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Qualifying Exam Reviewer 2
Qualifying Exam Reviewer 2
THEORIES FROM
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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 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.
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.
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
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
According to Operations of Activity – business is classified based on the nature of its activities
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
Public Accountants – are those who serve the general public and collect professional fees for their work
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
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
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
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
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
Total Assets of the business is exactly equal in amount to the sum of the Total Liabilities and the Capital
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
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
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
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
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
Gas and Oil – refers to the cost of gas and oil consumed
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
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
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
Statement of Cash Flows – reports the firm’s receipt and disbursement of cash which are classified
according to the company’s major 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
Net Pay – the remaining cash after deducting the following from the salary:
Components:
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
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
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
Discounting Own Note – creditor would collect interest the same day the loan was granted