Accounting 101

Chapter 1: Introduction to Accounting

Definition of Accounting
It is a process of identifying, recording, and communicating economic
information useful in making economic decisions.
It is a service activity. Its function is to provide quantitative information,
primarily financial in nature, about economic entities that are intended to be useful
in making economic decisions and in making reasoned choices among alternative
courses of action.

Essential Elements
o Identifying
o Analyzes each business transaction, whether it is a non-accountable or
accountable event.
o Only accountable events are recorded in the book of
accounts/record/journal.
o Recording
o It is the process of recording accountable events. It is also called
journalizing.
o After recording, the accountant classifies the events. This is called
posting.
o Communicating
o It is the process of summarizing the information to produce meaningful
reports. Information is communicated to interested users in the form of
financial statements.
Types of Information Provided by Accounting
1. Quantitative Information
2. Qualitative Information
3. Financial Information

Functions of Accounting in Business

1. To provide external users with useful information in making investment
and credit decisions.
2. To provide internal users with information that is useful in managing the
business.

Trivia
Fra Luca Bartolomeo de Pacioli, a Franciscan monk and mathematician, is
the father of accounting. The “double entry recording system” was included in
Pacioli’s book titled “Summa de Arithmetica Geometria Proportioni and
Proportionista,” published on November 10, 1494, in Venice.

Branches of Accounting
1. Financial Accounting
o General record-keeping (e.g., maintenance of journals or ledgers).
o It is the actual accounting process.
o Reports general financial information

2. Management Accounting
o Preparation of specifically tailored management reports.
o Reports specific financial information

3. Government Accounting
 o General record-keeping and preparation of financial reports for the
government and its agencies (e.g., preparations of budgets and
accountability reports).
o It deals with the receipt and disposition of public funds.
4. Auditing
o Expression of an opinion (i.e., financial statement) on the correspondence
between management assertions and established criteria.
o Auditing is checking and verifying financial statements if it is correct.
o The most common form of opinion is the Independent Auditor’s Report.

5. Tax Accounting
o Preparation of tax returns.
o Providing tax advice.

6. Cost accounting
o Analyses of cost of products and services.

7. Accounting Education
o The teaching of accounting and other related subjects.

8. Accounting research
o Accounting research papers, articles, and other similar publications.
o There are two types of accounting research- academic and
economic/industrial research.

Users of Accounting Information

1. Internal users
o Those who are directly involved in managing the business. They need
accounting information for decision-making.
Examples:
• Business owners who are directly involved in managing the business
• Board of directors
 • Managerial personnel

2. External users
o Those who are not directly involved in managing the business.
Examples:
• Existing and potential investors (e.g., stockholders who are not
directly involved in managing the business)
• Lenders (e.g., banks) and Creditors (e.g., suppliers)
• Non-managerial employees (e.g., normal employees).
• Public

Forms of Business Organizations

1. Sole propriety
o One owner/individual
o Registered in the Department of Trade and Industry (DTI).

2. Partnership
 o More than one (i.e., partners)
o Formed by contractual agreement
o Two people contribute money, property, or industry to a common fund
with the intention of dividing the profits among themselves.
o Registered in the Securities and Exchange Commission (SEC).

3. Corporation
o More than one (i.e., stockholders)
o It is an artificial being; for example, it can sue and be sued.
o Formed by operation of law
o Registered in the Securities and Exchange Commission (SEC).

4. Corporation
o More than one (i.e., members)
o Formed with the Cooperative Code
o Registered in the Cooperative Development Authority (CDA).
Types of Business According to Activities
1. Service business
o Service businesses generally utilize their employees to provide intangible
products or services to customers. They perform services for a fee. These
services include professional skills, advice, expertise, and other related
products (e.g., catering, airlines, healthcare, barber shops, repair shops).
2. Merchandising (Trading)
o Unlike service businesses, merchandising businesses sell tangible
products. This type of business buys finished or almost finished goods
from their suppliers and resells the same to customers (e.g., retail
business, sari-sari stores, markets).
o Keyword: Buy goods, then sell.
3. Manufacturing
o As the name suggests, manufacturers create their own products. They use
raw materials, components, or parts that are processed using machines,
computers, and labor to produce finished goods. They create and sell
their own products (e.g., automotive companies, bakeries, shoemakers
and tailors, car makers).
o Keyword: Manufacture goods then sell.

Chapter 2: Accounting Concepts and Principles

Generally Accepted Accounting Principles (GAAP)
It refers to a common set of accounting principles, standards, and procedures
issued by the Financial Accounting Standards Board (FASB).
In the Philippines, the PFRSs are Standards and Interpretations adopted by
the Financial Reporting Standards Council (FRSC). They consist of the following:
1. Philippine Financial Reporting Standards (PFRSs)
2. Philippine Accounting Standards (PASs)

Concepts and Principles

1. Separate Entity Concept

o The business is viewed as a separate entity. Only the transactions of the
business are recorded in the books of accounts: personal transactions are
not.

2. Historical Cost Concept (Cost principle)

o Assets are initially recorded at their acquisition cost.

3. Accrual Basis of Accounting

o Income/revenue is recorded when it is earned rather than when it is
collected. Expenses are recorded when it happens rather than when it is
paid. Both are recorded regardless of when cash is received or paid.

4. Going Concern Assumption

o The business is assumed to continue to exist for an indefinite period of
time, and the company closure is not imminent.
o The principle says, “Record transactions as if there is no closure of
business.”

5. Stable Monetary Unit

o Transactions are expressed in a monetary unit of measure (currency).
o For example, in the Philippines, Php is used in transactions. In Japan, yen
and so on.
6. Time/ Reporting Period
o The life of the business is divided into a series of reporting periods.
o Transactions are summarized and reported at regular time intervals.
o Example:
o Calendar Year (January 1- December 31)
o Fiscal Year (Any starting point + 12 months)

7. Full Disclosure Principle

o All of the information needed should be included so that the readers of
the financial statements will have informed judgment.
o There should be no hidden information

8. Matching
o Matching revenues with expenses to know the profit of the business. The
revenue from business activities and the expenses associated with earning
that revenue are recorded in the same accounting period.
o For instance, comparing revenues with expenses to know if you profited
or lost.

9. Materiality
o An item is considered material if its omission or misstatement could
influence economic decisions. Materiality is a matter of professional
judgment and is based on the size and nature of an item being judged.
o For example, if there was a lack of Php 1000 (due to a mistake) in Php
1000000, then it is not considered material. However, if there was a lack
of Php 100000 (due to a mistake) in Php 1000000, then it is considered
material because it can affect the decision/action of the owner.

10. Objectivity
o Recording and reporting process should be free from bias.
o When recording/reporting, “Walang labis, walang kulang.”

11. Consistency concept

o Like transactions are accounted for in like manner from period to period.
 12. Prudence
o If there is a choice between a potentially unfavorable outcome and a
potentially favorable outcome under conditions of uncertainty, the
unfavorable one is chosen.
o Inventory is recorded at a lower cost or net realizable value rather than
the expected selling price. This ensures profit on the sale of inventory is
only realized when the actual sale takes place.
o Owners/managers of a business should not be overly optimistic, as this
could lead to profits being inflated and deceptive to financial statement
users.

13. Cost-benefit
o The costs of processing and communicating information should not
exceed the benefits to be derived from the information’s use.
o Huwag kumuha nang mas marami sa kailangan.

Qualitative Characteristics of Useful Financial Information

I. Fundamental Qualitative Characteristics

- These are the characteristics that make information useful to
users.

1. Relevance
- Information is relevant if it can affect the decisions of users.
Relevant information has the following:
o Predictive value
- the information can be used in making predictions.
- Example: Sales in years one and two increase 10% each, then
you can predict in year three it will also increase 10%.

o Confirmatory value
- the information can be used to confirm past predictions.
 - Example: If you predict a 10% increase in year three, then it
actually happens; you confirm what happened.

2. Faithful Representation
- It means the information provides a true, correct, and complete
depiction of what it purports to represent.
Faithfully represented information has the following:
o Completeness
- all information necessary for users to understand should be
included.

o Neutrality
- information is selected or presented without bias.

o Free from error

- there are no errors in the description and in the process by
which the information is selected and applied.

II. Enhancing Qualitative Characteristics

- These are the characteristics that enhance the usefulness of the
information.

1. Comparability
- identifying similarities and differences between different sets of
information
- Example: Comparison of financial reports in years one and two.

2. Verifiability
- different users/accountants should reach an
agreement/consensus as to what the information (financial
statement) purports to represent
- there should be supporting documents when verifying

3. Timeliness
 - Information, records, and reports should be timely so they will
still be relevant and can influence decisions.

4. Understandability
- Financial reports should be understandable by knowledgeable
users (e.g., accountants).

Chapter 3: The Accounting Equation

The Accounting Equation

Assets = Liabilities + Equities

Resources
Claims of the owner
Claims of Creditors

Definition of Terms

Assets
o Are the resources controlled by the entity as a result of past events and can
provide future economic benefits.
o It is something you yourself should own.
Example: cash, land, equipment, office supplies, automobiles

Liabilities
 o Is a present obligation (utang) of the entity arising from past events and can
require you to give up economic resources when settling them.
Example: accounts payable, notes payable, loans

Equity/Capital
o Is the residual interest of the entity after deducting all its liabilities

Income (Kita)
o is increases in economic benefits during the period in the form of increases
in assets, or decreases in liabilities, that result in increases in equity,
excluding those relating to investments by the business owner.
Example: product sales, service sales

Expenses
o are decreases in economic benefits during the period in the form of
decreases in assets, or increases in liabilities, that result in decreases in
equity, excluding those relating to distributions to the business owner.
Example: salaries, repairs, rent, fees
Profit or Loss
o The difference between income and expenses represents profit or loss.

Accounting Formula

A= assets I= income
L= liabilities Ex= expenses
Eq= equity Pr/L= Profit or Loss

Formula
Assets = L + E
Liabilities = A – E
Equity = A – L
Income = Pr/L + Ex
Expenses = Pr/L – I
Profit/Loss = I – Ex
The Expanded Accounting Equation
Assets = L + Eq + I – Ex
Liabilities = A – Eq – I + Ex
Equity = A – L – I + Ex
Income = A – L – Eq
Expenses = L + Eq + I – A

Note: The profit or loss is added to equity.

Chapter 4: Types of Major Accounts

The Account
o is the basic storage of information in accounting
o It is a record of the increases and decreases of asset, liability, equity, income
or expense.
Classification of the Five Major Accounts

Chart of Accounts
o is a list of all the accounts used by a business.

The Five Major Accounts

Assets
o Current assets are the company's short-term assets; those that can be
liquidated quickly and used within a year.
o Noncurrent assets are long-term and have a useful life of more than a year.

Liabilities
 o Current liabilities are payable within a year (short term)
o Noncurrent liabilities are payable more than a year (Long term)

Equity

(Withdrawal of Cash)
- It will be deducted from the assets (cash) and
equity.

Revenue/Income

Gains Interest Income

Service fees Gains
Expenses

o Cost of sales (or Cost of goods sold)

o Freight-out
o Salaries expense
o Rent expense
o Utilities expense
o Supplies expense
o Bad debt expense
o Depreciation expense
o Advertising expense
o Insurance expense
o Taxes and licenses
o Transportation and travel expense
o Interest expense
o Miscellaneous expense
o Losses

Notes: Income and expenses affect the assets (usually if paid by cash) and equity.

Chapter 5: Books of Accounts and Double-entry System

Books of Accounts
Journal
o also called the “book of original entries,” is the accounting record where
business transactions are first recorded.

Types of Journals
1. Special Journal – is used to record transactions with similar nature (e.g.,
Sales journal, Purchases journal, Cash receipts journal, and Cash
disbursements journal)
2. General Journal – All other transactions that cannot be recorded in the
special journals are recorded in the general journal.
Ledger
o is used to classify the effects of business transactions based their account
title. It is also called the book of final entries.
Types of Ledgers
1. General ledger – contains all the accounts appearing in the trial balance.
2. Subsidiary ledger – provides a breakdown of the balances of controlling
accounts.

Double-entry System
Concept of duality
o each transaction is recorded in two parts – debit and credit
Concept of equilibrium
o each transaction is recorded in terms of equal debits and credits.

Rules of Debits and Credits

Db Cr
+ A-ssets –
- L-iabilities +
- I-ncome +
- C-apital/Equity +
+ E-xpenses -
Contra and Adjunct accounts
Contra accounts
o presented in the financial statements as deduction to their related accounts.
Adjunct accounts
o presented in the financial statements as addition to their related accounts.