Fundamentals of Accountancy,

Business and Management

(FDNACCT)

The Accounting Equation

Outline/Summary

1. Account and Chart of Accounts

2. Complete Set of Financial Statements
3. Elements of the Financial Statements
4. Accounting Equation
What is an Account and a Chart of Accounts?

Account – an accounting device used in summarizing the

effects of transactions (increases/ decreases) on
element of the financial statement.

Chart of Accounts – a listing of all account titles used by

an entity.
What is the purpose of the Financial Statements?

The financial statements are the means by which the

information accumulated and processed in financial
accounting is periodically communicated to the users.

These are the end product or main output of the financial

accounting process.

Financial statements are a structured representation of

the financial position and financial performance of an
entity.
What is the purpose of the Financial Statements?

The objective of financial statements is to provide

information about the financial position, financial
performance and cash flows of an entity that is useful to
a wide range of users in making economic decisions.

Financial statements also show the results of the

management’s stewardship of the resources entrusted to
it.
Complete Set of Financial Statements

1. Statement of Financial Position

2. Income Statement
3. Statement of Changes in Equity
4. Statement of Cash Flows
5. Notes to Financial Statements
Brief description of each component

Statement of Financial Position – summary statement of

the firm’s financial position at a given point in time.

Income Statement (Statement of Financial Performance)

– provides a financial summary of the firm’s operating
results during a specified period of time.

Statement of Changes in Equity – show’s all equity

account transactions that occurred during a given period
of time.
Brief description of each component

Statement of Cash Flows – provides a summary of the

firm’s operating, investing and financing cash flows and
reconciles them with changes in its cash and cash
equivalent during a period of time.

Notes to Financial Statements – explanatory notes keyed

to relevant accounts in the statements; they provide
detailed information on the accounting policies,
procedures, calculations, and transactions underlying
entries in the financial statements.
Elements of Financial Statements

 Relate to financial position

A present economic resource controlled by the entity as
a result of past events.
Asset • An economic resource is a right that has the potential
to produce economic benefits

A present obligation of the entity to transfer an economic

Liability resource as a result of past events.
• An obligation is a duty or responsibility that the entity
has no practical ability to avoid
The residual interest in the assets of the entity after
deducting all its liabilities.
Equity • Financial Instruments with Characteristics of Equity
research project further explores how to distinguish
liabilities from equity
Elements of Financial Statements

 Relate to financial performance

Increases in assets, or decreases in liabilities, that
Income result in increases in equity, other than those relating
to contributions from holders of equity claims.

Decreases in assets, or increases in liabilities, that

Expenses result in decreases in equity, other than those relating
to distributions to holders of equity claims.

Although income and expenses are defined in terms of changes

in assets and liabilities, information about income and expenses
is just as important as information about assets and liabilities.
What is meant by the term “normal operating cycle”?

The operating cycle of an entity is the time between the

acquisition of assets for processing and their realization
in cash or cash equivalents.

When the entity’s normal operating cycle is not clearly

identifiable, it is assumed to be twelve months.
Classification of Assets (Current and Non-current)

An entity shall classify an asset as current when:

a) it expects to realize the asset, or intends to sell or
consume it, in its normal operating cycle;
b) it holds the asset primarily for the purpose of trading;
c) it expects to realize the asset within twelve months
after the reporting period;
d) the asset is cash or a cash equivalent unless the
asset is restricted from being exchanged or used to
settle a liability for at least twelve months after the
reporting period.
An entity shall classify all other assets as non-current.
Common Types of Current Assets

 Cash – money which is available for immediately use

in current operations such as for payment of operating
expenses, for payment of current liability or for
acquisition of current asset. (bills, coins, checks,
money orders, bank drafts)
 Cash Equivalent - are short-term, highly liquid
investments that are readily convertible to known
amounts of cash and which are subject to an
insignificant risk of changes in value.
 Trading Securities (Short-term Investments or
Marketable Securities) - represents short-term
ownership in shares or bonds of other corporations.
Common Types of Current Assets

 Accounts Receivables - amounts owed to the entity by

charge account customers. It represents the entity’s
oral right to receive payment.
 Allowance for Doubtful Accounts - amount estimated
to be uncollectible on accounts receivable. (contra
account)
Accounts Receivable Pxx
Less: Allowance for Doubtful Accounts (xx)
Net Realizable Value Pxx
Common Types of Current Assets

 Notes Receivable – amounts collectible in the near

future from customers which is based on a formal,
written promise to pay at a specified date in the future.
 Advances to Employees - cash given to employees
which are to be liquidated upon completion of a certain
activity for which the advance was requested.
 Accrued Income - income already earned but not yet
received. (e.g. Interest Receivable)
Common Types of Current Assets

 Inventory - goods for sale in the ordinary course of

business. (applicable for merchandising and
manufacturing business).
 Prepaid Expenses - represents certain assets that are
to be used or consumed in operations (e.g. Supplies,
Rent, Insurance)
Common Types of Current Assets

 Cash and Cash Equivalent*

 Trading Securities*
 Trade and Other Receivables* (accounts receivable,
notes receivable, accrued income, advances to
employees)
 Inventories (for sale)
 Prepaid Expenses (for use/consumption)

*The first three items are classified as quick assets

because they can easily be realized (converted to cash).
Common Types of Non-current Assets

 Property, Plant and Equipment - are tangible items

that are held for use in the production or supply of
goods or services, for rental to others, or for
administrative purposes and are expected to be used
during more than one period. (e.g. Land, Building
Machinery and Equipment, Furniture and Fixtures).
 Accumulated Depreciation - aggregate periodic costs
of using a depreciable property. (contra asset)
Cost Pxx
Less: Accumulated Depreciation (xx)
Carrying Amount Pxx
Common Types of Non-current Assets

 Investment Property - property (land or a building—or

part of a building—or both) held (by the owner or by
the lessee as a right-of-use asset) to earn rentals or
for capital appreciation or both.
 Intangible Asset - identifiable non-monetary asset
without physical substance. (e.g. Goodwill, Copyright,
Patent, Trademark, Franchise)
 Long-term Investments - represents long-term
ownership in shares or bonds of other corporations.
 Other Assets - assets that are not classified under the
asset accounts mentioned above.
Classification of Liabilities (Current and Non-current)

An entity shall classify a liability as current when:

a) it expects to settle the liability in its normal operating
cycle;
b) it holds the liability primarily for the purpose of trading;
c) the liability is due to be settled within twelve months
after the reporting period;
d) it does not have an unconditional right to defer
settlement of the liability for at least twelve months
after the reporting period
An entity shall classify all other liabilities as non-current.
Common Types of Current Liabilities

 Accounts Payable - amounts owed by the entity to its

suppliers. It represents the entity’s oral promise to pay
a certain amount.
 Notes Payable - amounts owed/due to the creditors of
the company that is evidenced by a written promise to
pay.
 Accrued Expenses - expenses already incurred but
not yet paid. (e.g. Salaries Payable, Utilities Payable,
Interest Payable, Taxes Payable)
Common Types of Current Liabilities

 Unearned Income/Advances from Customers -

amounts received by an entity representing services to
be rendered or goods to be delivered in the future.
 Provision/Estimated Liability – a liability of uncertain
timing or amount (e.g. litigation, warranty)
Common Types of Non-current Liabilities

 Loans Payable - is a liability to pay a bank or a

financing institution for the amount of money borrowed
by the business.
 Mortgage Payable - account used for the unpaid cost
of real properties (like land and building) and is
secured by such properties of the entity.
 Bonds Payable - long-term promise (usually from five
to ten or twenty years) issued by corporations that are
supported by a formal contract containing the face
value of the bond, the interest rate, the interest
payment date and the maturity date.
Capital

Similar terms used in different context:

 Equity (for businesses)
 Net Assets (for non-profit organizations)
 Net Worth (for individuals, e.g. SALN)

For businesses:
 Owner’s Equity (for sole proprietorship)
 Partners’ Equity (for partnership)
 Shareholders’ Equity (for corporations – Share Capital
and Retained Earnings)
Income

Revenue – arises in the course of ordinary regular

activities of an entity (entity’s principal line of activity)
 Service Revenue (for sale of services)
 Sales Revenue (for sale of goods)

Other income/gains - represents the revenue and gains

from peripheral or incidental transactions of the entity.
Income

Examples of Other Income:

 Interest Income - derived by a payee from lending a
principal amount of money or income earned from
money deposited in a bank
 Dividend Income - earned in investing cash in shares
of other companies.
 Rent Income - income earned from allowing others to
use a property or facility of the entity.
 Royalty Income – income earned from allowing
someone the use an entity’s patents, copyrighted
works, natural resources, or franchises.
Expenses

Cost of Sales/Cost of Goods Sold – represents the cost

of buying/manufacturing merchandise which were sold.

Operating Expenses – costs incurred in the operations

(ordinary course) of the business.
 Distribution Costs/Selling Expense – constitute costs
which are directly related to selling, advertising and
distribution/delivery of goods to customers.
 Administrative Expenses – constitute cost of
administering the business. Include all operating
expenses not related to selling and cost of goods sold.
Expenses

 Other Expenses/Losses - those expenses which are

not directly related to the distribution and
administrative function.
(includes miscellaneous expense - other costs of operations that
may not be sufficiently big in amount to be classified separately)

Finance Cost/Interest Expense – costs incurred as a result

of borrowings (loans or notes) made. This is usually
presented separately from operating expenses.
Expenses

Examples of Operating Expenses:

 Salaries and Wages Expense - cost of services
rendered by the employees or laborers of a business
firms, including benefits provided.
 Rent Expense - cost of renting a facility or an
equipment.
 Supplies Expense - cost of coupon bonds, ballpens,
envelopes and other supplies consumed/used in
business operations.
 Utilities Expense - cost of power, light, water and
telephone usage for a period.
Expenses

Examples of Operating Expenses:

 Taxes and Licenses Expense - cost of all local and
national taxes that are incurred and required to be
paid in connection with the conduct of business.
 Transportation Expense - cost incurred by office
employees when commuting from the office to the
place of business of clients.
 Gas and Oil Expense – cost of oil and gas consumed
whenever company vehicles are used for official
business travels.
 Insurance Expense - amount of insurance policy
incurred during the period.
Expenses

Examples of Operating Expenses:

 Representation and Entertainment Expense - cost
incurred in entertaining future clients (lunch outs,
dinners etc.) and costs incurred by employees when
they represent the firm on official business functions.
 Doubtful Accounts Expense - estimated amount of
losses from uncollectible accounts arising from credit
customers during the period.
 Depreciation Expense - current periodic cost for using
depreciable plant assets.
The Accounting Equation

ASSETS CLAIMS

ASSETS LIABILITY CAPITAL

(Resources) (Creditors/Lenders) (Investors)
The Accounting Equation (Practice)