ACCOUNTING

 Accounting is a service activity. Its function is to provide quantitative information,

primarily financial in nature, about economic entities that is intended to be useful in making
economic decisions.
 Accounting is an art of recording, classifying and summarizing in a significant manner and
in terms of money, transactions and events which are, in part at lest, of a financial character,
and interpreting the results thereof.
 Business transactions are economic activities of a business.
 Money serves as a medium of exchange and a measure of value. It is the common financial
denominator.

Generally Accepted Accounting Principles (GAAP)

 Objectivity Principle – records and statements are based on most reliable data available.
 Historical Cost – acquired assets should be recorded at actual or historical cost.
 Revenue Recognition Principle – revenue is to be recognized in the accounting period
when goods are delivered or services are performed.
 Matching Principle – expenses should be recognized in the accounting periods in which
goods and services are used up to produce revenue and not when the entity pays for those
goods and services.
 Adequate Disclosure – all relevant information that would affect the user’s understanding
be disclosed in the financial statements.
 Consistency Principle – firms should use the same accounting method from period to
period to achieve comparability over time within a single enterprise.
 Materiality – financial reporting is only concerned with information that is significant
enough to affect evaluations and decisions.
 Timeliness – accounting information is communicated early enough to be used for the
economic decisions that it might influence.

5 BASIC ELEMENTS OF ACCOUNTING

 Financial Position / Balance Sheet
1. Assets – physical things (tangible or intangible) or rights which have monetary
value and are owned by the business entity. These are resources that are owned,
controlled, used or to be used by the business that are expected to result to future
economic benefits to the business.
2. Liabilities – debts or obligations owed by the business. These are the present
obligations of the business arising from past events, the settlement of which is
expected to result in an outflow from the entity of resources embodying economic
benefits.
3. Owner’s Equity/ Capital/ Equity – claim held by the owner against the assets after
the total liabilities are deducted.
 Financial Performance / Income Statement
4. Revenues – increases in the owner’s equity as a result of the performance of
services or sales by the business.
5. Expenses are the decreases in the owner’s equity caused by the revenue
generating activities of the business
 Net Income – amount by which total revenues exceeds total expenses
  Net Loss – amount by which total expenses exceeds total revenues

THE ACCOUNTING EQUATION

Assets must always equal the total of liabilities and owner’s equity

EXPANDED ACCOUNTING EQUATION

Assets = Liabilities + Owner’s Equity
Assets = Liabilities + Owner Investment – Owner Withdrawal + Net Income, or, – Net Loss

DEBITS (Dr.) and CREDITS (Cr.)

 Double Entry System – means that the dual effect of business transactions must be
recorded. A debit side entry must have a corresponding credit side entry. Each transaction
affects at least 2 account titles or 2 accounts in short. The total amount of all debits must
equal that of the credits.
 Normal Balance – means that usually an account should have a sum or balance coming
normally from just the debit side or just the credit side, and not on both sides, depending
on its major account classification.
Normal Balance of Each Account

Contra-Revenue Accounts Assets Liabilities Contra-Asset Accounts such as:

such as: Allowance of Bad Debts (against AR), and
Sales returns, allowances Expenses Equity Accumulated Depreciation (against PPE);
and discounts Contra-Expense Accounts such as: Purchase
Revenues returns, allowances and discounts

Normally Debit in Ending Balance Normally Credit in Ending Balance

TYPICAL EXAMPLES OF ACCOUNT TITLES

BALANCE SHEET ACCOUNTS
*Note that Assets and Liabilities are grouped into Current or Non-Current
1. Assets
A. Current Assets
 Cash – currency, checks, bank deposits, etc.
 Cash equivalents – short term investments with maturity of 3 months or less
 Notes Receivable – promissory note
 Accounts Receivable – a promise to pay by customers
 Inventory – held for sale, in the process of production for such sale, and to be
consumed in the production of goods and services to be available for sale.
 Prepaid expenses – expenses paid in advance (prepaid insurance, prepaid rent)
B. Non-Current Assets / Long-Term Assets
 Long-term investments of financial instruments
 Office Equipment
 Furniture and Fixtures
 Building
 Land
  Intangibles – patents, copyrights, licenses, franchises, trademarks and non-
competition agreements
2. LIABILITIES
A. Current Liabilities
 Notes Payable
 Accounts Payable
 Accrued Liabilities – unpaid expenses. Examples: salaries payable, wages
payable, interest payable, taxes payable.
 Unearned revenues – payments received in advance before providing customers
with goods or services.
B. Non-Current Liabilities / Long-Term Liabilities
 Mortgage Payable – business entity has pledged certain assets as security to the
creditor
 Bonds Payable – bond is a contract between the issuer and the lender specifying
the terms of repayments and interest to be charged.
3. Owner’s Equity / Equity / Capital
 Capital – original and additional investments made by the owner to the business
 Withdrawals / Drawings – withdrawals of cash or other assets from the business by
the owner.
INCOME STATEMENT ACCOUNTS
4. Revenue – sales, sales allowances, sales return, sales discounts
5. Expenses
 Cost of Sales / Cost of Goods Sold
 Salaries expense
 Utilities expense – telecommunication, electricity, fuel, water.
 Rent Expense
 Supplies Expense – expense upon using office supplies
 Depreciation Expense – portion of the cost of non-current tangible asset allocated as
expense. Both the decline in value of a long-term fixed asset over time as well as the
systematic allocation of the depreciable amount of an asset over its useful life.
 Doubtful Accounts Expense / Bad Debts Expense – amount of receivables estimated to
be doubtful of collection. It is created by forming a credit balance which is deducted from
the total receivables balance in the statement of financial position.
 Interest Expense – expenses related to the use of borrowed funds.

FINANCIAL STATEMENTS
Objective: assessing the prospects for future net cash inflows to the entity and assessing
management's stewardship of the entity's resources
…of a general purpose financial statements
 Income Statement / Statement of Financial Performance
 Statement of Changes in Equity
 Balance Sheet / Statement of Financial Position
 Statement of Cash Flows – shows operating, investing and financing activities
 Notes to Financial Statements
…special purpose financial statements
HISTORY OF ACCOUNTING
 Italian Father of accounting and bookkeeping – Luca Pacioli
 The historical origin of the use of the words "debit" and "credit" in accounting goes back
to the days of single-entry bookkeeping, which had as its chief objective keeping track of
amounts owed by customers (debtors) and amounts owed to creditors. Debit in Latin
means "he owes" and credit in Latin means "he trusts".
 Pacioli did not invent the double-entry bookkeeping but he recommends this Venetian
double-entry booking system above all others that exist that time.
 The main books that act as the direct basis of the double-entry bookkeeping are:
memoriale or memorandum, giornale or journal, and quaderno or ledger

USERS OF FINANCIAL REPORTS

 Internal Users – are directly involved in running the business. They use the financial
information to improve the profitability of the organization. (eg. Owners; managers to
assess when to buy inventories, assess the compensation package and benefits, to monitor
costs and ensure quality etc.; employees to get better pay and working conditions)
 External Users – users who are not directly involved in the running of an organization.
They have limited access to the financial information. They depend on reliable, relevant
and comparable accounting information to make important decisions. (eg. customers or
suppliers for stability or sustainability of the business for long term relationship;
investors; government for the payment of taxes; competitors to assess strategies in
competing in the market; creditors or lenders for repayment of the loan; unions,
stockholders to decide whether to buy, sell or hold shares)

BRANCHES OF ACCOUNTING
 Financial Accounting - is concerned with the preparation of periodic financial reports by
using historical data of a business enterprise. There are certain rules known as “generally
accepted accounting principles (GAAP)” that each business enterprise must follow while
preparing its financial reports to ensure that the financial information published by it is
useful, reliable and comparable with other companies. Financial accounting is also
termed as the “general purpose accounting” because the information generated by it is
published for the use of everyone connected with the business enterprise.
 Management Accounting – uses historical as well as estimated data to generate useful
reports and information to be used by internal management for decision making purpose
where there is no need to take care of GAAP.
 Cost Accounting - is concerned with categorizing, tracing and collecting manufacturing
costs of a business enterprise.
 Tax Accounting – includes computation of taxable income and presentation of financial
or other information to tax authorities required by tax laws and regulations of a country.
 Government Accounting - is concerned with the allocation and utilization of government
budgets. It ensures that the central or state government funds released for various
purposes are being utilized efficiently. The proper record keeping makes the audit of
completed projects possible.
 Auditing - generally refers to review, examination, verification, evaluation or inspection
of historical data, records or events belonging to an entity. The person who performs the
 work of audit is known as auditor. In accounting and business, there are two types of
auditing – external auditing and internal auditing.
o External auditing refers to the independent examination of an entity’s financial
statements and other accounting records that an entity publishes for the use of
external parties. The auditor gives his opinion about the fairness of all accounting
information examined by him. An important element of “fairness” is the
compliance of financial statements with the generally accepted accounting
principles (GAAP).
o Internal auditing is performed to determine whether or not the policies and
procedures set by management are being followed. An important purpose of
internal auditing is to evaluate whether the activities performed by the employees
at various levels are in line with the goals set by management. Internal auditing
may be performed by the existing accountants, however many companies employ
special staff for this purpose.
 Accounting Education – teaching of accounting in the academe
 Accounting Research – accountants in this area use their knowledge, skills and
techniques to deal with matters such as dispute resolution, claim settlement, fraud
investigation, court and litigation cases etc.

TYPES OF BUSINESS ORGANIZATIONS

A business is an organization the converts its inputs or resources into outputs.

…according to its form

 Sole Proprietorship – is a business with one owner who operates the business on his or
her own or employ employees. It is the simplest and the most numerous form. Contractor
is one example of a sole proprietorship.
ADVANTAGES DISADVANTAGES
Easy to start Unlimited liability
Minimal cost of registration/ None Employee benefits
No profit sharing Raising funds
Easy decision-making Limited life
Easy to wind up Loss in absence or non-operation
No corporate tax

 Partnership – is a business with two or more individuals who owns and manages the
business. Partners share the unlimited liabilities of the business and operate the business
together. There are general partnership and limited partnership.
ADVANTAGES DISADVANTAGES
Relatively easy to start Unlimited liability
Joint ability to raise funds Profit sharing
More skilled persons Conflicts
Loss sharing Limited life
No loss in absence Difficult transferability

 Corporation – is a limited liability entity doing business owned by multiple shareholders

and is overseen by a board of directors elected by the shareholders. It is distinct from its
 owners and can borrow money, enter into contracts, pay taxes and be sued. The
shareholders gain from the profit through dividend or appreciation of the stocks but are
not responsible for the company’s debts.
ADVANTAGES DISADVANTAGES
Limited liability Formation and winding up are not easy
Continuity of existence Controlled by a group
Large scale operation Higher restrictions and compliance issues
Professional management Delays in policy decisions
Social Benefit
 Cooperative - (also known as a co-op) is a business owned and controlled by those who
use its services. Individuals and firms who belong to the cooperative join together to
market products, purchase supplies, and provide services for its members. If run
correctly, cooperatives increase profits for its producer-members and lower costs for its
consumer-members. Cooperatives are fairly common in the agricultural community.

…according to its activities

 Service business – use its employees to provide services to its customers. These services
include professional skills, advice, expertise, and other related products. (eg. accounting
firms, law firms, dry cleaning establishments, spa, etc.)
 Merchandising – buys finished, almost finished goods from their suppliers and resell the
same to customers (eg. retailers that sells to customers, wholesalers that sells to retailers)
 Manufacturing – buys materials, convert those into other form or products, and sell it to
other companies or final consumers.
BUSINESS TYPE ADVANTAGES DISADVANTAGES
Service Less need for facilities Standardization of services
and its quality
Maintaining employees
Merchandising Visible products Need of product storage
Minimal or no conversion of Inventory losses
products
Manufacturing Visible products Need of facilities
Quality control High conversion costs
Cost of quality control
INTERNATIONAL FINANCIAL REPORTING STANDARDS (IFRS)

The Framework addresses:

 the objective of general purpose financial reporting
 qualitative characteristics of useful financial information

The two fundamental qualitative characteristics of a financial information, to be useful,

are relevance (there is an influence of materiality of information based on its nature and
magnitude to the user) and faithful representation (where it seeks to maximize the
underlying characteristics of completeness, neutrality, and freedom from error). The
enhancing qualitative characteristics are as follows:
o Comparability – information is useful if it can be compared with that of the
similar information with other entities, or that of an information across all
accounting periods.
o Verifiability - means that different knowledgeable and independent observers
could reach consensus, although not necessarily complete agreement
o Timeliness - means that information is available to decision-makers in time to be
capable of influencing their decisions
o Understandability – where complex information should be easy to comprehend

 financial statements and the reporting entity

 the elements of financial statements
 recognition and derecognition
Recognition is the process of incorporating in the balance sheet or income statement an
item that meets the definition of an element and satisfies the following criteria for
recognition:
o It is probable that any future economic benefit associated with the item will flow
to or from the entity; and
o The item's cost or value can be reliably measured.
 measurement bases
o Historical cost – most common but is combined with other measurement methods.
It is the original value of an asset at the time it was purchased or acquired.
o Current cost - is a valuation method whereby assets and goods used in production
are valued at their actual or estimated current market prices at the time the
production takes place.
o Net realizable (settlement) value – is the value of an asset that can be realized
upon the sale of that asset, less a reasonable estimate of the costs associated with
either the eventual sale or the disposal of the asset in question.
o Present value (discounted) – the present value of an amount that is received at a
future date
 presentation and disclosure
 concepts of capital and capital maintenance
10 STEPS OF ACCOUNTING CYCLE
1. Analyze Transactions
There is no contract unless the following requisites concur:
(1) Consent of the contracting parties;
(2) Object certain which is the subject matter of the contract;
(3) Cause of the obligation which is established.
2. Record transaction into Journals
 General Journal – records non-routine transactions
 Special Journals – Sales, Cash Receipts, Purchases, Cash Disbursements
3. Post transaction into Ledgers
 General Ledgers – per account books
 Subsidiary Ledgers – advisable to be used on accounts that has high volume of
transactions within an accounting period
4. Trial Balance – the history of trial balance traces back when single entry was the system
used and then trial balance is prepared in order to discover mathematical errors, clerical
errors, or posting errors. In a set up where accounting software is deployed, preparation
of trial balance can be eliminated.
5. Adjusting Entries – typically adjustments are made due to the following reasons: to bring
existing journal entries comply with accrual basis of accounting, and to correct errors.
 Accrued Revenues – (also called accrued assets) are revenues already earned but not
yet paid or recorded.
 Unearned Revenues – (or deferred revenues) are revenues received in cash and
recorded as liabilities prior to being earned.
 Accrued Expenses – (also called accrued liabilities) are expenses already incurred but
not yet paid or recorded.
 Prepaid Expenses – (or deferred expenses) are expenses paid in cash and recorded as
assets prior to being used.
 Other adjusting entries – like depreciation of fixed assets, allowances for bad debts,
and inventory adjustments, etc.
6. Adjusted Trial Balance
* In a set up where accounting software is deployed, preparation of trial balance can be
eliminated.
7. Financial Statements
8. Closing Entries – are made to ensure that each revenue and expense account will begin
the next accounting year with a zero balance. The closing entries require that a debit be
entered into each of the temporary accounts having a credit balance.
9. Post-Closing Trial Balance
* In a set up where accounting software is deployed, preparation of trial balance can be
eliminated.
10. Reversing Entries – are optional accounting procedures which may sometimes prove
useful in simplifying record keeping. A reversing entry is a journal entry to “undo” an
adjusting entry. It eliminates the chance of increasing or decreasing accounts that have
already been adjusted.
EXAMPLE OF ADJUSTING ENTRIES
Accrued revenues — Say your company provided $1,600 worth of consulting services to the
Bogus Manufacturing Company over the past month, and today is the end of the accounting
period. The consulting hours will be billed and collected next month, well past when you’ll be
preparing a trial balance, financial statements, closing entries, etc. In this case, you need an
adjusting entry to account for the unbilled services:

Accounts Receivable $1,600.00

Consulting Fees Earned $1,600.00

•Unearned revenues — Bogus Manufacturing Company purchased an annual service contract

from you for $24,000, which they paid up front. If only three months of their contract are within
this accounting period, then that means nine months of the contract’s revenues are unearned. In
order to properly reflect reality, you need an adjusting entry:

Unearned Revenue $18,000.00

Revenue $18,000.00

•Accrued expenses — If you pay weekly salaries and the accounting period ends mid-week, you
have accrued salary expenses that you haven’t yet paid. You’ll need an adjusting entry to reflect
the as-yet unpaid salaries:

Salary Expense $7,200.40

Salaries Payable $7,240.40

•Prepaid expenses — Let’s say you paid $3,000 for your property insurance six months ago, and
you still have six paid months remaining on the policy after this accounting period. To accurately
reflect the value and expense of the remaining policy, you need an adjusting entry:

Insurance Expense $1,500.00

Prepaid Insurance $1,500.00

•Other adjusting entries — Your company purchased $1 million of manufacturing equipment

two years ago, and according to your depreciation schedule it has depreciated by $350,500 this
accounting period. To ensure that your balance sheet doesn’t overstate the equipment’s value,
you need an adjusting entry:

Depreciation Expense $350,500.00

Accumulated Depreciation – Equipment $350,500.00