Introduction to Accounting

Basic Organizational Principles

An organization in its simplest form is a person or group of people intentionally organized to accomplish an
overall, common goal or set of goals. Organizations can range in size from one person to tens of thousands.
Types of Organization/Ownership
 Single/Sole Proprietorship – a type of organization registered and owned by one person who is normally
active in running and managing the business. Therefore, all profits earned or losses incurred are shared by
the sole owner. Most small businesses start out as single or sole proprietorships.
 Partnership – is a type of organization registered and owned by two or more people who are called
partners. In a partnership organization, the partners share the ownership, management, operating
decisions, and the profits and losses of the business based on a sharing percentage agreed upon by all the
partners in their formal legal agreement called Articles of Partnership.
 Corporation – is a type of organization registered and owned by five (5) or more individuals, called
shareholders, who normally are not active in the operations of the business. The shareholders elect a
Board of Directors which will handle the operations of the business. The ownership in a corporation is
represented by the number of shares acquired by the shareholder.
 Cooperative – usually called “co-op”, is a type of organization registered and owned by a minimum of 15
individuals, called members, who formed themselves voluntarily to achieve a common goal, usually social
and economic, for the benefit of its own members. The members usually elect a Board of Directors (like a
corporation) to run the organization.
Types of Business Activities
 Service Business – a type of business engaged in rendering or providing services to clients for a fee.
Examples are:- professional services, utilities, transportation, BPOs, entertainment services, hotel and
restaurant services, advertising, computer and information services, education and training, etc.
 Merchandising Business – a type of business engaged in buying and selling of products for a profit.
Examples are: supermarkets and grocery stores, department stores, car dealers, hardware stores, etc.
 Manufacturing Business – a type of business engaged in the manufacturing or processing of raw
materials into finished products which are then sold for a profit. Examples are:- car manufacturers, food
processors, wine and soft drinks producers, electronics manufacturers, pharmaceutical companies, etc.
Definition of Accounting
Accounting – is the medium of communication through which financial information is provided to interested
parties for economic decision-making. As such it is also called the “language of business”.
Users of Financial Information
A) Internal Users
 Owners – owner(s) need to know how much return is earned on his/their investment.
 Management – to know if their policies are effective and in using available resources.
B) External Users
 Banks, creditors and lenders –to determine the ability of borrowers to pay their loans on maturity.
 Government (such as BIR, SEC, DTI) – to determine compliance of tax and reporting requirements.
 Prospective investors – to know if the money they are going to invest will be placed in good hands.

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4 Phases of Accounting System
 Recording – involves recording business financial transactions in a systematic and chronological manner in
the appropriate books or databases, usually called a journal.
 Classifying – involves sorting and grouping similar items under the designated name, category or account.
This phase uses systematic analysis of recorded data in which all transactions are grouped in one place,
usually called a general ledger.
 Summarizing – involves compiling and summing up the data into financial information after each
accounting period, such as a month, quarter or year. The data must be presented in a manner which is
easy to understand and use by both external and internal users of the accounting statements.
 Interpreting – is concerned with analyzing financial data, and is a critical tool for decision-making. This final
function interprets the recorded data in a manner which allows end-users to make meaningful judgments
regarding the financial conditions of a business or personal account, as well as the profitability of business
operations. This data is then used to prepare future plans and frame policies to execute financial plans.

So, where does bookkeeping fits in all these?

Bookkeeping – is that part of accounting process where business transactions are systematically translated
into useful and relevant financial reports to be used by interested users for their economic decision-making in
order to achieve their objectives.
This systematic translation involves recording, classifying and summarizing business transactions using a
specified set of skills, procedures and policies bounded by a generally accepted financial reporting standard.
It is important to note that Accounting is not possible without Bookkeeping ... Financial Reporting is not
possible without Bookkeeping.

Financial Statements
Financial Statements are accounting or financial reports prepared periodically to inform the owner, creditors,
and other interested parties as to the financial condition and operating results of the business. Financial
statements provide the users and other interested parties with useful information that may affect the
decisions they are confronted with.

4 Basic Types of Financial Statements

1) Income Statement (Statement of Performance) – the financial statement that shows the operating results
of a business for a specific period of time, usually a month, a quarter, or a year. The components of an
income statement are Revenues and Expenses to determine Net Income or Net Loss, and is represented by
the following formula:-
Revenue – Expenses = Net Income or Net Loss
- If revenue is larger than expense the result is a net income.
- If revenue is lesser than expense, the result is a net loss.

2) Capital Statement (Statement of Equity) – is the financial statement that summarizes all the changes in
owner's equity that occurred during a specific period, usually a month or a year.
The capital statement serves as the bridge between the income statement and balance sheet. It uses the
net income/loss from the income statement in addition to the owner's drawings as derived from the
ledger to determine the Owner's Capital balance.
The major components of capital statement are the:-
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  Owner's Beginning Capital – contains the capital balance at the beginning of the period.
 Net Income/Net Loss – contains the final calculation of profit or loss as derived from the income
statement.
 Drawings – contains the owner’s total drawings as derived from the trial balance.
 Capital Balance – contains the final calculation of the capital balance at the end of the period.

3) Balance Sheet (Statement of Financial Position) – is the financial statement which shows the amount and
nature of a business’ assets, liabilities, and owner's equity (capital) as of a specific point in time. It shows
the current financial position or condition of a business as of a specific point in time. The key elements of a
balance sheet are:-
 Assets – properties used in the operation or investment activities of a business.
 Liabilities – claims by creditors to the assets of a business until they are paid.
 Owner’s Equity (Capital) – the owner's rights or claims to the assets of the business
4) Statement of Cash Flows – is the financial statement that shows the movement of cash in and out of the
business. It presents cash inflows (receipts) and outflows (payments) in the three activities of
business: operating, investing, and financing.
4 Qualitative Characteristics of Financial Statements
To be useful and helpful to users, financial statements must have the following qualities or characteristics
(Qualitative Characteristics).
 Understandable – Accounting information must be comprehensible. Accountants should present data
that can be understood by any users of information and should be expressed in a form properly classified
and with terminology adapted to the user’s range of understanding.
 Relevant – In order to be relevant, information must not only be timely but should also possess feedback
value and/or predictive value for it to be effective in business decisions.
- Feedback Value – refers to information about what has happened in the future.
- Predictive Value – refers to information that will help guide the user in predicting what will occur in
the future.
 Reliable – In order to be reliable, information must be:-
- Complete
- Free from material error
- Neutral and unbiased
- Faithfully represents the information contained therein.
 Comparable – In order to be comparable, financial reports should be consistent, which means that the
procedures and methods used in preparing the report should remain unchanged from period to period.
This allows users to compare financial statements of different entities (businesses) or to compare the same
entity (business) over different periods. Comparisons over time are difficult unless there is consistency in
preparing financial reports across periods. An exception to this concept is when a change would present a
better presentation of economic activity. However, when a change occurs, the reason for the change must
be disclosed and well-explained in the financial statements.

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Accounting Principles
Accounting principles are important concepts, assumptions, ideas, rules, procedures, methods and/or
accepted practices which accountants observe in recording business transactions and in reporting financial
information. These are set of rules that govern the accounting process, and can serve as its foundation in order
to avoid misconceptions and enhance the understanding and usefulness of the financial statements.
Below are some of the common accounting principles observed by the accounting industry:-
 Revenue Realization Principle – requires companies to record revenue at the time the goods are
actually sold or the services are rendered even if no cash has been received.
 Matching Principle – requires companies to “match” (or offset) the revenues with the expenses
incurred in generating this revenue during the same period. This principle prevents understatement of
expenses in one period and overstatement of expenses in another period.
 Cost Concept – requires that most assets are recorded at their original acquisition cost and no
adjustment is made for increases in market value.
 Business Entity Concept – requires every business to be accounted for separately from the owner.
Personal and business-related transactions are kept apart from each other. In other words, the
separate personal transactions of owners and others are not commingled with the reporting of the
economic activity of the business.
 Monetary Unit Assumption – assumes that business transactions and events are measured in money
and only transactions that can be monetized (stated in a monetary unit such as the peso) are recorded
and presented in financial statements. Simply stated, money is the common denominator or
measurement used for reporting financial information.
 Going Concern Assumption – assumes that a business will continue operating for a long time and will
not close or be sold in the foreseeable future. If a business is viewed to be closing in the near future
for some reason, there is no point in preparing its financial statements as it will not be useful to users
anymore.
 Accounting Period Assumption – assumes that business operations can be recorded and separated
into different time periods such as months, quarters, and years. This is required in order to provide
timely information that is used to compare present and past performances.
- Calendar Year – is a twelve-month period that starts on January 1 and ends on December 31.
- Fiscal Year – also a twelve-month period that starts from the first day of any month, except January,
and ends 12 months thereafter.
- Interim Period – is a business period within an accounting period. Some businesses prepare financial
reports at any date even if the 12 month period is still not due, e.g., monthly, quarterly, or semi-
annually.

Double Entry Bookkeeping System

The double-entry system is a type of accounting/bookkeeping system that requires every transaction to be
recorded in at least two places (or two accounts) using a debit and a credit. Every transaction is recorded in a
"formal" journal as a debit entry in one account, and as a credit entry in another account.
The double entry system also has built-in checks and balances. Due to the use of debits and credits, the
double-entry system is self-balancing, i.e., the total of the debit values recorded must equal the total of the
credit values recorded.
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Accounting Equation
Accounting Equation is the foundation of double-entry bookkeeping. It is the mathematical expression of the
relationship between the 3 major categories of accounts, i.e., Assets, Liabilities and Owner’s Equity. The
equation is expressed as under:
Assets = Liabilities + Owner's Equity (or Stockholder’s Equity)
Accounting is based on this fundamental accounting equation, which essentially means that what the business
owns is equal to what it owes to creditors and the owner or stockholders.
If a company keeps accurate records, the accounting equation will always be “in balance,” meaning the left
side should always equal the right side. The balance is maintained because every business transaction affects
at least two of a company’s accounts involving a Debit and a Credit.

Accounting Elements and Types of Accounts

An account is a separate record for each type of asset, liability, equity, revenue, and expense used to show the
beginning balance, the increases and decreases for a period, and the ending balance at the end of the period.
There are 3 accounting elements: Assets, Liabilities, Owner’s Equity (or Stockholder’s Equity).
 Assets – are the properties used in the operation or investment activities of a business. They are a
company’s resources, or the things that the company owns.
Current Assets – are cash and other properties normally expected to be converted to cash or used up
usually within a year. Examples are:-
- Cash – monetary items that are available to meet current obligations of the business. It includes currency
& coins, bank deposits, checks, money orders, and traveller’s checks.
- Accounts Receivable – business claims against the property of a customer arising from the sale of goods
and/or services on account.
- Notes Receivable – formal written promises given by customers or others to pay definite sums of money
to the business at specified times.
- Prepaid Expenses - expenses that are already paid in cash during the period, but not yet incurred or spent
as at the end of an accounting period. Examples are:
- Supplies – items used by a business in the course of its operation such as office supplies, medical
supplies, repair supplies, laundry supplies, etc.
- Prepaid Rent – advance payment of rental space.
- Prepaid Insurance – advance payment of insurance coverage.
Non-current (Fixed) Assets – are long-term, tangible assets or properties owned by the business which are
not expected to be consumed or converted to cash in the current or upcoming fiscal year.
- Equipment – properties used in the business during the production of income such as computers, repair
equipment, medical equipment, laundry equipment, etc.
- Furniture – items used in a business office such as tables, desks, chairs, and cabinets.
- Vehicles – includes trucks, cars, jeeps, motorbikes, etc. used for transportation purposes by the business.
- Buildings – properties or structures erected on land and used for the conduct of business.
- Land – parcels of earth on which an office building is constructed for use by the business.
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 Liabilities – are a company’s obligations or the amounts that it owes. It is also referred to as the claims by
creditors against the company’s assets (creditor’s equity).
Current Liabilities – debts or obligations of the business that are expected to be paid within one year using
current resources. Examples are:
- Accounts Payable – creditor's claims against the business's property arising from the business's purchase
of goods and/or services on account.
- Notes Payable – formal written promises to pay definite sums of money owed at specified times.
- Unearned Revenue – are advanced payments by clients for services to be rendered or goods to be
delivered in the future.
- Accrued Expenses – are expenses already incurred but are not yet paid at the end of an accounting
period. Examples are:
- Salaries Payable – salaries that are unpaid at the end of an accounting period.
- Rent Payable – rental payment that are unpaid at end of an accounting period.
- Interest Payable – interest payment that are unpaid at end of an accounting period.
- Utilities Payable – utilities payment that are unpaid at end of an accounting period.
Long Term Liabilities – debts or obligations of the business that are payable for more than a one-year.
- Mortgage Payable – long-term debts which are secured by collateral.
- Long-Term Notes Payable – notes payable that are due after one-year.
 Owner's Equity (or Capital) – also called net worth, is the rights, claims or interests of the owner to the
assets (or properties) of the business. Included in owner’s equity are additional investments, either cash or
property, which the owner puts in his business.
Sub-categories of Owner’s Equity
Owner's Drawing – is the amount the owner withdraws from his business for living and personal expenses.
Revenue (or Income) – is the amount a business earns by selling services and goods. Examples are:
- Sales – amounts earned from sale of goods or merchandise.
- Service Income – amounts earned from service rendered by a service company to its customers.
- Professional Fees – amounts earned from services rendered by a professional to its clients.
- Rent Income – amounts earned from renting properties or facilities.
- Interest Income – amounts earned representing the time value of money derived from loans or from
promissory notes received by a business.
Expense (or Cost) – is the cost incurred in conducting the business activities. Examples are:-
- Salaries Expense – expenditures for work performed by employees.
- Rent Expense – expenditures paid to an owner of building or an office space for the use of the property.
- Supplies Expense – expenditures for incidental materials needed in the conduct of business, such as
office supplies, medical supplies, repair supplies.
- Utilities Expense – expenditures for basic services, such as water, gas, electricity and telephone.
- Advertising Expense – promotional expenditures, such as in newspapers, television, radio and mail.
- Maintenance Expense – expenditures paid to repair and or maintain buildings and/or equipment.
- Miscellaneous Expense – other expenditures that cannot be categorized from the above.

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Chart of Accounts
Chart of Accounts is a coded or numbered listing of all the accounts used by a business entity. The chart is
prepared by the owner or the accountant to be used in recording business transactions in books of account.
The accounts are listed sequentially in the chart per the following arrangement:-
1. Asset accounts – which may be numbered from 101 to 199
2. Liability accounts – which may be numbered from 201 to 299
3. Equity accounts – which may be numbered from 301 to 399
4. Revenue accounts – which may be numbered from 401 to 499
5. Expense accounts – which may be numbered from 501 to 599.

Sample Chart of Accounts of a Service Business

Assets Equity
101 – Cash 301 – Owner, Capital
105 – Accounts Receivable 302 – Owner, Drawing
110 – Notes Receivable
115 – Prepaid Rent Revenue
120 – Prepaid Insurance 401 – Service Income
125 – Office Supplies 402 – Sales
130 – Office Furniture 403 – Computer Fees
135 – Equipment 405 – Rent Income
140 – Vehicles 407 – Medical Fees
409 – Consultation Fees
Liabilities 412 – Miscellaneous Fees
201 – Accounts Payable
205 – Notes Payable Expenses
210 – Unearned Revenue 501 – Salaries Expense
215 – Interest Payable 505 – Rent Expense
220 – Salaries Payable 510 – Supplies Expense
225 – Utilities Payable 515 – Advertising Expense
230 – Mortgage Payable 520 – Tax and Licenses Expense
235 – Long-term Notes Payable 525 – Utilities Expense
530 – Transportation Expense
535 – Miscellaneous Expense