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Course Code and Title: BAEN1 - Accounting Principles (BSBA)

Lesson Number: 2 Basic Accounting Concepts, Business Transactions, and

Elements

of Financial Statements
Topics : Accounting Concepts and Principles, Elements of Financial
Statements, The Chart of Accounts and Business Transactions

Professor: Ms. Rosario A. Calamba, CPA, MBM, Phd cand

Learning Objectives:

At the end of this lesson, the student should be able to:

• Read and explain the basic accounting concepts and principles.

• Identify the elements of financial statements.
• Create a chart of accounts.
• Illustrate business transactions.
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Pre-Assessment:

Exercise #1 – Multiple Choice:

1.The business is considered as an entity that is separate and distinct from the owner:
a. Accounting Entity c. Business Entity
b. Separate Entity d. All of these
B 2. The accounting assumption that gives the business a continuous life of existence:
c. Periodicity c. Stable Monetary Unit
d. Going Concern d. Accrual
F 3. It represents the residual interest in the assets of the business after deducting its
liabilities:
e. Net Worth c. Capital
f. Owner’s Equity d. All of the above
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C 4. Accounting is the bridge of communication between the owner of the business and
various users through:
a. Balance Sheet c. Financial Statements
b. Income Statements d. Statement of Owner’s Equity

C 5. The records of properties acquired, and services availed of by a business are

maintained in accordance with the:
c. Proprietorship Principle c. Cost Principle
d. Business Entity Concept d. Matching Principle

Exercise #2:

Hanna Grace Co. showed the following account balances. Determine the unknown
accounting values in two (2) separate cases:

Case 1 - Accounts Payable P 40,000

Unearned Income 25,000

Hanna Grace, Capital 207,000

How much is Assets? _____________

Case 2 - Cash in Bank P 70,000

Accounts Receivable 180,000

Estimated Uncollectible Accounts ( 3,000)

Prepaid Expenses 10,000

Supplies Inventory 15,000

How much is Owner’s Equity balance? __________

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Lesson Presentation:

You have studied in the previous lesson the meaning of accounting, the nature and
forms of business organizations, and the users of financial information. The preparation of
financial statements is guided by concepts or assumptions. Accounting concepts or
assumptions are the very foundations of Generally Accepted Accounting Principles
(GAAP). Generally Accepted Accounting Principles are a uniform set of accounting rules,
procedures, practices, and standards that are followed in preparing the financial
statements. They serve as “ground rules” that guide accounting practitioners in recording
(identifying, analyzing, and measuring) and reporting financial information of a business
entity.

ACCOUNTING CONCEPTS / ASSUMPTIONS:

Business Entity / Accounting Entity Concept

- The business is considered as “an entity that is separate and distinct from the owner
or management”.
- The personal transactions of the owner are separate from that of the business.
- There is a clear distinction between the business transactions and personal affairs of
the entrepreneur.
- Each entity should be evaluated separately.
- For example, Mr. Paulo De Jesus started a computer shop business named PTL
Computer by investing P100,000 cash. He purchased computer equipment worth
P50,000, Furniture for P15,000, and supplies worth P10,000. These are the assets
of the business and not of Mr. De Jesus anymore meaning the personal ownership
has been transferred from Mr. De Jesus to PTL Computer shop. If he made a cash
withdrawal of P5,000 for his personal purposes, the withdrawal by the owner from
the business is his private expense and not an expense of the business. It is called
Personal Drawings.
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Going Concern Concept

- This concept means that a business entity will continue to carry on its activities for an
indefinite period meaning that every business enterprise has continuity of life.
- Financial statements are prepared on the assumption that the business will continue
in operation in the future.
- Since business is to continue, fixed assets will be shown at cost less depreciation
basis.
- For example, a company purchases a Machinery & Equipment worth P100,000 and
its Estimated Useful Life is ten (10) years. According to this concept every year
some amount will be shown as expenses and the balance sheet amount as an
asset. Only a part of the value is shown as an expense in the year of purchase and
the remaining balance is shown as an asset.

Periodicity Concept

- The activities of a business entity can be divided into an equal time period like for a
month, quarter, semi-annual, or for a year for financial reporting purposes.
- The usual accounting period is one year. The year that begins from January 1 and
ends on December 31 is called Calendar Year. The year that begins from February 1
and ends after one year is called Fiscal Year.
- All transactions are recorded in the books of accounts on the assumption that profits
on these transactions are to be ascertained for a specified period.
- This concept allows users to obtain timely information to serve as a basis for making
decisions about future activities.

Monetary Unit Concept

- All business transactions are measured and recorded using only one unit of
measurement. Since money is used as a medium of exchange, it is therefore the
most practical unit of measuring financial data. (Manuel, 2018)
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- Without a common unit of measure, it would be impossible to produce financial

statements.
- The Philippine Peso is a reasonable unit of measure and that its purchasing power is
relatively stable.
- Thus, only data measurable in terms of money are recognized and recorded in the
books of the entity.
- For example, Service Income rendered worth P150,000, purchase of supplies
amounting to P15,000, payment of rental worth P10,000, etc., are expressed in
terms of money and so they are recorded in the books of accounts.

BASIC ACCOUNTING PRINCIPLES:

Historical Cost – assets, liabilities, revenues, and expenses should be recorded at their
actual cost. Cost is the amount agreed upon in an arm’s length transaction. It may be
based on cash or its cash equivalent if no cash was exchanged (paid) at the time the
transaction occurred.

Accrual Basis – assets, liabilities, revenues, or expenses should be recognized based on

the period they relate or based on the occurrence of transaction/event rather than based
on cash received or paid.

Matching Principle – revenues and any related expenses should be recognized together
in the same reporting period.

Conservatism / Prudence –it is the inclusion of a degree of caution in the exercise of the
judgments needed in making the estimates required under conditions of uncertainty. The
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preparer must always show a conservative approach while reporting profits, revenues, and
assets.

Materiality – states that an accounting standard can be ignored if the net impact of doing
so has such a small impact on the financial statements. In deciding whether an item or an
aggregate of items is material, the nature and size of the item are evaluated together.

Full Disclosure – all information should be included in an entity’s financial statements that
would affect a reader’s understanding of those statements

Online References:

https://www.accountingtools.com/articles/what-are-the-key-accounting-assumptions.html

https://www.accountingtolols.com/articles/basic-accounting-concepts.html
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CHART OF ACCOUNTS

- A chart of accounts is a listing of all the accounts used by a business in recording the
transactions. The accounts are properly arranged with the assets listed first, followed
by the liabilities, and lastly, the owner’s equity. (Manuel, 2018) An example is as
follows:

CHART OF ACCOUNTS

Acct. No. Account Name Acct. No. Account Name

ASSETS INCOME

110 Cash 410 Service Income

120 Accounts Receivable 420 Sales

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125 Allowance for bad debts 430 Interest Income

130 Notes Receivable 440 Gain

140 Prepaid Expenses

150 Leasehold Improvements EXPENSES

155 Accumulated Depreciation 510 Cost of Sales

160 Equipment 515 Freight Out

165 Accumulated Depreciation 520 Salaries Expense

LIABILITIES 525 Rent Expense

210 Accounts Payable 530 Utilities Expense

220 Salaries Payable 535 Depreciation Expense

230 Utilities Payable 540 Taxes and Licenses

EQUITY 545 Bad Debts Expense

310 Owner’s Capital

320 Owner’s Drawing

THE ELEMENTS OF FINANCIAL STATEMENTS

- The elements of financial statements are the general groupings of the line items
contained within the statements. Financial statements portray the financial effects of
transactions and other events grouping them into broad classes according to their
economic characteristics.

1.BALANCE SHEET

▪ Assets – these are resources controlled by the enterprise as a result of past

transactions and events and from which future economic benefits are expected to
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flow to the enterprise. Assets are classified into two, namely current assets and non-
current assets.
Current assets – refers to all assets that are expected to be sold or consumed
within the normal operating cycle of the business. Examples of current assets are:
o Cash – includes money or its equivalent that is readily available for
unrestricted use.
o Accounts Receivable – these are amounts collectible arising from services
rendered to a customer or client on credit or sale of goods to customers on
accounts. This constitutes an oral or verbal promise to pay by a customer.
o Allowance for Bad Debts – this is a contra-asset account. It provides for
possible losses from uncollected accounts.
o Notes Receivable – receivables supported by written or formal promise to
pay in the form of a promissory note.
o Inventories – these are assets that are held for sale in the ordinary course of
business.
o Prepaid Expenses – account title for expenses that are paid in advance but
are not yet incurred or have not yet expired such as Prepaid Rent, Prepaid
Insurance, Prepaid Supplies, etc.

Non-Current Assets

- Property, Plant and Equipment – “tangible assets which are held by an enterprise
for use in production or supply of goods and services, for rental to others, or
administrative purposes, and which are expected to be used during more than one
period” (International Accounting Standards No. 16) Examples are:
• Land – the site where the building used as office or store is constructed.
• Building – a finished construction owned by the business where
operations and transactions took place.
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• Equipment – various assets such as machinery, transportation

equipment, office equipment, delivery equipment, and store equipment.
• Accumulated Depreciation – this is a contra-asset account. This is a
Valuation Account which is shown as a deduction from property and
equipment.
- Intangible Assets – these are identifiable, non-monetary assets without physical
substance held for use in production or supply of goods or services.
• Liabilities – these are present obligations 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. Liabilities are classified
into two, namely: current liabilities and non-current liabilities. (PAS No.1)
Current Liabilities - financial obligations of the enterprise advance which are
expected to be settled in the normal operating cycle which is within one (1) year.
o Accounts Payable – obligations supported by oral or verbal promise to pay.
o Notes Payable (short-term) – obligations supported by written or formal
promise to pay by the debtor (enterprise) evidenced by a promissory note.
o Salaries Payable – salaries earned by employees but not yet paid.
o Utilities Payable – utilities already consumed but not yet paid o
Unearned Income – cash collected or received in but services have not
yet been rendered.

Non-current Liabilities - these are financial obligations of the enterprise which

are expected to be settled for more than a year.
o Notes Payable (long-term) – it is of the same nature with Notes Payable
(short-term) but only, this requires payment for more than one year.
o Mortgage \payable – a financial obligation of the enterprise which requires
a fixed or tangible property to be pledged as collateral to ensure payment.
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Equity or Capital – net worth or net assets of the enterprise o Owner’s Capital -
is the residual interest in the assets of the enterprise after deducting all its
liabilities.
o Owner’s Drawing – this is the account used for the temporary
withdrawals from the capital balance and then to be closed at the year-end
to the capital account.

2.INCOME STATEMENT:

- is increases in economic benefits during the accounting period in the form of

inflows or enhancements of assets or decreases of liabilities that result in
increases in equity, other than those relating to contributions from equity
participants. (IFRS)
- it summarizes the results of a company’s operations for a period of time. -
The following are the elements of an income statement:
• Revenues or Income - are inflows or settlements of liabilities (or a combination
of both) during a particular accounting period. (Cabrera, 2019)
a. Service Income – revenue earned from the rendering of services
b. Sales – income earned from the sale of goods
c. Interest Income - revenue earned from the issuance of interest-bearing
receivables
d. Gain – income earned from the sale of assets or other activities not
related to the main operations of the business.

• Expenses – refer to decreases in economic benefits during the accounting

period in the form of outflows or depletions of assets or incurrence of liabilities
that result in a decrease in equity, other than those relating to distribution to
equity participants.
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a. Cost of sales or cost of goods sold – refers to the cost to produce and
sell the goods and merchandise
b. Freight Out – transportation expenses of merchandise sold
c. Supplies Expense – this represents the cost of supplies that were used
and consumed during the period
d. Rent Expense – for the amount paid or incurred for use of property,
usually premises
e. Salaries Expense – for compensation given to employees of a business
f. Uncollectible or Bad Debts Expense – for the anticipated loss that the
business may incur arising from uncollectible accounts
g. Depreciation Expense – for the portion of the cost of property and
equipment or fixed assets that have expired based on systematic
allocation procedure
h. Taxes and Licenses – for the amount paid for the business permits,
licenses, and other government dues
i. Insurance Expense – for the expired portion of the insurance premium
paid
j. Utilities Expense – for the telephone, light and water bills (Lopez, Jr.
2018)

Online References:

https://www.accountingcoach.com/blog/elements-of-financial-statements
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BUSINESS TRANSACTIONS

- Business Transactions are exchanges of equal monetary values. This definition

implies the following concept of understanding:
• For every value received, another value is given away as an exchange;
• These values are measured in terms of pesos which are presumed to be equal.
• The business transaction must always have a dual effect and that is for every
value received, we call this Debit, there is an equal value parted with, we call this
Credit.

Debit, Value Received = Credit, Value Parted With

- Examples of Business Transactions:

a. Investment of cash or other assets by owners
b. Borrowings of cash from other entities for business use
c. Sale of goods or services
d. Collection of receivables from customers and other entities
e. Withdrawal of cash or other assets by the owners
f. Payment of borrowings
g. Payment of payables to suppliers or other entities
h. Acquisition of assets or services (either for cash or on credit/account)
i. Consumption or expiration of assets (such as the use of office supplies and
the expiration of insurance and rent, depreciation of fixed assets).

Generalization:
- In this lesson, we have learned about the basic concepts and principles of
accounting based on the Generally Accepted Accounting Principles (GAAP) which
will be the guide in preparing the financial statements. Also, we discussed the
elements of the financial statements, and the business transactions, the nature of the
chart of accounts, and how to prepare it.
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Activity/ Evaluation:
Exercise #1: Accounting Concepts, Assumptions, and Principles:

Multiple Choice: Encircle the letter that best describes the statement.
1. The financial statements should be stated in terms of the common financial
denominator:
a. Accrual c. Time period
b. Going concern d. Stable monetary unit

2. This principle requires relevant information to form part of financial statements for
decision-making purposes:
a. Objectivity c. Adequate disclosure
b. Materiality d. Accounting entity

3. They encompass the conventions, rules, and procedures necessary to define what is
the accepted accounting practice:
a. Accounting concepts
b. Generally accepted accounting principles
c. Conceptual frameworks
d. Accounting assumptions

4. The assumption that an entity will continue to operate for the foreseeable future is
called:
a. Accrual basis
b. Comparability
c. Going concern
d. Relevance

5. The records of properties acquired, and services availed of by a business are

maintained in accordance with the:
a. Matching principle
b. Cost principle
c. Business entity concept
d. Proprietorship principle
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Exercise #2: Elements of Financial Statements

Instruction: Classify the following account titles as to Assets, Liabilities, and Owner’s
Equity (Income, Cost, and Expense). Use a “check mark”.
Owner’s
Asset Liability Equity
1. Cash in Bank __________ __________ __________

2. Unused Office Supplies __________ __________ __________

3. Insurance Expense __________ __________ __________

4. Accrued Income __________ __________ __________

5. Taxes and Licenses __________ __________ __________

6. Juan Dela Cruz, Capital __________ __________ __________

7. Accounts Receivable __________ __________ __________

8. Freight Out __________ __________ __________

9. Accounts Payable __________ __________ __________

10. Sales __________ __________ __________

Reinforcement/ Assignment:
Open a Single Proprietor business of your choice and start creating your business
Chart of Accounts by applying the Elements of the Financial Statements. Submit in a
bond Paper.
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References:

Suggested Textbook:
Lopez, Jr. Rafael M. (2018 Revised Edition) Basic Accounting for Non-Accountants:
Simplified Procedural Approach based on PAS: MS Lopez Printing & Publishing

Additional Materials:
Vera Cruz-Manuel, Zenaida (2017), 21st Century Accounting Process: Concepts and
Procedures: Raintress Trading & Publishing

Ballada, Win (2017), Fundamentals of Accounting: DomDane Publishers

Balatbat-Cabrera, Ma. Elenita (2019), Financial Accounting and Reporting: GIC Enterprises
& Co., Inc.

Online References:
https://www.accountingtools.com/articles/what-are-the-key-accounting-assumptions.html

https://www.accountingtolols.com/articles/basic-accounting-concepts.html

https://www.accountingcoach.com/blog/elements-of-financial-statements
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