MODULE IN INCOME STATEMENT

The Income Statement is a formal statement showing the performance of an organization for a given period
of time. It summarizes all the revenues earned and expenses incurred for that period of time.

Information about the performance of an organization, in particular its profitability, is required in order to
assess potential changes in the economic resources that it is likely to control in the future. It is also useful in
predicting the capacity of the organization to generate cash flows from its existing resource base.

Principles / Concepts Related to Income Statement

Periodicity Concept
To provide timely information, accountants have divided the economic life of a business into artificial time
periods. Accounting periods are generally a month, a quarter or a year. A fiscal year is a period of any 12
consecutive months. A calendar year is an annual period ending on December 31. A period of less than a year
is an interim period.

Organizations need periodic reports to assess their financial condition (Balance Sheet) and performance
(Income Statement). This concept ensures that accounting information is reported at regular intervals. It
interacts with the revenue recognition and expense recognition principles to underlie the use of accruals.

Accrual Concept
The financial statements, except for the cash flow statement, are prepared on the accrual basis of accounting
in order to meet their objectives. Under the accrual basis, the effects of transactions and other events are
recognized when they occur and not as cash is received or paid. This means that the accountant records
revenues as they are earned and expenses as they are incurred. The timing of cash flows is relatively
immaterial for determining when to recognize revenues and expenses.

Revenue Recognition Principle

Revenue is recognized when it is probable that economic benefits will flow to the organization and these
economic benefits can be measured reliably according to Philippine Accounting Standards (PAS) No. 18. It
shall be measured at the fair value of the consideration received or receivable. In most cases, revenue is
earned in the accounting period when the services are rendered or the goods sold are delivered.

Expense Recognition Principle

Expenses are recognized in the income statement when it is probable that decrease in future economic
benefits related to a decrease in an asset or an increase of a liability has arisen, and that the decrease in
economic benefits can be measured reliably.

3 broad applications of the principle:

A. Direct Association
Expenses are recognized on the basis of direct association between the costs incurred and the earning of
specific items of income. Examples of these expenses are sales commissions and cost of goods sold. If there is
no sale, then the organization has no commission expense and cost of goods sold.

B. Systematic and Rational Allocation

When economic benefits are expected to arise over several accounting periods and the association with
income can only be broadly or indirectly determined, expenses are recognized in the income statement on
the basis of systematic and rational allocation procedures. Examples of these expenses are those associated
with the using up of assets such as property and equipment (depreciation expenses), allocation of prepaid
rent and insurance. These expenses are incurred regardless of the revenues earned during the period.

C. Immediate Recognition
An expense is recognized immediately in the income statement when an expenditure produces no future
benefits. Examples include officers’ salaries, most selling costs and amounts paid to settle lawsuits.

Purpose of the Income Statement

Per Philippine Accounting Standards (PAS) No. 1, the objective of the income statement is to provide
information about the financial performance of an organization that is useful to a wide range of users in
making economic decisions.

Broad Accounts included in the Income Statement

Generally, the income statement shows the (1) revenues and (2) expenses of the organization which result to
a profit or a loss. A profit occurs when revenues are higher than expenses. A loss occurs when expenses are
higher than revenues.

Analysis of the Income Statement

The income statement accounts can be analyzed using the vertical / common-size analysis. Each account is
stated as a percentage of the net revenues which means that the net revenues is the base, the 100%.

The income statement accounts can also be analyzed using the horizontal / trend analysis. This analysis
involves different comparative periods (example: school year) to evaluate the increases or decreases in a
particular account over a specific time frame.
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MODULE IN DEBIT & CREDIT RULES

THE ACCOUNT

The basic summary device of accounting is the account. A separate account is maintained for each element
that appears in the Balance Sheet (Assets, Liabilities & Equity) and in the Income Statement (Income &
Expenses).

An account is defined as a detailed record of the increases, decreases and balance of each element that
appears in an entity’s financial statements.

The simplest form of the account is known as the “T” account because of its similarity to the letter “T”. The
account has 3 parts as shown below:

Account Title___________
Left SideI Right Side
orIor
Debit SideI Credit Side
I
THE ACCOUNTING EQUATION

The most basic tool of accounting is the accounting equation. This equation presents the resources
controlled by the enterprise, the present obligations of the enterprise and the residual interest in the assets.

It states that assets must always equal liabilities and owner’s equity. The basic accounting model is:

ASSETS = LIABILITIES + EQUITY

Note that assets are on the left side of the equation opposite the liabilities and equity. This explains why
increases and decreases in assets are recorded in the opposite manner as liabilities and owner’s equity are
recorded. The equation also explains why liabilities and equity follow the same rules of debit and credit.

The logic of debiting and crediting is related to the accounting equation. Transactions may require:
1. Additions to both sides (left and right sides)
2. Subtractions from both sides (left and right sides)
3. Addition and subtraction on the same side (left or right side)

In all of these cases, the equality must be maintained.

DEBITS AND CREDITS – THE DOUBLE-ENTRY SYSTEM

Accounting is based on a double-entry system which means that the dual effects of a business transaction
are recorded. A debit side entry must have a corresponding credit side entry. For every transaction, there
must be one or more accounts debited and one or more accounts credited.

Each transaction affects at least 2 accounts. The total debits for a transaction must always equal the total
credits.

An account is debited when an amount is entered on the left side of the account and credited when an
amount is entered on the right side. The abbreviations for debit and credit are Dr. and Cr., respectively.
MODULE IN DEBIT & CREDIT RULES

THE ACCOUNT
The basic summary device of accounting is the account. A separate account is maintained for each element
that appears in the Balance Sheet (Assets, Liabilities & Equity) and in the Income Statement (Income &
Expenses).

An account is defined as a detailed record of the increases, decreases and balance of each element that
appears in an entity’s financial statements.

The simplest form of the account is known as the “T” account because of its similarity to the letter “T”. The
account has 3 parts as shown below:

Account Title___________
Left SideI Right Side
orIor
Debit SideI Credit Side
I

THE ACCOUNTING EQUATION

The most basic tool of accounting is the accounting equation. This equation presents the resources
controlled by the enterprise, the present obligations of the enterprise and the residual interest in the assets.

It states that assets must always equal liabilities and owner’s equity. The basic accounting model is:

ASSETS = LIABILITIES + EQUITY

Note that assets are on the left side of the equation opposite the liabilities and equity. This explains why
increases and decreases in assets are recorded in the opposite manner as liabilities and owner’s equity are
recorded. The equation also explains why liabilities and equity follow the same rules of debit and credit.

The logic of debiting and crediting is related to the accounting equation. Transactions may require:
1. Additions to both sides (left and right sides)
2. Subtractions from both sides (left and right sides)
3. Addition and subtraction on the same side (left or right side)

In all of these cases, the equality must be maintained.

DEBITS AND CREDITS – THE DOUBLE-ENTRY SYSTEM

Accounting is based on a double-entry system which means that the dual effects of a business transaction
are recorded. A debit side entry must have a corresponding credit side entry. For every transaction, there
must be one or more accounts debited and one or more accounts credited.

Each transaction affects at least 2 accounts. The total debits for a transaction must always equal the total
credits.

An account is debited when an amount is entered on the left side of the account and credited when an
amount is entered on the right side. The abbreviations for debit and credit are Dr. and Cr., respectively.
FUNDAMENTAL CONCEPTS

1. Entity Concept – An accounting entity is an organization or a section of an organization that stands apart
from other organizations and individuals as a separate economic unit. The transactions of different entities
should not be accounted for together. Each entity should be evaluated separately.

2. Periodicity Concept – An entity’s life can be meaningfully subdivided into equal time periods for reporting
purposes. It will be aimless to wait for the actual last day of operations to perfectly measure the entity’s net
income. This concept allows the users to obtain timely information to serve as a basis on making decisions
about future activities.

3. Stable Monetary Unit Concept – The Philippine Peso is a reasonable unit of measure and that its
purchasing power is relatively stable. It allows accountants to add and subtract peso amounts as though each
peso has the same purchasing power as any other peso at any time. This is the basis for ignoring the effects
of inflation in the accounting records.

CRITERIA FOR GENERAL ACCEPTANCE OF AN ACCOUNTING PRINCIPLE

The general acceptance of an accounting principle usually depends on how well it meets 3 criteria: relevance,
objectivity and feasibility.

A principle has relevance to the extent that it results in information that is meaningful and useful to those
who need to know something about a certain organization.

A principle has objectivity to the extent that the resulting information is not influenced by the personal bias
or judgment of those who furnish it. Objectivity connotes reliability and trustworthiness. It also connotes
verifiability, which means that there is some way of finding out whether the information is correct.

A principle has feasibility to the extent that it can be implemented without undue complexity or cost.

Conclusion: These criteria often conflict with one another. In some cases, the most relevant solution may be
the least objective and the least feasible.
BASIC PRINCIPLES

1. Objectivity Principle – Accounting records and statements are based on the most reliable data available so
that they will be as accurate and as useful as possible. Reliable data are verifiable when they can be
confirmed by independent observers. Ideally, accounting records are based on information that flows from
activities documented by objective evidence. Without this principle, accounting records would be based on
whims and opinions and is therefore subject to disputes.

2. Historical Cost – Acquired assets should be recorded at their actual cost and not at what management
thinks they are worth as at reporting date.

3. Revenue Recognition Principle – Revenue is to be recognized in the accounting period when goods are
delivered or services are rendered or performed.

4. Expense Recognition Principle – Expenses should be recognized in the accounting period in which goods
and services are used up to produce revenue and not when the entity pays for those goods and services.

5. Adequate Disclosure – Requires that all relevant information that would affect the user’s understanding
and assessment of the accounting entity be disclosed in the financial statements.

6. Materiality – Financial reporting is only concerned with information that is significant enough to affect
evaluations and decisions. Materiality depends on the size and nature of the item judged in the particular
circumstances of its omission. In deciding whether an item or an aggregate of items is material, the nature
and size of the item are evaluated together. Depending on the circumstances, either the nature or the size of
the item could be the determining factor.

7. Consistency Principle – The firms should use the same accounting method from period to period to
achieve comparability over time within a single enterprise. However, changes are permitted if justifiable and
disclosed in the financial statements.

UNDERLYING ASSUMPTIONS

1. Accrual Basis – The effects of transactions and other events are recognized when they occur and not as
cash is received or paid. This means that the accountant records revenues as they are earned and expenses
as they are incurred. The timing of cash flows (inflows/outflows) is relatively immaterial for determining
when to recognize revenues and expenses.

Financial statements prepared on the accrual basis inform users not only of past transactions involving the
payment and receipt of cash but also of obligations to pay cash in the future and of resources that represent
cash to be received in the future.

Generally Accepted Accounting Principles (GAAP) require that a business use the accrual basis.

In Cash Basis Accounting, the accountant does not record a transaction until cash is received or paid.
Generally, cash receipts are treated as revenues and cash payments as expenses. Cash basis income is the
difference between operating cash receipts and disbursements. These cash flows necessarily exclude
investments by and distributions to the owner in the computation of income.
Illustration. A client paid the Club Panoly Resort in Boracay Island Php7,000 on April 8, 2013 for a one-day
super deluxe accommodation on May 13, 2013.

Analysis:
Under Accrual Basis, the receipt of Php7,000 will be considered as revenues when the business has rendered
its services on May 13. Suppose a financial report is prepared at the end of April, no revenue or expense will
be reported.

Under Cash Basis, the hotel will recognize revenues on April 8. Expenses related to this revenue transaction
will be incurred on May 13. Suppose a financial report is prepared at the end of April, revenues of Php7,000
will be reported but the related expenses will be recognized when incurred on May 13.

Observation: The accrual basis provides a better measure of the results of transactions.

2. Going Concern – The financial statements are normally prepared on the assumption that an enterprise is a
going concern and will continue in operation for the foreseeable future. Hence, it is assumed that the
enterprise has neither the intention nor the need to liquidate or curtail materially the scale of its operations.

This assumption underlies the depreciation of assets over their useful lives. If an entity expects to liquidate in
the near future, its assets are valued at their worth at liquidation rather than original cost.

A CLOSER LOOK AT THE BALANCE SHEET

STATEMENT OF FINANCIAL POSITION

What is an asset?
An asset is a resource controlled by the enterprise as a result of past events and from which future economic
benefits are expected to flow to the enterprise. The future economic benefits embodied in an asset may flow
to the enterprise in a number of ways.

• “Controlled by the Enterprise” – Control is the ability to obtain the economic benefits and to restrict the
access of others.
• “Past Events” – The event must be past before an asset can arise. For example, equipment will only
become an asset when there is the right to demand delivery or access to the asset’s potential. Dependent on
the terms of the contract, this may be on acceptance of the order or on delivery.
• “Future Economic Benefits” – These are evidenced by the prospective receipt of cash. This could be cash
itself, an account receivable or any item which may be sold.

In simple terms, assets are valuable resources owned by the entity.

Assets include: (1) Cash (2) Receivables (3) Inventories (4) Prepaid Expenses (5) Property, Plant and
Equipment (6) Investments (7) Intangible Assets

What is a liability?
A liability is a present obligation of the enterprise arising from past events, the settlement of which is
expected to result in an outflow from the enterprise of resources embodying economic benefits.

• “Obligations” – These may be legal or not.

• “Transfer economic benefits” – This could be a transfer of cash or other property, or the provision of a
service.
• “Past transactions or events” – refer to the discussion in assets.

In simple terms, a liability is an obligation of the entity to outside parties who have furnished resources.

Liabilities include (1) Payables (2) Accrued liabilities (3) Unearned revenues

What is equity?
Equity is the residual interest in the assets of the enterprise after deducting all its liabilities.