and sells goods or merchandising.
C. Manufacturing Business - buys raw materials, forms this to a finished product and then sells
this to the customers.

PICPA – Accounting is a service activity. Its function is to provide quantitative information primarily
financial in nature about an economic entity that is intended to be useful in making economic decisions.

AICPA – Accounting is an art of recording, classifying, summarizing business transaction and events
which are in part of or at least of financial character and in terms of money and interpreting the results
thereof.

Stakeholders – is a person or entity who has an interest in the economic performance or a business.

USERS OF FINANCIAL STATEMENT

1. Owner/Investor – is one who puts capital (such as money or property) in a business venture
with objective or receiving a return on capital or investment from the profits earned by the
business.
 2. Manager - is responsible for organizing, planning, directing and controlling the operation of the
business.
3. Lender - assesses the ability of the business-borrower to pay the principal debt and the interest,
as well.
4. Supplier – offers goods or merchandise on cash basis or on credit term depending on the paying
ability of the business-customer.
5. Government - uses the accounting reports in several ways. As tax collector, it investigates tax
return and assesses truthfulness of the reported profit and the tax liability to be paid by the
business.
6. Employee – wants higher wages, benefits, good working conditions and security of tenure.
7. Customer – assesses the company’s ability to continuously supply the goods they need at the
right price and quality.

Management – as art of managing or directing people and resources as efficiently as possible with a
view of accomplishing the goal of the organization.

1. Efficiency – requires that the company’s resource inputs (material, labor hours) be used at the
least time, effort and cost to produce the required output (products or services).
2. Effectiveness – the company’s attainment of its goals in terms of being able to produce and sell
the number of products or services as stated in the plan.
3. Planning – management decides what activities to be undertaken to accomplish the goals set
up.
4. Organizing – company structure upon which management will work out its plans will be formed.
Position will be created, people will be hired. Their role will be defined.
5. Directing – management will oversee the day to day operation of carrying out the planned
activities- act, decide, agree, argue, question, approve, solve.
6. Controlling – management will ensure that the daily activities conform with the planned
activities.

Department Heads of Business Organization

A. Production Manager – makes a study on what products to produce, how to produce it, how
much cost must be incurred, what machine will be needed, how many workers will be hired,
how big the factory should be.
B. Marketing Manager – makes a study market-place, product, price, people.
C. Finance Manager – takes charge the company’s financial resources- how to source it (looking for
investor and creditors), how to use it (purchase of capital asset, new product, payments of
loans).
D. Personnel Manager – takes charge of employees and workers- selecting, hiring, training and
overseeing them.

Information System – is an orderly way of gathering and processing data so that meaningful information
will come out and reports may be prepared.
Accounting Information System – involves an orderly way of accumulating and reporting business
transactions through a process of analyzing, measuring, recoding, classifying and summarizing, and from
which reports are generated to decision makers.

Fundamental System Principles

1. Control Principle – prescribes that the AIS of the firm must possess internal control.
Internal Control – enumerates the methods and procedures necessary to monitor the activities
of the business and ensure efficient operation.
2. Cost-Benefit Principle – prescribe that the advantages enjoyed from installing the system must
outweigh its cost.
3. Relevance Principle – prescribes that the information must be reported promptly and that
information must be understandable and useful for the statement user to reach a conclusion
and make decision.
4. Compatibility Principle - prescribes a system designed to fit the unique characteristic of the
company- its personnel, activities and structure.
5. Flexibility Principle – prescribes that the company’s system should be changed, if change is
needed, to come up with timely and updated information in response to industry demand,
government promulgation, technological advances and competitive pressures.

Documents – evidences of business transaction.

Business Documents – describes in words and amounts the nature of transaction. Examples: Official
Receipts (when receiving cash), Cash Voucher (when paying cash), Invoice (when selling or buying goods
or services).

Transaction – is an activity or event taking place in business which is expressed in terms of money.

Input Device – is used to record the data captured in the document.

Records – are the books of accounts that must be maintained by the accounting department.

Journal – accounting data are gathered and recorded in a book.

Ledger – the data is organized and classified into related groups and stored in another book.

Financial Statement Analysis – interpreting the financial data through a tool.

Online Processing - data are entered and processed as soon as the document is available.

Batch Processing – data is first accumulated over a period of time before it is processed all at once in a
batch say weekly, daily or monthly.
 FINANCIAL REPORTS

A. Cash Flow Statement – is a financial statement which explains why the amount of cash changed
over a period of time. Summarizes the cash activities of the business: cash inflows or sources of
cash and cash outflows or uses of cash.
B. Profit Statement – financial performance is reported in this statement. This is a report which
describes how the business operated or produced wealth over a given period of time, say one
year. This is also called “Statement of Comprehensive Income”. The operating activities of a
business showing the revenues earned and the expenses incurred during a specific period.
“Temporary or Nominal Values”
Revenue – income earned Expenses – incurred by the business

Profit or Net Income – results when revenues exceed expenses.

Net Loss – results when expenses exceed revenues.

C. Capital Statement – showing the changes (increases or decreases) that took place during the
specified period of time.
D. Balance Sheet - gives information about the financial position of the business by showing a list
of its assets and liabilities and from which the net worth or wealth of the business representing
the claim (equity) of the owner may be determined. “Real Values”
Net Worth or Wealth - represents the net assets of the business (assets left after deducting the
liabilities) belonging to the owner.
Account Form – follows the accounting equation where assets are listed on the left hand column
of the report with the liabilities and owner’s equity listed on the right of the column.
Report Form – shows in one straight column the assets followed by the liabilities and owner’s
equity.
E. Statement of Changes in Owner’s Equity – explains the activities for a period of time that
changed the owner’s share over the net assets of the business. Net worth or Owner’s Equity is
affected by four activities: Investment, Withdrawal, Profit or Loss.

Trade liberalization - free flow of goods and services anywhere around the world.

Trade internationalization - global market, global economy.

Profitability – is the ability of the company to increase the owner’s net worth by generating more
revenues than cost and expenses.

Solvency - is the ability of the company to pay for its long-term debts to ensure its continued existence.

Debt Ratio – shows the proportion of the assets provided by the creditors

Equity Ratio – shows the proportion of the assets invested by the owner

Liquidity – is the ability of the company to pay its currently maturing or short-term obligations.
 Career Fields in Accounting

1. Public Accounting – is a career field open to firms and individual CPA which offers to the public,
for a fee, expert services like bookkeeping, auditing, accounting, tax, and financial planning.
2. Industry Accounting – is another career field where the accountant is employed in a
merchandising, manufacturing or service firm to serve as financial accountant, controller,
budget officer, internal auditor.
3. Government Accounting - is another career field where one works as accountant, auditor of
any of the government agencies.
4. Research and Education – is another professional field where the accountant assumes the role
of researcher, teacher or reviewer.

Accounting Areas

1. Basic Accounting or Bookkeeping - is the routine activity of recording, classifying and

summarizing business transactions in a systematic manner.
2. Financial Accounting – involves the preparation and interpretation of financial statement
primarily for external users.
3. Cost Accounting – deals with the recording, classifying and summarizing the details of materials,
labor and overhead necessary to produce and overhead necessary to produce and sell a product
or service.
4. Managerial Accounting - is the presentation of financial and non-financial information primarily
for management who are considered the internal users.
5. Auditing – deals with independent verification and examination of the accounting records for
the purpose of giving an opinion on the fairness of the presentation of the financial statements.
6. Government Accounting – which uses Fund Accounting deals with the administration or use of
public funds to bring about services to the community.
7. Tax Accounting – deals with tax matters affecting firms (partnership and corporation),
individual, trusts and estates.

Qualitative Characteristics

A. Understandability – requires that terminologies must be clear and presentation form orderly to
be understood by users.
B. Relevance - prescribes the quality of information that will make difference and influence a
statement user to make a meaningful decision.
C. Reliability – is a degree of confidence users have on the financial statement because there are
free from material errors or misstatement.
D. Comparability - helps on identify changes taking place in the business from one period to
another period and gives the reader an idea on whether the company is going up or down the
require level of performance.
E. Substance Over Form - require that the information should reflect the substance (essence or
intention) rather than its legal form.
Principle – are broad laws or rules adopted as guides to the conduct and practice of the profession.

GAAP (General Accepted Accounting Principle) – when the concept or assumption is formalized and
approved by the Accounting Standards Council/ Financial Reporting Standards Council then it will be
part of GAAP.

A. Business Entity Concept – concept assumes that a business enterprise is separate and distinct
from the owner or investor.
B. Cost Concept – assets should be recorded based on cash which is the amount exchanged at the
time of purchase or equal to cash basis (cash equivalent) if no amount was exchanged (paid) at
the time of acquisition.
C. Going Concern Concept – that the business is a continuing concern or that it has an indefinite
existence.
D. Accrual Concept – items are recognized as assets, liabilities, revenues and expense based on the
period they relate or based on the occurrence of the transaction/event rather than on whether
cash is received or paid.
E. Objectivity Concept – requires that financial data entered in the records must be verifiable and
substantiated by documents such as invoice, vouchers or official receipts.
F. Disclosure Concept – information important enough to influence the decision of a statement
user should be disclosed either in the body of the report or as a supplementary note or
schedule.

Asset – is a resource controlled by the enterprise as a result of a past event and from which probable
future economic benefits are expected to flow to the enterprise.

Economic Benefit - is the ability of the asset to produce future cash flows whether directly (as when the
asset is sold for cash) or indirectly (as when it is used to create other assts such as machine used to
produce goods or services).

Liabilities – are debts of the business owing to outside parties like the banks, the financing companies
and the supplier of assets (equipment or furniture) or services (telephone, light, water) received by the
business.

Equity - the residual right or interest of the owner in the enterprise net assets. Another for equity is net
worth or net assets.

Account – is a device used to record the changes (increases or decreases) in the accounting elements.

Assets = Liabilities + Owner’s Equity

Exchange of Value - means that for every value received by the business there must be an equal value
parted with.

Revenue Recognition Concept – revenue is recognized when it is earned.

Expense Recognition Concept – expenses are recognized in association with the earnings of specific
income items within a specific period of time.

Revenue – an increase in economic benefits during the period of that results in increases in equity.

Expense – a decrease in economic benefit during the accounting period in the form of outflow or
depletion or asset or increase in liabilities that results in a decrease in equity.

Calendar Accounting Period – twelve month accounting period that ends on December 31

Fiscal Accounting Period – twelve month accounting period ending other than December 31

Intracomparability – financial statements are presented side by side for two periods. This makes the
report more meaningful as the performance for one period is compared against another period.

Intercomparability – comparison of performance for one period of different companies.

Business Papers

1. Invoice – issued when service or merchandise is given to a customer or client.

2. Official Receipt – issued when cash is received by the business.
3. Cash Voucher – is a document used when cash is paid by the business.
4. Check – is a negotiable instrument used as a substitute for cash, the payment for which is drawn
against the company’s or individual current account.
5. Statement of Account - is a bill presented to a customer for service rendered or merchandise
given for which payment is demandable.
6. Promissory Note – is a written promise to pay a certain sum of money at a future date. The
maker is the debtor and it is addressed to the payee or creditor.
A. Non-Interest Bearing Note – is one which face value is the same as its maturity value. No
interest
B. Interest Bearing Note - where the maturity value (amount to be paid on the due date) is
higher than its face value or principal (the amount stated in the promissory note) because of
the interest charge.
Interest = Principal x Interest Rate x Time
Maturity Value = Principal + Interest

Chart of Accounts – is a listing of account titles which guides the bookkeeper in the recording of the
transactions.

T Account – simplest form of an account used to analyze the effects of the transaction hence it has two
sides: one side is for recording increases and the other side is for recording decreases.

Debit – is accounting term which simply means left side of an account

Credit – simply means right side of an account

Double Entry Bookkeeping System – also called Venitian Model, that every transaction entry must have
a debit equal to a credit no matter how many accounts are affected

Account Balance - difference between the debit total and credit total

Debit Balance – debit total is higher than the credit total the account balance

Credit Balance – credit total is higher than the debit total the account balance

General Ledger – formal book of account is used containing not only the account title, date and amount
but also the page reference (to identify the entry source), the account number and the balance of the
account. Each page is called a Ledger.

Ledger – Books of final entry

Posting – the process of transferring debits and credits from the journal to the ledger

Journal – Books of Original entry

General Journal – simple form of journal

Journalization – process of recording transaction in the journal

Footing – total the debit column and record it in small figures directly underneath the last debit amount.

Market Value – represents the amount for which the asset could be sold or bought in its present
condition.

Book Value - (cost less accumulated depreciation), represents the unexpired cost or remaining utility
value of the assets.

Capital Expenditures – all cash outlays charged to the asset account

Rebate – discount granted for paying an account promptly

Discount – granted when large quantities are purchased when the buyer is regularly patronizing the
business

Obsolescence – occurs when a better model is invented or produced than what was originally acquired

Inadequacy - means that the asset can no longer meet the demand of the business

Cost – amount paid in cash or its cash equivalent for properties acquired

Allowance – reduction in the price of an asset acquired for being defective or not of the correct
specification

Payroll – represents salaries and wages paid to employees and workers

Payroll Sheet – is a salary computation sheet showing the names of the workers, their positions,
corresponding gross salaries, deductions and the net pay to be received.

Salary – regular employee are paid monthly and semi-monthly

Wages – workers based on hour rate or piece rate

Net Pay – take home pay of the employee

Signatures – signifying that they have received their salaries and wages

Gross Pay – represents the total compensation earned by an employee or worker for a certain period
Adjusting Entries – entries needed to update these accounts to ensure their accuracy

Cash Basis – income is recognized only when cash is collected or expense is recognized only when cash
is paid.

Revenue Recognition Principle – income is recognized as earned at the time service is rendered
regardless of when cash is collection

Expense Recognition Principle - the expense is recognized as incurred at the time service is received or
used up regardless of when cash is paid

Accrued Income – uncollected income

Accounts Receivable Interest Receivable

Service Income Interest Income

Accrued Expense – unpaid expense

Salaries Expense

Salaries Payable

Deferred Income or Unearned Income – advance collection of income

Income Method – records the advance collection with a credit to an income account (unearned)

Cash Service Income

Service Income Unearned Service Income

Liability Method – recording the advance collection since it was immediately credited to an
unearned or deferred income account. (earned)

Cash Unearned Service Income

Unearned Service Income Service Income

Prepaid Expense – represents advance payment for service to be received or expense to be incurred in
the future

Expense Method – to record the advance payment immediately to an expense account (unused)

Supplies Expense Supplies

Cash Supplies Expense

Asset Method – advance payment is debited to a prepaid expense account (used)

 Prepaid Rent Rent Supplies

Cash Prepaid Rent

Bad Debts – uncollectible accounts receivable / estimate of the account receivable that may not be
collected

Direct Write Off Method – recognizes bad debts only when it is certain that the company will
not be able to collect the account anymore

Bad Debts Expense

Accounts Receivable

Allowance Method – provides for bad debts or doubtful accounts at the time the sales is
recorded. Doubtful accounts are determined by estimation based on the company’s past
experience

Bad Debts Expense/Doubtful Accounts

Allowance for Bad Debts/Doubtful Accounts

Net Realizable Value – is the difference between the accounts receivable and the allowance for
doubtful accounts.

Depreciation Accounting – process of allocating the cost of plant and equipment to the years or periods
excepted to benefit from their use

Utility Value – represents the ability of the asset to yield service

Market Value – represents the amount that could be realized if the asset is to be sold

Scrap/Residual/Disposal Value - realizable value or recovery value of the asset at the end of its
useful life

Useful Life – represents the production life of the assets which may be expressed in number of
years

Cost – Scrap Value = Depreciation

Useful life

Accumulated Depreciation – decrease in the cost of the asset

Book Value – difference between the cost and the accumulated depreciation, represents the
unexpired cost or the net utility value of the asset
Worksheet – is a columnar paper where the first two columns are provided for the trial balance, which
is the starting point for the preparation of the financial statements.

Closing Entries – bringing nominal or temporary account to zero balances.

Income and Expense Summary – used to close the nominal accounts.

Post Closing Trial Balance – prepared after the closing the books. It contains real accounts only

Reversing Entries – reverse some adjusting entries to prepare them for a new accounting period

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Merchandiser – person who buys and sells good or merchandise

Wholesaler – is one who buys in bulk from a manufacturer or another wholesaler and sells them to
other wholesaler or retailers.

Retailers – buys merchandise from the manufacturer or wholesaler and sells them to ultimate
consumers.

Sales Revenue – is earned when the merchandiser or seller of the goods transfer the merchandise to the
customer

Invoice – sales is supported by this source document

Merchandise – represents the stock of goods or items brought by the merchandiser for resale to its
customer

Cost of Sales – a major expense of a merchandiser, represents the cost of buying the merchandise which
were sold to obtain a revenue

Gross Income on Sales/Gross Profit – is the mark-up or margin of profit in selling the goods to the
customers and would be a good basis for determining whether the company’s pricing policy is adequate
or not

Cost of Goods Sold - is the cost of merchandise given to the customer for the sales revenue received. It
is the major expense on a merchandiser’s income statement

Merchandise Inventory – refers to good purchased for resale to customers

Perpetual Inventory – complete movement of the merchandise is recorded. Continuous

recording and control of the merchandise from the time it is purchased to the time it is sold

Periodic Inventory – the merchandise when bought is recorded as Purchases representing

goods available for sale. When the goods are sold, only the sales revenue representing the
amount obtained from the customer is recorded. Cost of goods sold as well as the merchandise
 inventory balance are determined only at the end of the year based on an inventory count
which is supported by a document

Sales Discounts

Trade Discount – which is percentage from a published list price may be granted to retailers or
wholesalers for buying large quantities or for regularly patronizing the business

Cash Discounts – “Sales Discount” is meant to encourage a customer to pay immediately, speed
up seller’s cash inflow and allow him to use the cash for another profitable operating cycle

Returns and Allowances – a customer may return merchandise if it is defective or broken or it is not as
ordered Or the customer may request for a reduction or allowance in the price, for the same reason ,
without returning the merchandise purchased

Credit Memo – business document issued by the seller informing the buyer that his account was
decreased accordingly for the return made or for the reduction of price requested (Sales
Returns and Allowances)

Debit Memo – the buyer could issue the document instead of the seller in which case an
accounts payable is decreased on the debit side (Purchased Returns and Allowances)

Net Sales – at the end of the accounting period several accounts like sales returns and allowances and
sales discount deducted from gross sales to arrive the net sales

FOB Shipping Point – means that title of ownership passes to the buyer as soon as seller turns over the
goods to a common carrier such as cargo ship for delivery of the goods to the buyer. It also means that
the buyer, as owner of the goods, should pay for the freight “Freight In or Transportation In”

FOB Destination – which means free on board at destination, the seller is liable for the freight and is still
considered the owner of the goods until it reaches the buyer “Freight Out or Transportation Out”

Gross Purchases – merchandiser uses the title Purchases whenever merchandise is bought for resale
“Goods Available for Sale”

Net Cost of Purchases – Gross Purchases and Freight In is added to arrive at Total Cost of Delivered
Goods, purchase returns and allowances and purchase discounts are deducted to arrive the Net Cost of
Purchase

Operating Expenses

Selling/Distribution Expenses – are those incurred in storing, promoting, packaging and

delivering merchandise such as freight out, sales salaries, advertising, sales commission and
depreciation of store equipments
General/Administrative Expenses – consist of expenses needed in the general administration of
the office other that the store such as bad debts, office supplies expense, salaries, utilities
expense and depreciation for office furniture and equipment