 Summarizing is the preparation of financial
Principles of
Accounting
DEFINITION OF 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 decision.
COMPONENTS OF ACCOUNTING
 Identifying - This accounting process is the
recognition or nonrecognition of business
activities as "accountable'' events. Not all
business activities are accountable.
Example
1. Company A bought a furniture and fixture for
P100,000 on account. (This is an accountable event.)
Journal Entry:
Furniture and Fixture P100,000
Accounts Payable P100,000
To record the purchase of Furniture and Fixture on
account.
2. The entity celebrated its anniversary
incurring P180,000.
This is not an accountable event because
this is not a business activity.
 Measuring -This accounting process is the
assigning of peso amounts to the accountable
economic transactions and events.
 Communicating - This is the process of
preparing and distributing accounting reports to
potential users of accounting information.
(Through the presentation of financial
statements.)
Implicit in the communication are:
 Recording or journalizing – is the
process of systematically maintaining a record
of all economic business transactions after they
have been identified and measured.
 Classifying is the sorting or grouping of
similar and interrelated economic transactions
into their respective classes. This is
accomplished by posting to the ledger.
The ledger is a group of accounts which are
systematically categorized into asset
accounts, liability accounts, equity
accounts, revenue accounts and expense
accounts.
statements which include the statement of
financial position, income statement, statement
of comprehensive income, statement of
changes in equity and statement of cash flows.
OVERALL OBJECTIVE OF ACCOUNTING
 The overall objective of accounting is to provide
quantitative financial information about a
business that is useful to statement users
particularly owners and creditors, in making
economic decisions.
THE ACCOUNTANCY PROFESSION
 Republic Act No. 9298
-is the law regulating the practice of
accountancy in the Philippines. This law is
known as the “Philippine Accountancy Act of
2004”.
ACCOUNTING EQUATION
 Asset = Liabilities + Equity
 Equity= Asset – Liabilities
 Liabilities= Asset-Equity
TYPES OF MAJOR ACCOUNTS
ACCOUNT
 basic storage of info in accounting
 record of the increases and decreases in a
specific item of asset, liability, equity, income,
and expense.
T-ACCOUNT

ASSETS
 An economic resource is a right that has the
potential to produce economic benefits.
 In layman's language and in short, assets are
properties owned.
 The essential characteristics of an asset are:
a. The asset is controlled by the entity.
 b. The asset is the result of a past event
(Transaction).
c. The asset has the potential to produce
economic benefits.

LIABILITIES

 The essential characteristics of a liability are:

a. The entity has a present obligation.
b. The obligation is to transfer an economic
resource. Specifically, the obligation must be to pay
cash, transfer noncash asset or provide service at some
future time.
c. The liability arises from past event. This means
that the liability is not recognized until it is incurred.

WORKING CAPITAL

 working capital is the excess of current asset.

over current liabilities

 Working capital= current asset – current

liabilities

 Working capital ratio = current assets

current liabilities

EQUITY

 is the residual interest in the assets of the entity

after deducting all of the liabilities.

 Simply stated, equity means net assets or total

assets minus liabilities.

 Equity is increased by profitable operations and

contribution by owners.

 Conversely, equity is decreased by unprofitable

operations and distribution to owners.

 Equity= Total assets - liabilities

ACCOUNTING PROCESS

Steps in the Accounting Cycle – There are 9 basic steps in the accounting cycle, which includes 2 phases known as
recording and summarizing.

RECORDING PHASE

1. Analyzing the transaction (business document)-

 This is where the accountant gathers information from source documents and determines the impact of
the transaction on the financial position as represented by the equation “assets equals liabilities plus
equity”.

2. Journalizing –
 This is the process of recording the transactions in the appropriate journals.
 A journal is a chronological record of transactions also known as the book of original entry.
 Although all transactions could be recorded in the general journal, it is more efficient to use special
journals in recording a large number of like transactions.
 Special journals that enterprises usually use are:
1. Sales Journal – Only sales of merchandise on account are recorded.
2. Cash receipts journal – All types of cash receipts are recorded.
3. Purchase journal – Used to record all purchases on account (merchandise, equipment and supplies).
4. Cash disbursement journal – All payments of cash for any purpose are recorded.

 Type of journal entries according to form:

1. Simple journal entry – One which contains a single debit and a single credit element.
2. Compound journal entry – One which has two or more elements and often representing two or more
transactions. Accounts are the storage units of accounting information and used to summarize changes in assets,
liabilities and equity including income and expenses.

 The following are a broad classification of kinds of accounts:

1. Real account – Statement of financial position or so called permanent accounts. These accounts are
not closed and carryover to the next accounting period. (ex. Cash, AR and PPE)
2. Nominal account – Income statement or temporary capital accounts. These accounts are closed at the
end of the accounting period. (ex. Sales and expenses)
3. Mixed account – A combination of real and nominal accounts. (ex. Prepaid expenses)
4. Clearing account – Holds temporarily certain information pending transfer to other ledger accounts.
5. Controlling account – The general ledger account that summarizes the detailed information in a
subsidiary ledger.
6. Suspense account – Is an account that holds temporarily certain information pending for disposition.
7. Reciprocal account – Has a counterpart in another book with in the entity or in another ledger or
another entity.
8. Principal account – An account that is independent or can stand alone.
9. Auxiliary account – An account that cannot stand alone and are technically neither assets, liabilities
nor income and expenses.
 10. Summary account

3. Posting –
 It is the process of transferring data from the journal to the appropriate accounts in the general ledger and
subsidiary ledger.
 This process classifies all accounts that were recorded in the journals.

 Kinds of ledgers
1. General ledger – Includes all the accounts appearing on the financial statements.
2. Subsidiary ledgers – Affords additional detail in support of certain general ledger accounts.

SUMMARIZING PHASE

4. Preparing the unadjusted trial balance –

 A list of general ledger accounts with their respective debit or credit balance.

 The purpose of the unadjusted trial balance is to provide evidence that the total debits in the general
ledger equal the total credits and prepares the accounts for adjustments.

5. Preparing adjusting entries –

 To take up accruals, expiration of prepayments and deferrals, estimations and other events often not
signaled by new source documents.

 Adjusting entries are made at the end of each accounting period. The concepts involved behind
adjusting entries are ACCRUAL, MATCHING OF COSTS AGAINST REVENUE and ACCOUNTING PERIOD.

6. Preparing the financial statements –

 The most important part of the summarizing phase

 this is where the processed information is communicated to external users.

 Basic financial statements

a. Statement of financial position
b. Income statement or a statement of comprehensive income
c. Statement of changes in equity
d. Statement of cash flows
e. Notes and disclosures

7. Preparing the closing entries –

 Recorded and posted for the purpose of closing all nominal or temporary accounts to the income
summary account and

 the resulting net income or loss is afterwards closed to the capital or retained earnings account.

8. Preparing the post closing trial balance –

 A listing of general ledger accounts and their balances after closing entries have been made.
 The post closing trial balance is the same with the year-end statement of financial position, the only
difference is that valuation accounts like allowances for assets are found in the credit side instead of
being deducted from the related asset account.

9. Preparing reversing entries –

 The last and optional step in the accounting cycle.
  Reversing entries are made at the beginning of the new accounting period to reverse certain adjusting
entries from the succeeding accounting period.

 The purpose of reversing entries is a matter of convenience for accruals and consistency for the
adjustments in the following year for prepaid expenses and deferred income when the income
statement method was used to record the cash flow.

 Once again, reversing entries will only apply to the following but remember that they are not necessary
and only optional:
1. Accrued income
2. Accrued expense
3. Prepaid expense, only if the expense method was used in recording the payment
4. Unearned income, only if the income method was used in recording the collection

BUSINESS TRANSACTIONS

TRANSACTION ASSETS LIABILITIES EQUITY

1. Increase in Asset Decrease in asset

Decrease in Asset Increase in Asset

2. Increase in Asset Increase in Liabilities

Decrease in Asset Decrease in Liabilities

3. Increase in Asset Increase in Equity

Decrease in Asset Decrease in Equity

4. Increase in Liabilities Increase in Liabilities Decrease in Equity

Decrease in Liabilities Decrease in Liabilities Increase in Equity

Examples
1. Bought an Equipment using cash.
Equipment XXX Increase in Asset
Cash XXX Decrease in Asset

2. Bought a Machine on account.

Machine XXX Increase in Asset
Accounts payable XXX Increase in Liabilities
Payment of Machine bought on account.
Accounts payable XXX Decrease in Liabilities
Cash XXX Decrease in Asset

3. Received cash from services performed.

Cash XXX Increase in Asset
Service income XXX Increase in Equity
Payment of salaries to employees.
Salaries expense XXX Decrease in Equity
Cash XXX Increase in Asset

4. Loan for withdrawals of the entity’s owner.

A, Drawings XXX Decrease in Equity
 Loans payable XXX Increase in Liabilities
Accounts payable paid through providing services.
Accounts payable XXX Decrease in Liabilities
Service income XXX Increase in Equity

GENERAL LEDGER (T-ACCOUNTS)

Kinds of ledgers

1. General ledger – Includes all the accounts appearing on the financial statements.

2. Subsidiary ledgers – Affords additional detail in support of certain general ledger accounts.

ASSETS
DR (Normal Balance) CR

Increase Decrease

Ex. Cash, Accounts

Receivable, Supplies

LIABILITIES
DR CR (Normal Balance)

Decrease Increase

Ex. Accounts Payable, Notes

and Mortgage payable

EQUITY
DR CR (Normal Balance)

Decrease Increase

Ex. Expenses and drawings Ex. Service income and

investments
ADJUSTING ENTRY

Adjusting entries are journal entries usually made at the end of an accounting period to allocate income and
expenditure to the period in which they actually occurred.

CLASSIFICATION OF ADJUSTING ENTRIES

DEFFERALS –
 cash paid or received before consumption.

1. Prepaid expenses/insurance: for expenses paid in cash and recorded as assets before they are used

Ex. Acquired insurance paid in advance for one year for P100,000 on July 1, 2019.

Initial entry:
ASSET METHOD EXPENSE METHOD
Prepaid Insurance 100,000 Insurance Expense 100,000

Cash 100,000 Cash 100,000

*In this method, the insurance was treated as an
ASSET as a whole but in December 31, 2019, the
portion of 50,000 (100,000 x 6/12) should be
EXPENSED and the remaining will be left for the
balance of prepaid insurance.
ADJUSTMENT (December 31, 2019)
*In this method, the insurance was treated as an
EXPENSE as a whole but in December 31, 2019, the
portion of 50,000 (100,000 x 6/12) should be put as an
ASSET and the remaining will be left for the balance
of Insurance expense.
ADJUSTMENT (December 31, 2019)

Insurance Expense 50,000 Prepaid Insurance 50,000

Prepaid insurance 50,000 Insurance Expense 50,000

T-ACCOUNT
PREPAID INSURANCE (asset method)
100,000 50,000 (adjustment)

50,000 (Remaining balance)

 INSURANCE EXPENSE (expense method)
100,000 50,000

50,000 (Remaining balance)

2. Unearned revenue: for revenues received in cash and recorded as liabilities before they are earned

Ex. A customer paid 100,000 on October 1, 2019 for one year service.

Initial entry:
ASSET METHOD EXPENSE METHOD
Cash 100,000 Cash 100,000

Unearned Revenue 100,000 Service revenue 100,000

*In this method the Revenue was treated as a
LIABILITY as a whole but in December 31, 2019, the
portion of 25,000 (100,000 x 3/12) should be treated as
INCOME and the remaining will be left for the balance
of Unearned revenue.
ADJUSTMENT (December 31, 2019)
*In this method, the Service revenue was treated as an
Income as a whole but in December 31, 2019, the
portion of 75,000 (100,000 x 9/12) should be treated as
Unearned revenue and the remaining will be left for the
balance of Service revenue.
ADJUSTMENT (December 31, 2019)

Unearned revenue 25,000 Service revenue 75,000

Service revenue 25,000 Unearned revenue 75,000

UNEARNED REVENUE (asset method)

25,000 100,000
75,000 (Remaining balance)

SERVICE REVENUE (expense method)

75,000 100,000

25,000 (Remaining balance)

ACCRUALS –
 cash paid or received after consumption.
1. Accrued expenses: for expenses incurred but not yet paid in cash and not yet recorded

Ex. Sam Company paid salaries for 3 months service, from November 1, 2019 to January 31, 2020 for 30,000.

Adjusting entry (December 31, 2019)

Salaries expenses 20,000

Salaries payable 20,000

*30,000 x 2/3 = 20,000

2. Accrued revenues: for revenues earned but not yet recorded and not yet received in cash

Ex. Dean Company have not yet billed a customer and was only discovered at reporting date.

Adjusting entry (December 31, 2019)

Accounts Receivable XXX

Service Income XXX

Ex. Winchester Company receives interest annually from an investment dated September 1, 2019 for 5,000.

Adjusting entry (December 31, 2019)

Interest Receivable 1,666.67

Interest income 1,666.67

*5,000 x 4/12 = 1,666.67

3. Depreciation: the allocation in accounting statements of the original cost of the assets to periods in which the assets
are used

Adjusting entry (December 31, 2019)

Depreciation Expense XXX

Accumulated depreciation XXX