QUALIFYING EXAM REVIEWER

THEORIES FROM

VARIOUS BASIC ACCOUNTING HANDOUTS

BY DLSU PROFESSORS AND STUDENTS

Prepared by:

Laron Yvette Vicente de Ocampo

ACTBAS1

INTRODUCTION TO ACCOUNTING
Bookkeeping and Accounting Distinguished

Bookkeeping – a procedural element of accounting which primarily deals with the systematic method of
recording and classifying financial transaction of business

Accounting – as defined by the American Institute of Certified Public Accountants (AICPA), is the art or
recording, classifying and summarizing in a significant manner and in terms of money, transactions and
events that are, in part at least, of a financial character, and interpreting the results thereof

 as defined by the Philippine Institute of Certified Public Accountants, is a system that measures
business activities, processes given information into reports, and communicates those findings to
decision-makers

Accounting as the “Language of Business”

Accounting is often referred to as the language of business because it is the medium of communication
between a business firm and various parties interested in its financial activities by providing quantitative
financial information through financial statements.

Major information needed is as follow:

Financial Condition or Position – amount and kinds of its assets and liabilities

Financial Performance or Results of Operations – whether the operating activities of the business
resulted to net income or net loss

Financing and Investing Activities – sources and applications of fund which are responsible for the
changes in the financial resources of the business during a given period of time
Brief History of Accounting

The development of accounting is a result of Italian merchants’ needs of information. In that commercial
climate, Luca Pacioli published the first known description of double-entry bookkeeping entitled Summa
de Arithmetica, Geometria, Proportioni et Proportionalite (Everything about Arithmetic, Geometry and
Proportion) published in Venice in November 1494.

The pace of accounting development increased during the Industrial Revolution as the economics of
developed countries began to mass-produce goods. Merchandise was price-based on managers’
hunches about cost until competition required merchants to adopt more sophisticated accounting
system.

The growth of corporation during the 19 th century spurred the development of accounting. Corporate
owners were no longer necessary the managers of their business. Managers then, had to create
accounting systems to report to the owners the status of the business.

Accounting supplied the concept of income. When the government started using the income tax, it
further helped accounting develop. Also, government at all levels has assumed expanded roles in health,
education, labor and economics planning. To ensure that the information that it uses to make decisions
is reliable, the government has required strict accountability in the business community.

At the beginning of third millennium, there would still be a lot of developments in the field of
accounting. The great challenge of globalization and the effects of new technologies pose a shift in the
structure and pattern in this field. More and better information are now being required and therefore,
accounting, being the means in communicating business and financial information must also evolve into
a more efficient level.

Users of Financial Statements

Internal Users – those who are directly involve in the business

 Owners – those who provide the money/capital in the business who would need accounting
information to properly manage and monitor the business and analyze whether or not they can
expect reasonable return from their investment
 Management – uses accounting information to set goals for the organization, to evaluate the
progress made toward those goals and to take corrective actions if necessary
 Employees – uses accounting information to assess the ability of the enterprise to compensate
for the services, industry or labor they are contributing to the business, to provide retirement
benefits and other employee opportunities and benefits

External Users – those who are indirectly involved in the business

 Potential Investors – use accounting information to evaluate what income they can reasonably
expect from their investment
  Creditors – use accounting information to determine the business’ ability to meet scheduled
payments
 Customers – use accounting information to know whether the business will continue operating
especially when they have long-term involvement with, or are dependent on that company’s
offerings of either services or goods
 Taxing Authorities – use accounting information to determine the amount of tax that should be
charged to the business
 Government Regulation Agencies – use accounting information to determine regulatory
activities to be imposed to the business
 Nonprofit Organization – use accounting information the same way the profit-oriented
businesses do
 Other Users – use accounting information to know that amount of income the company is
earning

Forms of Business Organization

According to Ownership – business is classified based on owner/s investing or putting capital on a

business being started

 Sole or Single Proprietorship – only one person makes the investment

 Partnership – two or more persons, who are therefore called partners, agree to operate the
business
 Corporation – a body formed and authorized by law to act as a single person although
constituted by one or more persons, called the stockholders/shareholders, and legally endowed
with various rights and duties

According to Operations of Activity – business is classified based on the nature of its activities

 Service Concern – rendering of services for a fee

 Merchandising or Trading Concern – buying and selling of goods
 Manufacturing Concern – processing of products or conversion of raw materials into finished
goods that are then sold

Basic Accounting Concepts

Generally Accepted Accounting Principles (GAAP) – are concepts which are developed by the
accounting profession over the years to serve as ground rules that govern how accountants measure,
process and communicates financial information and to provide a consistent system of financial
reporting in a constantly changing business environment

 Entity Concept – business is regarded as having a separate and distinct personality from that of
the owner/s – generating its own revenue, incurring its own expenses, owning its own assets
and owing its own liabilities thus, personal transactions of the owner/s must not be combined
with the transaction of the business
 - Business Transactions – events that can be measured in terms of money that affects the
enterprise
 Monetary Concept – money is used as the unit of measure in preparing various financial reports
of the company
- Stable Money Concept – assumes that monetary unit does not change overtime, even if in
fact it does
 Time Period/Periodicity Concept – divides the life of the business into regular intervals at the of
which financial statements are prepared (usually one year)
- Calendar Year – a twelve-month period beginning with January 1 and ending December 31
- Fiscal Year – does not start with January 1 and end on December 31
 Revenue Realization Concept – income is recognized when earned regardless whether cash is
received as long as it meets the following conditions:
 when services are fully rendered
 when goods or merchandise are fully delivered
- Income – is the inflow of assets that results from producing goods or rendering services
 Accrual Concept – income be recorded when earned regardless whether cash is received and an
expense be recognized when incurred
 Accrual Method of Accounting – attempts to record the financial effects on a company of
transactions and other events and circumstances in the periods in which those transactions,
events and circumstances occur rather that only the periods in which cash is received or
paid by the firm
 Cash Basis – records a journal entry upon exchange of cash, typically does not require many
adjusting entries
 Matching Concept – all expenses incurred to generate revenues must be recorded in the same
period that the income are recorded to properly determine net income or net loss of the period
 Revenues – inflows of resources from providing goods or services to customers
 Expenses – outflows of resources incurred in generating revenue
 Objectivity/Reliability Concept – all transactions must be evidenced by business documents
free from personal biases and independent experts can verify reports
 Cost Concept – assets are acquired in business transactions conducted at arm’s length
transactions – transactions between a buyer and a seller at a fair value prevailing at the time of
the transaction
 Going Concern Concept – assumes that the business is to continue its operations indefinitely
meaning, the business will stay in operation for a period of time sufficient to carry out
contemplated operations, contracts and commitments
 Conservatism Concept – assumes that when uncertainty exists, the users of financial statements
are better served by understatement than by overstatement of net income and assets
 Consistency Concept – states that once a method is adopted, it must not be changed from year
to year to allow comparability of financial statements between years and between businesses
 Materiality Concept – refers to relative importance of an item or event
  Material – if knowledge of it would influence the decision of prudent users of financial
statements
 Disclosure Concept – all relevant and material event affecting the financial condition/position of
a business and the results of its operations must be communicated to users of financial
statements in variety of ways:
 Parenthetical Comments/Modifying Comments - placed on the face of the financial
statements
 Disclosure Notes – conveying additional insights about company operations, accounting
principles, contractual agreements and pending litigation
 Supplemental Financial Statements – report more detailed information that is shown in
the primary financial statements

The Accounting Profession

Public Accountants – are those who serve the general public and collect professional fees for their work

Private Accountants – work for a single business

Certified Public Accountants (CPA) – professional accountant who earns his title through a combination
of education, qualifying experience and an acceptance score in the written national examination given
by the Board of Accountancy – prepares grades and gives results of the examination to the Professional
Regulation Commission (PRC) – who then issues licenses that allow qualifying examinees to practice
accounting as CPAs

Ethical Values – provide foundation on which civilized society exists whose purpose in the business
world is to direct business men and women to abide by a code of conduct that facilitates public
confidence in their products and services

 Honesty
 Integrity
 Promise-keeping
 Fidelity
 Fairness
 Caring
 Respect for Others
 Responsible Citizenship
 Pursuit of Excellence
 Accountability

MEASURING AND REPORTING FINANCIAL POSITION

Forms of Statement of Financial Position

Statement of Financial Position – shows what the business is worth in terms of the properties it owns,
the debts it owes and the investment of its owners

Account Form – assets are listed on the left side of the report and the liabilities and proprietorship on
the right side

Report Form – shows assets on the tope section of the statement and the liabilities and owner’s equity
on the bottom section

Parts of the Statement of Financial Position

Statement Heading – name of the business, kind of statement and the date

Asset, Liability and Proprietorship – special captions on which items are grouped

Captions – classifications of each group appearing on the left margin of the statement

Account Titles – individual account titles are indented

Current Assets – listed in order of their liquidity

Plant, Property, Equipment – listed in order of their expected useful life

Note (#) – explaining in detail the aggregated amount presented on the face of the financial statement

Current Liabilities – listed in order of due date with the earliest due date appearing first

Captions Indicating Totals – group of items which is indented further

Single Rule Line – last figure in each group

Final Totals – double ruled

Peso Sign – are used (a) to the left of the first amount of a group of amounts being combi ned and (b) to
the left of each final total

Peso Amount – shown in one column

The Accounting Equation

Total Assets of the business is exactly equal in amount to the sum of the Total Liabilities and the Capital

ASSETS = LIABILITIES + OWNER’S EQUITY

Assets – includes anything owned or possessed by the business which represents the resources of the
business
  Current Assets
 Cash
 Investment in Trading Securities
 Notes Receivable
 Interest Receivable
 Accounts Receivable
 Advances to Employees
 Merchandise Inventory
 Accrued Income
 Supplies on Hand
 Prepaid Insurance
 Prepaid Rent
 Non-Current Assets
 Land
 Building
 Equipment
 Furniture and Fixtures
 Accumulated Depreciation

Liabilities – economic obligations payable to an individual or an organization outside the business

 Current Liabilities
 Accounts Payable
 Notes Payable
 Interest Payable
 Deferred Income
 Taxes Payable
 Non-Current Liabilities
 Notes Payable Long Term
 Installment Contracts Payable
 Mortgage Payable

Owner’s Equity – claim of an owner of a business over the assets of the business after the claims of the
creditors have been satisfied

 Capital
 Withdrawal

MEASURING AND REPORTING FINANCIAL PERFORMANCE

Forms of Income Statement

Income Statement – summary of the results of business operations covered in an interval known as the
accounting period, which shows whether or not the business achieved its primary objective of earning
profit or net income

Natural Form – arranges all income accounts in one group, all expense accounts in another group and
then deducts the total expenses from the total income in a single-step operation of subtraction to arrive
at the final result of net income or net loss

Functional Form – clearly shows specific sections of income, costs and expenses in a series of arithmetic
operations and requires that cost of goods sold and expenses be subtracted in steps to arrive at the net
income

Income Accounts

Service Income – income from services rendered

Other Income – refers to income from sources other than the principal line of activity of the business

 Interest Income – revenue to the payee for loaning out a principal amount to a borrower
 Dividend Income – income earned in investing cash in stocks of other businesses

Expense Accounts

Salaries – cost of services rendered by employees

Rent – rental cost of office space, equipment, etc

Office Supplies – refers to the cost of office supplies used

Utilities – refers to the cost of light, water and telephone facilities used

Taxes and Licenses – refers to all payments required to be made to the Bureau of Internal Revenue

Transportation – cost incurred by office employees when commuting from the office to the place of the
business of clients

Traveling – used when business trips are made out of town

Gas and Oil – refers to the cost of gas and oil consumed

Representation – cost incurred when entertaining clients or prospective clients

Depreciation – refers to the expense associated with the use of the company’s PPE

Bad Debts – allocation or provision for this future uncollectibility of some of the accounts of credit
customers
Donations and Contributions – refers to the contribution made to charitable institutions or any other
worthwhile projects

Miscellaneous – any other costs of operations that may not be sufficiently big in amount to be classified
separately are charged to this account

MEASURING AND REPORTING CHANGES IN EQUITY

Statement of Changes in Owner’s Equity/Capital Statement – presents a summary of the changes that
occurred in the owner’s equity of the entity during a specific time period

 opens with the owner’s capital balance at the beginning of the period, add net income (deduct in
case of net loss), add additional investment, subtract withdrawals and the statement ends with
owner’s capital balance at the end of the period

Withdrawals – withdraw assets for personal use

 Temporary Withdrawal – withdraw business assets for personal use in anticipation of profits
 Permanent Withdrawal – capital withdrawal that is substantial in amount wherein the owner
intends to remove the assets permanently from the business operations

MEASURING AND REPORTING CASH FLOWS

Forms of Statement of Cash Flows

Statement of Cash Flows – reports the firm’s receipt and disbursement of cash which are classified
according to the company’s major activities:

 Operating – cash effects of revenue and expense transactions

 Investing – relating to investing activities involving plant assets, intangible assets and
investments
 Financing – result from debt and financing activities

Direct Method – list the receipts of cash from specific operating, investing and financing activities

Indirect Method – normally used by companies that employ accrual method rather than cash method in
their accounting system

Usefulness of the Statement of Cash Flows

 Company’s ability to produce future cash flows

 Firm’s ability to meet current and future obligations
 The reasons for the difference between net income and net cash provided (used) by operating
activities
 The cash investing and financing transactions during the period
ACCOUNTING FOR SALARIES
Recording Salary Expense

Payroll Register – the summary of employees

Net Pay – the remaining cash after deducting the following from the salary:

 Social Security System

 Philhealth
 PAG-Ibig
 Withholding Income Tax

ACCOUNTING FOR PROMISSORY NOTE

Promissory Note – an unconditional promise to pay a definite sum of money on demand or at a future
date

Components:

 Maker – person who signs the note

 Payee – the person to whom the promise to pay is made
 Principal Amount – the amount loaned by the payee
 Interest – the cost of borrowing the principal amount
 Interest Period- the period of time during which interest is to be computed
 Interest Rate- percentage rate that is multiplied to the principal amount and the term of note
 Maturity Date – date when payment is due
 Maturity Value – sum of principal and interest
 Place of Issue – locality where maker executed the note

Typical Transactions

 The client receives services of goods and issued promissory note as payment
 The client has an outstanding account and wishes to extend the payment of his account
 A loan is extended to a borrower who issues promissory note

Interest on Note

Promissory note may either be:

 Interest Bearing – provides payment for interest so that the amount paid at maturity date is the
maturity value – principal plus interest
 Non-Interest Bearing – does not provide any payment for interest so the amount that would be
paid on maturity date is exactly the same as the face value of the note
Discounting a Note Receivable

Discounting a Note Receivable – endorsing a note before maturity during which the payee would
receive lesser amount than the maturity value – the price the payee is willing to pay for wanting to
receive cash earlier

Endorsing may either be:

 With Recourse – there is a contingent liability on the part of the endorser (payee), which is
equal to the maturity value plus any protest fee, in any case that the bank does not collect any
payment from the payer or maker of the note
 Without Recourse – words “Without Recourse” must appear at the back of the note
- exempts the endorser for any contingent liability

Contingent Liability may be presented in the Statement of Financial Position as:

 Contingent Liability on the Liability side

 Deduction from Notes Receivable
 Footnote to the Statement of Financial Position with the Notes Receivable reported at net
amount
 Parenthetical Note in the Notes to the Financial Statements

Discounting Own Note Issued

Discounting Own Note – creditor would collect interest the same day the loan was granted

GENERAL JOURNAL, GENERAL LEDGER AND TRIAL BALANCE

Accounting Cycle – a series of sequential steps done every accounting period

 Journalizing – chronological recording of business transactions in the journal – book of original

entries
 Posting to the General Ledger – summary of the journalized accounts in the ledger – book of
final entry – which may be posted in two forms:
 Standard Form
 Running Balance Form
Chart of Accounts – lists of account titles being used by the business in its operations
 Preparing Trial Balance – a list of schedule of open accounts in the general ledger with their
corresponding balances
- prepared to verify the equality of all the debits and credits
 Preparing Worksheet – an optional step in the accounting cycle but greatly aids in preparation
of the financial statements
 Adjusting Entries – done with the purpose of updating some accounts to prevent their
overstatement or understatement
 Preparing Financial Statements – the end points of the whole accounting cycle
 Closing the Books – done with the purpose of closing all the nominal accounts to the capital
 Preparing Post-Closing Trial Balance – presents only real accounts which will be carried on to
the next accounting period
 Reversing Entries – done with the purpose of bringing back entries to their original amounts