Introduction to Accounting Fundamentals

INTRODUCTION TO
ACCOUNTING
PREPARED BY : PROF. JONAH C. PARDILLO

LEARNING OBJECTIVES
After reading this chapter, you should be able to:
 Define accounting;
 Describe the nature of accounting;
 Explain the functions of accounting in business;
 Narrate the history/origin of accounting.

What is Accounting?
Accounting
 The main purpose of accounting is to ascertain profit or loss during a specific

period, to show financial condition of the business on a particular date and to
have control over the firm’s property. Such accounting records are required to be
maintain to measure the income of the business and communicate the
information so that it may be used by managers, owners and other interested
parties. Accounting is a discipline which records, summarizes and interprets
financial information about the activities of a concern so that intelligent decisions
can be made about the concern.
What is Accounting?
 The American Institute of Certified Public Accountants has defined the Financial
Accounting as “the art of recording, classifying and summarizing in as significant
manner and in terms of money transactions and events which in part, at least of a
financial character, and interpreting the results thereof”.
 American Accounting Association defines accounting as “the process of identifying,

measuring, and communicating economic information to permit informed judgments
and decisions by users of the information.
Functions of Accounting
 Recording: it is concerned with the recording of financial transactions in an

orderly manner, soon after their occurrence in the proper books of accounts.
 Classifying: it is concerned with the systematic analysis of the recorded data

so as to accumulate the transactions of similar type at one place. This
function is performed by maintaining the ledger in which different accounts
are opened to which related transactions are posted.
Cont..
 Summarizing: it is concerned with the preparation and presentation of the classified

date in a manner useful to the users. This functions involves the preparation of financial
statements such as Income Statement, Balance Sheet, Statement of Changes in
Financial Position, Statement of Cash Flow, Statement of Value Added.
 Interpreting: nowadays, the aforesaid three functions are performed by electronic date
processing devices and the accountant has to concentrate mainly on the
interpretation aspects of accounting. The accountants should interpret the statements
in a manner useful action. The accountant should explain not only what has happened
but also (a)why it happened, (b)what is likely to happen under specified conditions.
Distinction Between Bookkeeping and
Accounting
 Bookkeeping
 Book-keeping is a part of accounting and is concerned with the recording of transactions

which is often routine and clerical in nature, whereas accounting performs other functions as
well, viz., measurement and communication, besides recording. An accountant is required to
have a much higher level of knowledge, conceptual understanding and analytical skill than
is required of the book-keeper.
 An accountant designs the accounting system, supervises and checks the work of the book-
keeper, prepares the reports based on the recorded data and interprets the reports.
Nowadays, he is required to take part in matters of management, control and planning of
economic resources.
Distinction Between Accounting and
Accountant
 Although in practice Accountancy and Accounting are used interchangeably yet
there is a thin line of demarcation between them. The word Accountancy is used for
the profession of accountants - who do the work of accounting and are
knowledgeable persons. Accounting is concerned with recording all business
transactions systematically and then arranging in the form of various accounts and
financial statements. And it is a distinct discipline like economics, physics, astronomy
etc. The word accounting tries to explain the nature of the work of the accountants
(professionals) and the word Accountancy refers to the profession these people adopt.
Nature of Accounting
The various definitions and explanations of accounting has been propounded by different
accounting experts from time to time and the following aspects comprise the nature of
accounting :
 Accounting as a service activity
 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
decisions, in making reasoned choices among alternative courses of action. It means that
accounting collects financial information for the various users for taking decisions and tackling
business issues. Accounting in itself cannot create wealth though, if it produces information
which is useful to others, it may assist in wealth creation and maintenance.
 Accounting as a profession
 Accounting is very much a profession. A profession is a career that involve the acquiring of a
specialized formal education before rendering any service. Accounting is a systematized body
of knowledge developed with the development of trade and business over the past century.
 The accounting education is being imparted to the examinees by national and international
recognized the bodies like The Professional Regulations Commissions (PRC), Philippine Institute
of Certified Public Account (PICPA), etc. (discuss next slide). The candidate must pass a
vigorous examination in Accounting Theory, Accounting Practice, Auditing and Business Law.
Regulatory Bodies of Accounting
 Professional Regulation Commission (PRC)

 a government agency in charge of regulating and licensing the practice of
a profession like accounting.
 Board of Accountancy (BOA - BOARD)
 Under jurisdiction of the PRC is in charge in regulating the accounting
profession by setting up and promulgating a set of professional standard
and ethics.
 Philippine Institute of Certified Accountants (PICPA)
 It is the basic authority of all Philippine certified accountants setting up and
implementing rules vital to the accounting profession.
 Other committees
 Financial Reporting Standard Council (FRSC)
 Accounting Standard Council (ASC)
 Philippine Financial Reporting Standard (PFRS) formerly Statement Financial

Accounting Standard(SFAS)
 Under PICPA umbrella
 Association of Certified Public Accountants Education (ACPAE) – for

accounting educators.
 Government Association of Certified Public Accountant(GACPA) – for

government accountants.
 Association of Internal Auditors(AIA) – for internal auditors
 All private and public members (ACPACI)

International Accounting Standards
 International Accounting Standard Council (IASC) – tacked to set up

international accounting standards in 1973.
 In 2002 has 152 professional accounting bodies and coming from 112 countries
including Philippines.
 Objective is to formulate and publish accounting standards for financial

reporting which is to be observed and adopted worldwide.
 Accounting as a profession as social force
 In early days, accounting was only to serve the interest of the owners. Under the changing
business environment the discipline of accounting and the accountant both have to watch
and protect the interests of other people who are directly or indirectly linked with the operation
of modern business. The society is composed of people as customer, shareholders, creditors and
investors. The accounting information/data is to be used to solve the problems of the public at
large such as determination and controlling of prices. Therefore, safeguarding of public interest
can better be facilitated with the help of proper, adequate and reliable accounting
information and as a result of it the society at large is benefited.
 Accounting as a language of business
 Accounting is rightly referred the "language of business". It is one means of reporting and
communicating information about a business. As one has to learn a new language to converse
and communicate, so also accounting is to be learned and practiced to communicate business
events. A language and accounting have common features as regards rules and symbols. Both
are based and propounded on fundamental rules and symbols. In language these are known as
grammatical rules and in accounting, these are termed as accounting rules. The expression,
exhibition and presentation of accounting data such as a numerals and words and debits and
credit are accepted as symbols which are unique to the discipline of accounting.
 Accounting as science or art
 Science is a systematized body of knowledge. It establishes a relationship of cause and effect in

the various related phenomenon. It is also based on some fundamental principles. Accounting has
its own principles e.g. the double entry system, which explains that every transaction has two fold
aspect i.e. debit and credit. It also lays down rules of journalizing. So we can say that accounting is
a science. Art requires a perfect knowledge, interest and experience to do a work efficiently. Art
also teaches us how to do a work in the best possible way by making the best use of the available
resources. Accounting is an art as it also requires knowledge, interest and experience to maintain
the books of accounts in a systematic manner. Everybody cannot become a good accountant. It
can be concluded from the above discussion that accounting is an art as well as a science.
 Accounting as an information system
 Accounting discipline will be the most useful one in the acquisition of all the business
knowledge in the near future. You will realize that people will be constantly exposed
to accounting information in their everyday life. Accounting information serves both
profit-seeking business and non-profit organizations. The accounting system of a profit-
seeking organization is an information system designed to provide relevant financial
information on the resources of a business and the effect of their use. Information is
relevant and valuable if the decision makers can use it to evaluate the financial
consequences of various alternatives.
Cont..
 Accounting generally does not generate the basic information (raw financial data),
rather the raw financial data result from the day to day transactions of the business.
 As an information system, accounting links an information source or transmitter
(generally the accountant), a channel of communication (generally the financial
statements) and a set of receivers (external users).
Objectives of accounting
The following are the main objectives of accounting :
1. To keep systematic records :
 Accounting is done to keep a systematic record of financial transactions. In the absence of

accounting there would have been terrific burden on human memory which in most cases
would have been impossible to bear.
2. To protect business properties:
 Accounting provides protection to business properties from unjustified and unwarranted use.
This is possible on account of accounting supplying the following information to the manager
or the proprietor:
Cont..
ii. The amount of the proprietor's funds invested in the business.
ii. How much the business have to pay to others?
iii. How much the business has to recover from others?
iv. How much the business has in the form of (a) fixed assets, (b) cash in hand, (c) cash at bank, (d)
stock of raw materials, work-in-progress and finished goods?
Information about the above matters helps the proprietor in assuring that the funds of the business
are not necessarily kept idle or underutilized.
Cont…
4. To ascertain the financial position of the business:
 The Profit and Loss Account gives the amount of profit or loss made by the business during a
particular period. However, it is not enough. The businessman must know about his financial
position i.e. where he stands ?, what he owes and what he owns? This objective is served by
the Balance Sheet or Position Statement. The Balance Sheet is a statement of assets and
liabilities of the business on a particular date. It serves as barometer for ascertaining the
financial health of the business.
Cont…
5. To facilitate rational decision making:
 Accounting these days has taken upon itself the task of collection, analysis and reporting of
information at the required points of time to the required levels of authority in order to facilitate
rational decision-making. The American Accounting Association has also stressed this point while
defining the term accounting when it says that accounting is the process of identifying,
measuring and communicating economic information to permit informed judgments and
decisions by users of the information. Of course, this is by no means an easy task. However, the
accounting bodies all over the world and particularly the International Accounting Standards
Committee, have been trying to grapple with this problem and have achieved success in laying
down some basic postulates on the basis of which the accounting statements have to be
prepared.
Cont…
6. Information system:
 Accounting functions as an information system for collecting and communicating economic

information about the business enterprise. This information helps the management in taking
appropriate decisions. This function, as stated, is gaining tremendous importance these days.
History of Accounting
 Earliest Accounting was found as early as 2000 BC in the cities of Babylonia, Greece, Egypt and
3500 BC in Assyria. It consisted then of records of taxes imposed by the kings and collected from
the people by their tax collectors as well as records of materials, labor, and overhead which the
pharaoh required when the pyramids were being constructed in Egypt.
 Babylonia was known as the city of commerce. Accounts was used for business to uncover losses
due to fraud and to uncover losses due to inefficiency.
 Greece accounts was used to apportion the revenue received maintaining total receipts/payments
and balance of government financial transaction.
ONE OF THE OLDEST
PROFESSION
Archeologist Dr. Gunter
Dreyer of the German Institute  In the ancient Egypt, the accountant
of Archeology discovered that was called as “eye and ear” of the
the numerous inscribed bone king.
labels attached to bags of oil
and linen in the tomb of king
scorpion, Egypt-date back
5300 year.
Accounting in Ancient Mesopotamia
Accounting token made of clay, from

Susa.
…this is represented a huge cognitive
leap of mankind
Globular envelope with a

cluster of accountancy
tokens, Uruk period, from
Susa.
 Writing clay tablet and Economic tablet with numeric
signs (Roman, Mesopotamian, Susa 3200 BC)
 In ancient Greece, the account books of bankers who that they changed and loaned money
and helped people make cash transfers through affiliate banks in other cities.
 In ancient Rome, government and banking accounts grew out of records keep by the
heads of the families. They also used memorandum or day book (adversaria) to record
receipts and payments and posted to ledgers or cash books (codex acepti et expensi) on
monthly basis (700BC-400BC).
Father of Accounting  Luca Pacioli an Italian mathematician
is a father of accounting who
Fr. Luca Bartolomeo de Pacioli
introduced the modern double-entry
bookkeeping system in 1494 at Venice
in Italy.
 Pacioli described double-entry
bookkeeping, and other commerce-
related concepts, in his book
Particularis De Computis et Scripturis
(Details of Calculation and Recording)
Father of Accounting  In Summa de Arithmetica, Pacioli
introduced symbols of plus and minus, a
Fr. Luca Bartolomeo de Pacioli
symbols which became standard
notation in Italian Renaissance
mathematics also known as Algebra.
Cont…
 In 15th century, the Italian mathematician usually entrusted their properties to their
servants or employees who were required to keep track of their daily activities by listing
down what properties (assets) are owned by the merchants and what debts (liabilities)
are owed to others.
 From their records came the term debtor and creditor. Debtor is one who lends money
or buy goods or services with a promise to pay at a future date. Creditor is one who
lends money or sells services or goods to be collected in the future.
Cont…
 In 19th century, the massive development of trade and industry and the simple structure
of a business changed to a more complex one with the formation of business
combinations, mergers and consolidations.
 It became necessary to improve the process of recording and reporting financial

information. And with the advent of the information age driven by electronic devices
such as the computer, the design for processing information turned manual to
electronically assisted.
THE END
References:
Kimwell, M.B., “Fundamentals of Accounting”

Manuel, Z.C “Accounting Process, Basic Concepts and Procedures, Int’l Ed.”
www.wikipedia.com
BRANCHES OF
ACCOUNTING

LEARNING OBJECTIVES
 Differentiate the branches of accounting;
 Explain the kind/type of services rendered in each of these

branches.
Financial Accounting
 is a branch of accounting that is primarily concerned with the measurement

and communication of information that summarizes and reports the financial
condition and operating results of a business enterprise.
 The art of recording financial transactions and events in a systematic manner in

the books of account is known as book-keeping. The recorded information has
to be classified, analyzed and presented in a manner in which business results
and financial position can be ascertained.
Cont…
 Financial accounting provides, as objectively as feasible the diverse information needs

of both the internal and external data-users who may have conflicting interests in the
business affairs.
 Important requirement of financial accounting is that, the information should be

recognized, measured, and reported in conformity with generally accepted principles.
These accounting principles apply to all types and all sizes of business organizations.
Management Accounting
 The object of management accounting is to supply relevant information

at appropriate time to the management to enable it to make decisions
and effect control.
 Management accounting, it is a useful tool to achieving the functions of

management, which are:
o to make both short-range and long-range plans
o To measure the success in carrying out these plans

Cont…
o To identify the areas that require special attention
o To choose from among the available alternative courses of actions
o To be able to meet the business’ goals, management also utilizes the cost
accounting method and forecasting techniques.
Government Accounting
 Government accounting which uses “Fund Accounting”, deals with the

administration or use of public funds to bring about service to the community.
Its objective is more on how the funds are used to service the people rather
than to earn profit. Aside from the government. Fund Accounting is also
applicable for non-profit organizations such as the Red Cross which is a
charitable institution.
Government Accounting
 Government accounting is another career field where one works as

accountant, auditor budget officer or electronic data processing head of
any of the government agencies. Examples of government agencies
requiring the services of professional accountants are the Commission on
Audit (COA), Bureau of Internal Revenue (BIR), Bangko Sentral ng Pilipinas
(BSP), Government Service and Insurance System (GSIS) and Bureau of
Custom (BOC).
Auditing
 Deals with independent verification and examination of the accounting

records for the purpose of giving an opinion on the fairness of its presentation.
It is required that an auditor must first pass the Licensure Examination given by
the Board of Accountancy in order to practice as a Certified Public
Accountant (CPA).
 An auditor is a person who is licensed to make an independent review of the

financial records of the firm.
Cont…
 an internal auditor is an employee of the business enterprise.
 Internal auditors have the responsibilities of evaluating the efficiency of

operation and determining whether the business’ policies are being
followed consistently in all organizational levels of operations.
 Audited financial statements are required not only by the government

and financing institution but also by the stockholders of the corporation.
Tax Accounting
 Tax accounting is the accounting process that focuses on tax issues including filing tax
returns and planning for future tax responsibilities as opposed to the preparation of
financial statements.
 The CPA is frequently retained to prepare the clients’ periodic income tax returns that
will be filed with the Bureau of Internal Revenue (BIR). A CPA may also help a
taxpayer-client in making plans about certain future transactions, such as the
acquisition of a new equipment, so that the taxes that the business has to pay could
be legally kept at a minimum amount.
Cont…
 A CPA could help his tax-payer client on areas involving alternative courses of
action that would have a material effect on the tax that the business
enterprise will pay to the government.
 To be able to render tax services, a CPA must have extensive knowledge of

tax statutes, regulations, and tax court decisions, aside from having a
thorough knowledge of accounting.
Cost accounting
 Cost accounting deals with the following:
 determining the costs of products, processes, projects, etc. in order to report the correct
amounts on the financial statements, and
 assisting management in making decisions and in the planning and control of an organization.
 For example, cost accounting is used to compute the unit cost of a manufacturer's products in
order to report the cost of inventory on its balance sheet and the cost of goods sold on its
income statement. This is achieved with techniques such as the allocation of manufacturing
overhead costs and through the use of process costing, operations costing, and job-order
costing systems.
Cont…
 Cost accounting assists management by providing analysis of cost behavior, cost-

volume-profit relationships, operational and capital budgeting, standard costing,
variance analyses for costs and revenues, transfer pricing, activity-based costing, and
more.
 Cost accounting had its roots in manufacturing businesses, but today it extends to
service businesses. For example, a bank will use cost accounting to determine the cost
of processing a customer's check and/or a deposit. This in turn may provide
management with guidance in the pricing of these services.
Accounting Research and Education
 Is another professional field where the accountant assumes the role of researcher, teacher, and
reviewer.
 A researcher investigates and makes a study creating, applying, relating or improving accounting
theories and business concepts that will suit the changes taking place in a particular business or
industry.
 An accounting professor is responsible for the formation of competitive accountants and consultants
and teaches subjects such as accounting, auditing, management advisory services, finance, financial
management, business law, taxation and other technically related subjects. An accounting reviewer
helps prepare the candidates for the CPA Licensure Examination.
Accounting Research and Education
 An accounting professor is responsible for the formation of competitive accountants

and consultants and teaches subjects such as accounting, auditing, management
advisory services, finance, financial management, business law, taxation and other
technically related subjects.
 An accounting reviewer helps prepare the candidates for the CPA Licensure
Examination.
 A CPA may also render professional services to his clients like: Preparation of financial
forecasts or feasibility studies.
THE END
References:

USERS OF
ACCOUNTING INFORMATION

LEARNING OBJECTIVES
 Define external users and gives examples
 Define internal users and give examples

Users of Accounting Information
The basic objective of accounting is to provide information which is useful for

persons inside the organization and for persons or groups outside the
organization. Accounting is the discipline that provides information on which
external and internal users of the information may base decisions that result in the
allocation of economic resources in society
External Users of Accounting Information
 External users are those groups or persons who are outside the organization for
whom accounting function is performed. Following can be the various external
users of accounting information:
1. Investors: Those who are interested in investing money in an organization are

interested in knowing the financial health of the organization of know how safe
the investment already made is and how safe their proposed investment will be.
Cont…
To know the financial health, they need accounting information which will help them in
evaluating the past performance and future prospects of the organization. Thus, investors
for their investment decisions are dependent upon accounting information included in
the financial statements. They can know the profitability and the financial position of the
organization in which they are 12 interested to make that investment by making a study of
the accounting information given in the financial statements of the organization
External users of information
2. Creditors
 Creditors (i.e. supplier of goods and services on credit, bankers and other lenders
of money) want to know the financial position of a concern before giving loans or
granting credit. They want to be sure that the concern will not experience difficulty
in making their payment in time i.e. liquid position of the concern is satisfactory. To
know the liquid position, they need accounting information relating to current
assets, quick assets and current liabilities which is available in the financial
statements.
2. Members of Non-Profit Organizations
 Members of non-profit organizations such as schools, colleges, hospitals, clubs,

charitable institutions etc. need accounting information to know how their
contributed funds are being utilized and to ascertain if the organization deserves
continued support or support should be withdrawn keeping in view the bad
performance depicted by the accounting information and diverted to another
organization. In knowing the performance of such organizations, criterion will not
be the profit made but the main criterion will be the service provided to the society
3. Government
 Central and State Governments are interested in the accounting information

because they want to know earnings or sales for a particular period for purposes of
taxation. Income tax returns are examples of financial reports which are prepared
with information taken directly from accounting records. Governments also needs
accounting information for compiling statistics concerning business which, in turn
helps in compiling national accounts.
4. Customers
 Consumers need accounting information for establishing good accounting control

so that cost of production may be reduced with the resultant 13 reduction of the
prices of goods they buy. Sometimes, prices for some goods are fixed by the
Government, so it needs accounting information to fix reasonable prices so that
consumers and manufacturers are not exploited. Prices are fixed keeping in view
fair return to manufacturers on their investments shown in the accounting records.
5. Research Scholars
 Accounting information, being a mirror of the financial performance of a business

organization, is of immense value to the research scholars who wants to make a
study to the financial operations of a particular firm. To make a study into the
financial operations of a particular firm, the research scholar needs detailed
accounting information relating to purchases, sales, expenses, cost of materials
used, current assets, current liabilities, fixed assets, long term liabilities and
shareholders' funds which is available in the accounting records maintained by the
firm.
Internal Users of Accounting
Information
 Internal users of accounting information are those persons or groups which are
within the organization. Following are such internal users :
1. Owners: The owners provide funds for the operations of a business and they want
to know whether their funds are being properly used or not. They need
accounting information to know the profitability and the financial position of the
concern in which they have invested their funds. The financial statements
prepared from time to time from accounting records depicts them the
profitability and the financial position.
Information
2. Management: Management is the art of getting work done through others, the
management should ensure that the subordinates are doing work properly.
Accounting information is an aid in this respect because it helps a manager in
appraising the performance of the subordinates. Actual performance of the 14
employees can be compared with the budgeted performance they were expected
to achieve and remedial action can be taken if the actual performance is not upto
the mark. Thus, accounting information provides "the eyes and ears to
management".
Cont…
The most important functions of management are planning and controlling. Preparation of
various budgets, such as sales budget, production budget, cash budget, capital
expenditure budget etc., is an important part of planning function and the starting point for
the preparation of the budgets is the accounting information for the previous year.
Controlling is the function of seeing that programmed laid down in various budgets are
being actually achieved i.e. actual performance ascertained from accounting is compared
with the budgeted performance, enabling the manager to exercise controlling case of
weak performance.
Cont…
Accounting information is also helpful to the management in fixing reasonable selling prices.
In a competitive economy, a price should be based on cost plus a reasonable rate of return.
If a firm quotes a price which exceeds cost plus a reasonable rate of return, it probably will
not get the order. On the other hand, if the firm quotes a price which is less than its cost, it will
be given the order but will incur a loss on account of price being lower than the cost. So,
selling prices should always be fixed on the basis of accounting data to get the reasonable
margin of profit on sales.
Information
3. Employees: . Employees are interested in the financial position of a concern they

serve particularly when payment of bonus depends upon the size of the profits
earned. They seek accounting information to know that the bonus being paid to
them is correct. The employee wants higher wages, benefits, good working
conditions and security of tenure. A review of the company’s financial reports will
enable one to assess the ability of the business to grant these demands. The
company cannot afford to grant higher salaries and more benefits of the business is
losing as reflected in its financial reports.
Channels of Accounting Information Flow
Management
(A)
Management
Reports
Certain
Taxing (B) Tax Special Regulatory
Accounting Process
Agencies Returns Reports (c) Agencies
Financial
Reports
(D)
Suppliers Lenders Investors Employees Regulatory Board Customs

Four types of Reports
(A) Management reports are internal reports prepared for management use. Management
required additional information such as product cost, estimate of profit to be earned for
a planned project, comparison of two alternative courses of solving a problem, and
budgets.
(B) All firms are required to prepare and file Tax Returns to the Bureau of Internal Revenue
(BIR). Different taxes require different tax forms which are to be filled up and submit to
the BIR. Example: Income Tax, VAT, Sales Tax, among others.
(A) Some firms, by the nature of their organization/operation, are required to prepare Special
Reports by certain regulatory bodies. For example: banks prepare monthly, quarterly, and
annual reports to be submitted to Bangko Sentral ng Pilipinas.
(B) Financial Reports are the main source of information of stakeholders. These are general
purpose financial statements usually audited by a Certified Public Accountant who attest to
its fair presentation and validity thus making it reliable and acceptable by the stakeholders.
Accounting Information System
 Accounting Information System (AIS) involves an orderly way of accumulating and

reporting business transactions through a process of analyzing, measuring, recording,
classifying and summarizing, and from which reports are generated for proper
communication to decision-makers.
Accounting Information System (Simple)
Analyzed Summarized
Classified Decision
Data gathered Measured Reported
Stored Making
Recorded Interpreted
Computerized Accounting System
INPUT OUTPUT OUTPUT

From the source documents The data are measured, recorded, Reports come out from
data are analyzed and classified, summarized and stored by processed data.
encoded by the employees the computer
Financial Reports
 The accounting information resulting from transactions or economic events documents recorded
and classified are summarized into financial statements. These are prepared at least annually and
are directly toward the common needs of practically all the stakeholders.
 Components of financial statements:
 Balance Sheet
 Income Statement
 Statement of Changes in Owners Equity
 The Cash Flow Statement

Balance Sheet
 Balance Sheet
 It gives information about the financial position of the business by showing a list of its assets
(cash and properties) and liabilities (debts or obligations to pay) and from which the net
worth of the business representing equity or share of the owner could be determined.
 Net Worth represents the net assets of the business (assets left after deducting the liabilities)
belonging to the owner.
Balance Sheet
 Example: assume that as at May 31 of the current year your business has listed
a total of P1,000,000 assets, against P400,000 liabilities. The net asset of your
business is P600,000. Compare this against business of your friend with asset
listed as P1,5000,000 against which it owes creditors P1,200,000. Your friend has
net worth of P300,000 only.
 It is apparently your business is financially stronger and solvent.
 Solvency is the ability of the business to pay for its liabilities.

Income Statement
 Income statement
 is a report which describes how the business operated over a given period of time.
 It describes the revenues or income earned as well as the expenses incurred by the
business.
 A favorable operation called profit or income.
 Example: Revenues earned for the year P750,000, while expenses incurred amounted
to P500,000 only, the profit is P250,000. The revenues is greater than expenses incurred
by the business, therefore the results of operation is favorable.
Statement of Changes in Owner’s
equity
 It explains the activities foe the period of time that changed the owner’s share
over the net assets of the business. Net worth or owner’s equity is affected by
the following activities:
 Investment
 withdrawal
 Profit or loss
Statement of Changes in Owner’s
equity
 Example:
 If the Balance Sheet this year showed net worth of P600,000, last year showed net worth of
P500,000, the owner’s equity increase P100,000 may be due to profit of P50,000 plus
additional investment of the owner amounting P50,000. Or may be due to profit of P150,000
less owner’s withdrawal of P50,000.
 A cash withdrawal decreases the assets which in turn decrease owner’s equity.
The Cash Flow Statement
 The Cash Flow Statement
 It is another financial statement prepared by the accountant. This report explains why
the amount of cash changes over a period of time by listing the cash inflow activities
(cash receipts) and the cash outflow activities (cash payments) of the business.
 Example: assume that the cash (assets) at the end of the current year was listed in
the balance sheet as P50,000, while the balance last year showed it to be P25,000.
you might ask why the cash increased by P25,000 only when business earned
P250,000, and the owner invested another P50,000.
 The cash flow statement will explain what happened to the cash.
Reporting Periods
 Reporting periods
Divided into equal time-periods as:
o Accounting periods
o Bookkeeping periods or reporting periods
..this basic accounting assumption, called the periodicity concept, is useful so

that timely financial reports can be made available to the data-users.
Cont….
 A reporting period that begins on January 1 and ends on December 31 ----- is
so called calendar year or a calendar year reporting period.
 A one year reporting periods that ends on a date other than December 31 -----
is called fiscal year or a fiscal year reporting period.
 Some of the business enterprise also prepare interim financial statements

(semester, quarter, or month)
1 year = 52 weeks = 12 months = 4 quarters = 2 semesters
1 semester = 26 weeks = 6 months = 2 quarters
1 quarter = 13 weeks = 3 months

Relationship of the balance sheet with
other statements
Income Income
Statement Statement
+ +
Balance Statement of Balance Statement of Balance
sheet changes in sheet changes in sheet
Owner’s equity Owner’s equity
+ +
Statement of Statement of
Cash flows Cash flows
reporting period reporting period
As of As of As of
reporting date reporting date reporting date
Relationship among the Financial
Statements
 The statement of cash flows complements both the income statement
and the balance sheet. The statement of changes in equity explains
why the ending capital of the owner increased or decreased as
compared with the beginning balance. This ending balance of capital
is then forwarded to the balance sheet. The income statement
explains, partly, why the cash position of the company increased or
decreased. Usually, a balance sheet cannot be prepared without first
preparing an income statement. The net profit of a period can be
computed by analyzing the balance sheets of two dates.
Role of Management in the
Preparation of Financial Statement
 The proprietor or manager reviews these statements and gives the final approval
before they are released to any government agency, creditor, or other data-user. He
decides what other financial information should be gathered or other data user.
 He decides what other financial information should be gathered and presented in

order to meet the financial information needs of the decision-makers.
 He has the advantage of having immediate access to additional management and

financial information that is helpful in carrying out his various planning, decision-
making, and controlling responsibilities.
Limitations of Financial Statements
 External users should understand that there are some constraints in the manner of
preparing and presenting the traditional general-purpose financial statements.
 Data-users should be aware of both the usefulness and limitations of the prepared
financial statements.
 They should remember that the prepared general-purpose financial statements are
not instant tools for decision-making.
 They must also have a clear understanding of the accounting elements reported in
the balance sheet and income statement. Knowledge of accounting would give
them a far deeper appreciation for the information contained in the financial reports.
THE END
References:

FORMS OF BUSINESS
ORGANIZATIONS

LEARNING OBJECTIVES
 Differentiate the forms of business organization
 Identify the advantages and disadvantages of each form

Sole proprietorship (Single Proprietorship)
 is the simplest form of business and the easiest to register, through

the Bureau of Trade Regulation and Consumer Protection (BTRCP)
of the Department of Trade and Industry (DTI). It is owned by an
individual who has full control/authority of its own and owns all the
assets, as well as personally answers all liabilities or losses. The fact
that it is run by the individual means that it is highly flexible and
the owner retains absolute control over it.
Sole proprietorship (Single Proprietorship)
 The problem, however, is that a sole proprietor has unlimited liability.

Creditors may proceed not only against the assets and property of the
business, but also after the personal properties of the owner. In other
words, the law basically treats the business and the owner as one and
the same. This uniform treatment also has important tax implications.
Partnerships and corporations may lessen their tax liability through a
myriad of business expenses and other tax avoidance techniques. These
tax deductions may not be applicable to a sole proprietorship. Also, the
potential growth and reach of a sole proprietorship pale in comparison
with that of a corporation.
Advantages of Sole proprietorship
1. Easy formation - The formation of sole proprietorship business is very easy

and simple. No legal formalities are involved for setting up the business
excepting a license or permission in certain cases. The entrepreneur with
initiative and certain amount of capital can set up such form of business.
2. Direct motivation - The entrepreneur owns all and risks all. The entire profit
goes to his pocket. This motivates the proprietor to put his heart and soul in
the business to earn more profit. Thus, the direct relationship between effort
and reward motivates the entrepreneur to manage the business more
efficiently and effectively
3. Better control - The entrepreneur takes all decisions affecting the

business. A sole proprietor has complete control and decision-making
power over the business. This results in better control of the business and
ultimately leads to efficiency.
4. Promptness in decision-making - When the decision is to be taken by

one person, it is sure to be quick. Thus, the entrepreneur as sole
proprietor can arrive at quick decisions concerning the business by
which he can take the advantage of any better opportunities.
5. Easy dissolution - Like that of formation, the dissolution of the sole

proprietorship is also very easy. Since the proprietor is the supreme
authority and no regulations are applicable for closure of the business
he can dissolve his business any time he likes.
6. No corporate tax payments – individual income tax shall be imposed

on the sole proprietor. The proprietors shall be liable for income tax only
in their separate and individual capacities.
Disadvantages of Sole proprietorship
1. Limited resources - The financial resources of any small entrepreneur as an individual is

limited. He mainly finances from his own savings or borrows from financial institutions,
friends and relatives as per his capacity. Thus, limited resource is the major drawback
of this form of business. Investors won’t usually invest in sole proprietorships.
2. Limited managerial capability - Modern business requires updated managerial skills in

each and every sphere of activity. We cannot hope a single individual to possess all
the managerial talents necessary to carry on a business efficiently. The limited financial
resources of the sole proprietorship are a hindrance to hire the services of managers
with expertise in different areas, thereby the growth of the business.
Disadvantages of Sole proprietorship
3. Unlimited liability - The sole proprietor of the business can be held

personally liable for the debts and obligations of the business.
Additionally, this risk extends to any liabilities incurred as a result of acts
committed by employees of the company.
4. Uncertainty of continuity - The continuity of the business is uncertain

because the business may come to an end due to the incapacity or
death of the proprietor. Even if at all the business passes on to the
successor of the proprietor, it is unlikely that they may posses the
business acumen like that of the proprietor.
Examples of Sole proprietorship
1. Computer Repair Services

 Computer repair companies are often operated as sole
proprietorships. Some business owners operate commercial
shops, while others work from home. Small computer repair
businesses typically cater to individuals.
2. Catering Company
• Catering companies offer their services for parties,
weddings, church functions and business events. In most
cases, a sole proprietor operating a catering company
needs to hire employees.
3. Housecleaning Service
 The start up costs for a housecleaning business are generally
low. Business owners can offer a variety of additional services,
such as laundry, window washing and carpet cleaning.
4. Financial Planners
 Sole proprietors work as financial planners, offering their
services to individuals and small businesses. They help families
plan for retirement, save for college expenses and invest in
securities. Financial planners catering to businesses may help a
company set up its employee retirement packages and other
employee benefits.
5. Landscaper
 A landscaper may work alone or hire a small team of
employees. Landscapers maintain lawns, plants and trees of
homeowners and businesses. Most landscaping companies
working with commercial customers hire employees to work on
projects.
6. Tutoring
 Tutoring businesses provide learning assistance to students in a
variety of subjects. Tutors may work with students in person or
through online video chats. Many tutors have teaching
experience or extensive knowledge in the subject they are
teaching.
7. Virtual Assistant
 Virtual assistants help entrepreneurs with administrative
functions through the Internet. The tasks completed by virtual
assistants depend upon the needs of clients. Common tasks
may include checking emails, creating excel spread sheets
and typing documents.
Partnership
 A Partnership is defined in Articles 1767 to 1867 of the Civil

Code of the Philippines as “a contract whereby two or more
persons bind themselves to contribute money, property, or
industry into a common fund with the intention of dividing
profits among themselves.
Characteristics of a Partnership
1. Mutual Agency – Any partner may act as an agent of the

partnership in conducting its affairs.
2. Unlimited Liability – Generally, the personal assets (assets not

contributed to the partnership) of any partner may be used to
satisfy the creditors’ claims of the partnership, if the partnership
assets are not enough to settle the liabilities to outsiders upon
liquidation except for limited liability partnership.
3. Limited Life – A partnership may be dissolved at any time by action

of the partners or by operation of law.
4. Mutual participation in profits – A partner has the right to share in

partnership profits.
5. Legal entity – A partnership has legal personality separate and

distinct from partnership profits (except general professional
partnership).
6. Co-ownership of contributed assets – Property contributed to the

partnership are owned by the partnership by virtue of its separate
legal personality.
7. Income tax – Taxable income of a partnership (except general

professional partnership) is computed in the same manner as in a
corporation. Partners' shares in taxable partnerships profits are
treated like dividends. A general professional partnership as such
shall not be subject to corporate tax instead persons engaging in
business as partners in a general professional partnership shall be
liable for income tax only in their separate and individual capacities.
Advantages of Partnership
1. Easy to Organize. Partnership is easy and inexpensive to organize,

as it is formed by a simple contract between two or more persons.
2. Unlimited Liability. The unlimited liability of the partners makes it

reliable from the point of view of creditors.
3. Huge Resources. Possibility of bigger resources than in the single

proprietorship exists. Financial institutions may extend bigger loans
to such business organization considering the combined resources
of the partners.
Advantages of Partnership
4. Better Management. The participation in the business by

more than one person makes possible a closer supervision of
all its activities/operations.
5. Better distribution of Profits. The profits were distributed
according to the agreement of the partners or equally
distributed among them. The direct gain to the partners is an
incentive to give close attention to the business.
Disadvantages of Partnership
1. Unlimited liability of the partners. The personal liability of as partner

for firm debts deters many from investing capital in a partnership.
2. Partners are solidarity liable. A partner may be subject to personal

liability for the wrongful acts or omission of his associates.
3. It lacks stability. It is less stable because it can easily be dissolved by

death or withdrawal of any partners.
4. Conflict Arise. There is divided authority among the partners. There is

constant likelihood of dissention or disagreement when each of the
partners has the same authority in the management of the firm.
Kinds of Partnership
As to liability of Partners
 General Partnership - A general partnership is a partnership with only
general partners. Each general partner takes part in the
management of the business, and also takes responsibility for the
liabilities of the business. If one partner is sued, all partners are held
liable. General partnerships are the least desirable for this reason.
 Limited Partnerships – A limited partnership includes both general

partners and limited partners. A limited partner does not participate
in the day-to-day management of the partnership
 and his/her liability is limited. In many cases, the limited partners are
merely investors who do not participate in the partnership other than
to provide an investment and to receive a share of the profits.
Limited partners have limited liability to the extent of his contribution.
 Limited Liability Partnerships – A limited liability partnership (LLP) is

different from a limited partnership or a general partnership, but is
closer to a limited liability company (LLC). In the LLP, all partners
have limited liability.
As to Duration
 Partnership at Will – one for which no term is specified and is not formed
for a particular undertaking or venture and which may be terminated
any time by mutual agreement of the partners or the will of one alone.
 Partnership with a fixed term – one in which the term or period for which
the partnership is to exist is agreed upon. It may also refer to a
partnership formed for a particular undertaking and upon expiration of
the term and completion of the particular undertaking; the partnership
is dissolved, unless continued by the partners.
As to Representation to others
 Ordinary Partnership – One which actually exists among the partners
and also to third persons.
 Partnership by estoppels – one which in reality is not a partnership

but is considered partnership only in relation to those who, by their
conduct or omission, are precluded to deny or disprove its
existence.
Classes of Partners
As to Contribution
 Capitalist Partner – one who contributes capital in money or property.
 Industrial Partner – one who contributes industry, labor, skill or service.
 Capitalist Industrial Partner – one who contributes money, property and

industry.
As to Liability
 General Partner – one whose liability to third persons extends to his
separate personal properties.
Classes of Partners
 Limited Partner – one whose liability is limited only to the extent of his
capital contribution to the partnership.
As to Management
 Managing Partner – one who manages actively the business of the
partnership.
 Silent Partner – one who does not participate in the management of

the partnership affairs.
Corporation
 A corporation is an artificial being created by

operation of law, having the right of
succession and the powers, attributes and
properties expressly authorized by law or
incident to its existence. (Section 2.
Corporation Code of the Philippines)
Characteristics of a Corporation
 Separate Legal entity (Artificial being) – A corporation is an

artificial being with a personality that is separate from that of
its individual owners. Thus, it may, under its corporation name,
take, hold or convey property to the extent allowed by law,
enter into contracts and sue or be sued.
 Created by operation of Law – A corporation is generally
created by operation of law. The mere agreement of the
parties cannot give rise to a corporation.
 Right of Succession – A corporation has the right of succession. Irrespective of the death,
withdrawal, insolvency, or incapacity of the individual members or stockholders and
regardless of the transfer of their interest or shares of the stock, a corporation can
continue its existence up to the period of time stated in the articles of incorporation but
not to exceed 50 years.
 Powers, attributes, properties authorized by law – A corporation has only the powers,
attributes and properties expressly authorized by law or incident to its existence. Being a
mere creation of law, a corporation can exercise powers provided by law and those
powers which are incidental to its existence.
 Ownership divided into shares – Proprietorship in a corporation is

divided into units known as shares of stocks. The buyers of this stock
are called stockholders and are considered as owners of the
business.
 Board of Directors – Management of the business is vested in a

board of directors elected by the stockholders. The board of
directors is the governing body or decision making body of the
corporation. The Corporation Law provides that the number of
directors be not less than five but more than fifteen.
Advantages of a Corporation
 Limited liability for the owners. Since a corporation is a

separate and distinct legal entity, owners of a corporation
are only indebted to the extent of their interest in the
corporation. This means that the creditors of a corporation
can only run after the assets of the corporation and not the
personal assets of the stockholders in the settlement of the
corporation’s debts and obligations. In other words
stockholders enjoy a “shield” from most creditors.
 Shares of ownership are transferable. The shares of stock or

interest of a publicly traded corporation can be traded easily
though a stockbroker. Shares of corporations are freely
transferable except when shareholders have “buy-sell”
agreements restricting when and to whom share may be sold or
transferred. Securities laws and regulations may also limit the
transferability of certain shares. For non-publicly traded
corporations, the stock certificate can be transferred or
assigned to another owner by executing a deed of assignment
of shares of stock.
 Continuity. The corporation’s power of succession enables it to

enjoy a continuous existence. The life-span of a corporation is
50 years, and subject to renewal for another 50 years. The
death, withdrawal of some officers and members does not
affect the existence of the corporation. Unlike a sole
proprietorship and partnership, the death of a stockholder will
not terminate the corporation. The corporation will continue as
a separate and distinct legal entity and the shares of its interest
can be transferred from one owner to another owner.
 It attracts more investors. Corporations attract investors

because of its stock structure, perpetual existence, ownership
transferability, and limited liability. Attracting more investors
allows a corporation to raise more capital or equity to manage
and expand their operations. Furthermore, because of a more
regulated form of corporation and the fiduciary duties of its
board of directors, it earns more trust and confidence not only
from investors, but also from its employees, creditors, suppliers,
customers and other outside stakeholders.
 Centralized Management. As can be gleaned from Sec. 23 of

Corporation Code “It is the board of directors or trustees which
exercises almost all the corporate powers in a corporation.
”Firmev. Bukal Enterprises and Dev. Corp., 414 SCRA 190 (2003).
The exercise of the corporate powers of the corporation rest in
the Board of Directors save in those instances where the
Corporation Code requires stockholders’ approval for certain
specific acts.
Disadvantages of a Corporation
1. Incorporation is costly. Incorporating a business needs to file with the

Securities and Exchange Commission (SEC) and may involve a lot of
formal and legal papers, such as by laws, articles of incorporation,
affidavit and board resolutions. This is sometimes done by getting the
service of a corporate attorney or firms which are specialized in
incorporating a business. It may also require higher amount of initial or
paid-up capital for other types of corporation like financing and lending
corporations. Furthermore, the amount of subscribed capital is taxed
with documentary stamp tax, which may result to additional expenses
to be incurred by the incorporators.
2. Corporations are highly regulated. Ordinary corporations are regulated

by the SEC. Special corporations may be required with secondary
licenses and are further regulated by other government agencies, such
as Bangko Sentral ng Pilipinas (BSP) for financing and lending
companies, Commission on Higher Education (CHED) for companies
operating secondary schools and Insurance Commission (IC) for
insurance companies.
Moreover, corporations also need to comply with the quarterly or annual

reportorial requirements with the SEC and other agencies requiring those
reports for certain types of corporations. This also means that the more
compliance it requires, the more paper works and cost it involves. And
when there are more to comply, bigger penalties are awaiting to be paid
if they are not complied.
3. Limited liability may discourage creditors. The limited liability feature of

the corporation can be an advantage for stockholders. However, it
can also be a disadvantage when a corporation doesn’t have a
good financial condition and performance. Because of the limited
liability, a corporation with a low credit score may discourage
creditors to lend their money to the corporation.
4. It may result to double taxation. Since the corporation is already taxed

on its income, distributing this income to shareholders in the form of
dividends may result to double taxation. Dividends income received
by the shareholders are subject to final 10% tax and shareholders is
also taxed on their personal income tax returns.
5. It is not easy to dissolve. Corporations are difficult to dissolve as it is

also difficult to form. Everything is regulated from formation, to
operation, and to dissolution. An application for dissolution must be
filed with the S.E.C with complete requirements, including tax
clearance with the Bureau of Internal Revenue. The liquidation
process is also regulated to ensure that the rights of any creditor
having a claim against it are not prejudiced.
Classes of a Corporation
As to membership holdings
 Stock Corporation – a private corporation in which the capital is
divided into shares of stock and is authorized to distribute corporate
earnings to holders on the basis of shares held. The owners of a stock
corporation are called stockholders or shareholders.
 Non-stock Corporation – a private corporation in which capital comes

from fees paid by the individuals composing it. The owners of the non-
stock corporation are called members.
As to Purpose
 Public Corporation – a corporation that is organize to perform a governmental function

or to operate under government control such as government controlled corporations
and statutory corporations.
 Private Corporation –a corporation that is organized for a private benefit, aim or end.
 Quasi-public Corporation – a private corporation which is given a franchise to perform

functions of a public character. Classified under this type are the so called public utility
corporations such as MERALCO and PLDT.
As to Law of Creation
 Domestic Corporation – a corporation that is organized under Philippine Laws.
 Foreign Corporation – a corporation that is organized under the laws of other countries.
As to Extent of Membership
 Open Corporation – a corporation whose ownership is widely held by many investors

usually a private stock corporation.
 Closely held corporation or Family Corporation – a private corporation in which 50% or

more of its stock is owned by five (5) persons or less.
Components of Corporation
 Incorporators – they are the persons who originally formed the corporation and whose
names appear in the Articles of Incorporation. They must be natural persons as
distinguished from artificial persons
 Corporators – they are the persons who compose the corporation whether are
stockholders or members.
 Stockholders or shareholders – they are the corporators of a stock corporation.
 Members – they are the corporator’s of non-stock corporation.

Organizing a Corporation
The process of organizing the corporation generally consists of three stages which
normally require the aid of legal, competent advisers.
1. Promotion – the incorporators make preliminary arrangements to set up a tentative

working organization and to solicit subscription to raise sufficient capital for the
business.
2. Incorporation – the process of formalizing the organization of the corporation. This

stage includes:
 Drafting the articles of incorporation which must be duly executed and acknowledge
before a notary public.
 Filing the articles of incorporation with the Securities and Exchange Commission
(SEC) together with the statement showing that at least 25% of the total authorized
capital stock has been subscribed and that at least 25% of the total subscription has
been paid.
 After the required fees have been paid and upon approval of the articles of
incorporation, the SEC issues a certificate of incorporation, the date of which being
considered as the date of registration or incorporation.
3. Commencement of Business
 The business should start within two years from the date of incorporation.
Failure to do so will automatically dissolve the corporation without the need
for a hearing.
Cooperative
 A co-operative is a member-owned business structure with at least five members, all of whom have
equal voting rights regardless of their level of involvement or investment. All members are
expected to help run the cooperative.
 A co-operative is a separate legal entity and members, directors, managers and employees are
not liable for any debts incurred unless they are the result of recklessness, negligence or fraud.
 A co-operative usually only allows a limited distribution of profits to members (some don’t allow
any). This business structure encourages a democratic style of management and promotes the
concepts of sharing resources and delegation to increase competitiveness.
Advantages of Cooperative
 Generally inexpensive to register.
 All members must be active in the co-operative.
 Members have an equal vote at general meetings regardless of their level of

investment or involvement.
 Other than directors, members can be aged under 18 years. These members
cannot stand for office and don’t have voting rights
Disadvantages of Cooperative
 As co-operatives are formed to provide a service to members rather than a

return on investment, it may be difficult to attract potential members seeking a
financial return.
 There is usually limited distribution of profits to members and some co-

operatives may prohibit the distribution of any surplus.
 Members providing greater involvement or investment than others will still only
get one vote.
 Requires ongoing education programs for members.

THE END
References:

TYPES OF BUSINESS
ACCORDING TO ACTIVITIES

LEARNING OBJECTIVES
 Compare and Contrast the types of business according to

activities;
 Identify the advantages, and disadvantages, and business

requirements of each type.
Service Business
 This type of business provides various forms of services, not tangible products, to its
customers or clients. Some examples of entities that render services are:
professional, repair shops, banks, brokers, consultants, schools, hotels, insurance
companies, utility enterprises, and service contractors. A service enterprise
recognizes income in the form of fees, rents, interests, realties, retainers, or
commissions.
Service Business
 The typical financial transactions recorded for a service company include
collecting a deposit from the customer, providing the service and receiving
payment. These activities may occur in the same accounting cycle or in several
cycles.
Receive Cash
Cash
Accounts
Receivable
Merchandising Business
 This type of business entity is in the “buy and sell” business. A “trading” or
merchandising enterprise buys ready-to-use products, such as appliances,
vehicles, households items, toys, clothing apparels, supplies, ready-to-eat food. A
business enterprise that purchases ready-to-use materials from wholesalers or
manufacturers, and then sells the same to other processors or manufacturers,
without changing the form of the materials bought and sold, is also classified as a
merchandising enterprise.
Merchandising Business
 Wholesaler buys large quantities of finished goods directly from the manufacturers
or importers, and then resells the same to the different merchandisers.
 Retailers or traders sell the goods directly to the end-customers. Examples: (SM,
Mercury Drugs, Uniwide, Rustan’s and supermarkets.
Merchandising Operating Cycle
 The primary sources of revenues is referred to as sales revenue or

sales.
 The operating cycle of a merchandising company ordinarily is longer
than that of a service company
Income Measurement of Merchandising Business
Not used in a service
business
Sales less
Revenue
Equals
Cost of Gross
Good sold Profit
less
Cost of goods sold is the total cost Operating Equals Net Income
Of Merchandise sold during the period. Expenses (Loss)
Inventory systems
 Perpetual System
Features:
1. Purchases increase Merchandise Inventory.
2. Freight costs, Purchase Returns and Allowances and Purchase discounts are included in
Merchandise Inventory.
3. Costs of Goods Sold is increased and Merchandise Inventory is decreases for each sale.
4. Physical count done to verify Merchandise Inventory balance.
The perpetual inventory system provides a continuous record of Merchandise Inventory and
Cost of Goods Sold.
Inventory systems
 Periodic system
Features:
1. Purchases of merchandise increase purchases.
2. Ending inventory determined by physical count.
3. Calculation of Cost of Goods Sold:
Beginning inventory
Add: Purchases, net
Goods available for sale

Recording Purchases of Merchandise
 Made using cash or credit (on account)
 Normally recorded when goods are received.
 Purchase invoice should support each credit purchase.

 Freight Costs
Terms
 FOB shipping point – seller places goods Free on Board the carrier, and buyer pays
freight costs.
 FOB destination – seller places the goods Free on Board to the buyer’s place of
business, and seller pays freight costs.
Freight costs incurred by the seller on outgoing merchandise are an operating

expense to the seller (Freight-out or Delivery Expense).
 Purchase Returns and Allowances
 Purchaser may be dissatisfied because goods are damaged or defective, of inferior

quality, or do not meet specifications.
 Purchase Return
 Return goods for credit if the sale was made on credit, or for a cash refund if the
purchase was for cash.
 Purchase Allowance
 May choose to keep the merchandise if the seller will grant an allowance (deduction)
from the purchase price.
 Purchase Discounts
 Purchase terms may permit buyer to claim a cash discount for prompt payment.
 Advantages:
 Purchaser saves money.
 Seller shortens the operating cycle.
 Example:
 Credit terms of 2/10, n/30, is read “two-ten, net thirty”. 2% cash discount if payment is
made within 10 days.
 Purchase Discounts Terms
Credit term: 2/10, n/30
 2% discount of paid within 10 days, otherwise net amount due within 30 days.
Credit term: 1/10 EOM
 1% discount if paid within first 10 days of next month.
Credit term: n/10 EOM
 Net amount due within the first 10 days of the next month.
Computation of the Profit of service vs. merchandising
business
Service Business
Revenue from services rendered P xx
Less: Operating expenses xx
Profit of the period P xx
Merchandise Business
Revenue from goods sold P xx
Less: Cost of goods sold xx
Gross profit on sales P xx
Less: other operating expenses xx
Profit of the period P xx
Gross Profit on sale equation
Derived Equation:
Sales – Cost of goods sold = Gross profit on sales
Sales – Gross profit on sales = Cost of goods sold
Sales – Cost of goods sold + Gross profit on sales
Gross profit on sales – other operating expenses = Profit
Gross profit on sales – Profit = Other operating expenses
Gross profit on sales = Other operating expenses + Profit

Sample Computation of gross profit on sale
Compute for the missing amounts.
Case 1 Case 2 Case 3 Case 4

Sales Revenue 1,244,325 2,468,540 1,425,360 ?
Cost of goods sold 825,450 1,727,970 ? 875,890
Gross margin ? ? ? ?
Other operating expenses 245,330 ? 301,320 275,280
Profit during the period ? 210,335 132,550 125,200
Check your Answers

Sales Revenue 1,244,325 2,468,540 1,425,360 1,276,370
Cost of goods sold 825,450 1,727,970 991,490 875,890
Gross margin 418,875 740,570 433,870 400,480
Other operating expenses 245,330 530,235 301,320 275,280
Profit during the period 173,545 210,335 132,550 125,200
Cost of goods sold Equation
Cost of goods sold formula on periodic Inventory system:
Inventory that is
Inventory at the + Net purchases = available for sale
beginning of the during the during the reporting
reporting period reporting period period
Inventory that is Unsold portion, which is Sold portion, which

available for sale becomes,
Ending merchandise
- = cost of goods sold,
during the inventory, reported reported in the income
reporting period statement
in the balance sheet
Sample Computation on cost of goods sold

Inventory, beginning 125,750 87,985 55,780 ?
Purchases 775,350 822,500 ? 695,220
Inventory available for sale ? ? ? ?
Inventory, ending 85,755 ? 45,230 91,245
Cost of goods sold ? 750,335 615,750 855,455
Check your Answers

Inventory, beginning 125,750 87,985 55,780 251,480
Purchases 775,350 822,500 605,200 695,220
Inventory available for sale 901,100 910,485 660,980 946,700
Inventory, ending 85,755 160,150 45,230 91,245
Cost of goods sold 815,345 750,335 615,750 855,455
Manufacturing Business
 Manufacturer also called fabricator, producer or processor
 Is in the normal business of producing the goods that he sells. He has factory
facilities where the finished goods are produced out of materials and supplies
by applying labor and other manufacturing costs.
 Manufacturing firms will purchase raw materials from suppliers and convert
them into finished products, such as Apple iPods, Levi Stauss jeans, and Ford
trucks and cars.
Manufacturer
Wholesaler
Selling Goods and
Services to Customers
Retailer
Consumer
Service
Company
 Manufacturing Costs
 Represents all the costs associated with producing or manufacturing a physical product.
 Direct materials: includes the major material inputs that can be directly and conveniently
traced to each unit of product(the cost object).
 Direct labor costs: refers to the “hands on” labor that can be directly conveniently traced
to the product, such as the wages of employees on the production of the product (pizza)
production line and in the packaging department.
 Manufacturing overhead: includes all manufacturing costs other than direct materials and
direct labor incurred to produce a physical product. It includes all of the indirect costs that
are incurred inside the manufacturing facility or factory that cannot be traced to each unit
of product, such as indirect materials, indirect labor, factory rent, factory insurance, and
factory utilities.
 Manufacturing Costs
 Represents all the costs associated with producing or manufacturing a physical product.
 Direct materials: includes the major material inputs that can be directly and conveniently
traced to each unit of product(the cost object).
 Direct labor costs: refers to the “hands on” labor that can be directly conveniently traced
to the product, such as the wages of employees on the production of the product (pizza)
production line and in the packaging department.
 Manufacturing overhead: includes all manufacturing costs other than direct materials and
direct labor incurred to produce a physical product. It includes all of the indirect costs that
are incurred inside the manufacturing facility or factory that cannot be traced to each unit
of product, such as indirect materials, indirect labor, factory rent, factory insurance, and
factory utilities.
 Prime costs: taken together, direct materials and direct labor. Direct labor and
direct materials are considered as “primary” costs of manufacturing product.
Formula:
Prime Cost = Direct materials + Direct labor
 Conversion costs: the costs incurred to convert direct materials into a finished
product. Direct labor and manufacturing overhead are referred to collectively as
conversion costs.
Formula:
Direct labor + Manufacturing overhead

Non-Manufacturing Costs
 Non-manufacturing costs: are the costs associated with running the business and
selling the product as opposed to manufacturing the product. They are generally
classified into one of two groups:
 Marketing or selling expenses: are incurred to get the final product to the customer.
 General and administrative expenses: are associated with running the overall business.
They include general management salaries, rent and utilities for corporate
headquarters, and corporate service functions such as the accounting, payroll, and
legal departments.
Product and Period Cost Flows
Manufacturing Cost Concepts
Financial Accounting Managerial Accounting

Cost is a measure of resources Product costs are the costs a
used or given up to achieve a company assigns to units
stated purpose. produced.
Manufacturing Costs
Direct Direct Manufacturing

Materials Labor Overhead
The Product
Classifications of Costs
Manufacturing costs are often
combined as follows:
Direct Direct Manufacturing

Materials Labor Overhead
Prime Conversion
Cost Cost
Nonmanufacturing Costs
Marketing and selling costs . . .
– Costs necessary to get the order and deliver the product.
Administrative costs . . .
– All executive, organizational, and clerical costs.
Product Costs Versus Period Costs
Product costs include direct Period costs are not included in
materials, direct labor, and product costs. They are expensed
manufacturing overhead. on the income statement.
Inventory Cost of Good Sold Expense
Sale
Balance Income Income

Sheet Statement Statement
Balance Sheet
Merchandiser Manufacturer
Current Assets Current Assets
– Cash  Cash
– Receivables  Receivables
– Prepaid Expenses  Prepaid Expenses
– Merchandise Inventory  Inventories
Raw Materials
Work in Process
Finished Goods
Balance Sheet
Merchandiser Manufacturer
Current Assets Current Assets
– Cash  Cash
– Receivables  Receivables
Materials waiting to be
– Prepaid Expenses processed.
 Prepaid Expenses
– Merchandise
Partially Inventory
complete products –  Inventories
some material, labor, or overhead Raw Materials
has been added. Work in Process
Finished Goods
Completed products awaiting

sale.
The Income Statement
Cost of goods sold for manufacturers differs only slightly from cost of goods
sold for merchandisers.
Merchandising Company Manufacturing Company
Cost of goods sold:

Cost of goods sold:
Beg. merchandise Beg. finished
inventory $ 14,200 goods inv. $ 14,200
+ Purchases 234,150 + Cost of goods
Goods available manufactured 234,150
for sale $ 248,350 Goods available
- Ending for sale $248,350
merchandise - Ending
inventory (12,100) finished goods
= Cost of goods inventory (12,100)
sold $ 236,250 = Cost of goods
sold $236,250
Manufacturing Cost Flows
Income
Balance Sheet Statement
Costs Inventories Expenses
Material Purchases Raw Materials
Income
Direct Labor Work in

Process
Manufacturing
Overhead
Income

Process
Manufacturing
Overhead Cost of
Finished
Goods
Goods
Sold
Income

Process
Manufacturing
Overhead Cost of
Finished
Goods
Goods
Sold
Selling and Period Costs Selling and

Administrative Administrative
Inventory Flows
Beginning
Additions Available
balance + $$$ = $$$$$
$$
_
Withdrawals
$$$
=
Ending
balance
$$
Product Costs - A Closer Look
Manufacturing Work
Raw Materials Costs In Process
Beginning raw
materials inventory
Beginning inventory is the

inventory carried over from the
prior period.
Manufacturing Work
Beginning raw Direct materials

materials inventory
+ Raw materials
purchased
= Raw materials
available for use
in production
– Ending raw materials
inventory
= Raw materials used
As items are removed from raw materials inventory and
in production placed into the production process, they are
called direct materials.
Manufacturing Work
Conversion costs are
Beginning raw Direct materials costs incurred to convert
materials inventory + Direct labor
+ Raw materials + Mfg. overhead the direct material into a
purchased = Total manufacturing finished product.
= Raw materials costs
available for use
in production
– Ending raw materials
inventory
= Raw materials used
in production
Manufacturing Work
Beginning raw Direct materials Beginning work in

materials inventory + Direct labor process inventory
+ Raw materials + Mfg. overhead + Total manufacturing
purchased = Total manufacturing costs
= Raw materials costs = Total work in
available for use process for the
in production period
– Ending raw materials – Ending work in
inventory All manufacturing costs incurred during the period
process are
inventory
= Raw materials used added to the beginning balance of work
= Cost in process.
of goods
in production manufactured.
Manufacturing Work
Beginning raw Direct materials Beginning work in

materials inventory + Direct labor process inventory
+ Raw materials + Mfg. overhead + Total manufacturing
purchased = Total manufacturing costs
= Raw materials costs = Total work in
available for use process for the
in production period
– Ending raw materials – Ending work in
Costs associated
inventory with the goods that are completed during process inventory
= Raw materials used = Cost of goods
the period are transferred to finished goods inventory.
in production manufactured.
Work
In Process Finished Goods
Beginning work in Beginning finished

process inventory goods inventory
+ Manufacturing costs + Cost of goods
for the period manufactured
= Total work in process = Cost of goods
for the period available for sale
– Ending work in - Ending finished
process inventory goods inventory
= Cost of goods Cost of goods
manufactured sold
Cost Classifications for Predicting Cost Behavior
How a cost will react to changes in

the level of business activity.
– Total variable costs change when
activity changes.
– Total fixed costs remain unchanged
when activity changes.
Total Variable Cost
Your total long distance telephone bill is based on how many
minutes you talk.
Total Long Distance
Telephone Bill
Minutes Talked
Variable Cost Per Unit
The cost per long distance minute talked is constant. For example,
10 cents per minute.
Telephone Charge
Per Minute
Minutes Talked
Total Fixed Cost
Your monthly basic telephone bill probably does not change
when you make more local calls.
Monthly Basic
Telephone Bill
Number of Local Calls

Fixed Cost Per Unit
The average cost per local call decreases as more local calls are
made.
Monthly Basic Telephone Bill

per Local Call
Number of Local Calls
Cost Classifications for Predicting Cost Behavior
Behavior of Cost (within the relevant range)

Cost In Total Per Unit
Variable Total variable cost changes Variable cost per unit remains
as activity level changes. the same over wide ranges
of activity.
Fixed Total fixed cost remains Fixed cost per unit goes
the same even when the down as activity level goes up.
activity level changes.
Direct Costs and Indirect Costs
Direct costs Indirect costs
• Costs that can be • Costs cannot be easily and
easily and conveniently traced to a conveniently traced to a unit of
unit of product or other cost product or other cost object.
objective. • Example: manufacturing overhead
• Examples: direct material and direct
labor
Differential Costs and Revenues
Costs and revenues that differ among alternatives.
Example: You have a job paying $1,500 per month in your hometown. You have a
job offer in a neighboring city that pays $2,000 per month. The commuting cost to
the city is $300 per month.
Differential revenue is:

$2,000 – $1,500 = $500
Differential Costs and Revenues
Costs and revenues that differ among alternatives.
Example: You have a job paying $1,500 per month in your hometown. You have a
job offer in a neighboring city that pays $2,000 per month. The commuting cost to
the city is $300 per month.
Differential revenue is:

$2,000 – $1,500 = $500
Differential cost is:
$300
Opportunity Costs
The potential benefit that is given up
when one alternative is selected over
another.
Example: If you were
not attending college,
you could be earning
$15,000 per year.
Your opportunity cost
of attending college for one year is
$15,000.
Sunk Costs
Sunk costs cannot be changed by any decision. They are not differential
costs and should be ignored when making decisions.
Example: You bought an automobile that cost $10,000 two years ago.
The $10,000 cost is sunk because whether you drive it, park it, trade
it, or sell it, you cannot change the $10,000 cost.
Types of Definition Input Output Advantages Disadvantages Examples
Business
According to
Activities
Service Firms that Labor Intangible • Absence of • Inability to Accounting
generally inventory standardize and law
use their • No services firms,
employees production hospitals,
to provide facilities schools,
services to salons
customers
Merchandisi Firms that Goods or Tangible; • Visible Managing Supermarket
ng buy finished merchan merchand products inventory s
or almost dise ise • Less convenienc
finished bought conversion, e stores,
goods from from time, and book stores,
their suppliers effort department
suppliers stores
and resell
the same to
customers
Types of Definition Input Output Advantages Disadvantages Examples
Business
According to
Activities
Manufacturing Firms that Raw Tangible; • Quality control • Generally Car
create their materials, manufacture • Visible need companies,
own products labor, d products products production consumer
overhead facilities products,
• High electronics
conversion companies,
costs energy
• Cost of manufacturers
Quality
control
• Managing
inventory
THE END
References:

www.slideshare.net
ACCOUNTING CONCEPTS
AND PRINCIPLES

LEARNING OBJECTIVES
 Explain the varied concepts and principles
 Solve exercises on accounting principles as applied in various cases

Accounting Principles
 Principles
 are broad laws or rules adopted as guides to conduct and practice of the profession.
 Generally Accepted Accounting Principle (GAAP),
 In accounting it is specially used as a guide in identifying, measuring, and reporting financial

information. It helps you to make decisions regarding accounting cases and problems and helps you
use and effectively interpret the financial statement.
 These accounting principles are accepted, supported and understood by the members of the
accounting profession. These are not rigid or fixed, but are continually evolving in response to the
changes in the business environment.
 Accounting Principles are rules and procedures that were developed
based on custom, usage, business practice, experience and opinions of
accountants and other professionals.
 Accounting Assumptions are the basic notions or fundamentals

premises on which certain accounting processes or procedures are
based.
Cont…
 The accounting system of a business enterprise must be able to provide for the
general information needs of the varied data-users through the general-purpose
accounting reports must be prepared in accordance with certain generally
accepted “ground rules” and assumptions so that the different users will be able to
interpret their contents properly.
 Example: Assume that a piece of land with an assigned value of P200,000 is included
in the financial report of a business enterprise. Some questions that may need answer
are:
o What does this reported amount of P200,000 represent?

Cont…
o Is it land’s original cost to the business enterprise, is it the current market value of the land, or is
this amount its assessed value for purposes of levying property taxes?
o Who owns the land? Is the land fully paid for?
o Furthermore, are there other claims on this property?
Basic Accounting Assumptions
The data-users must have knowledge of these concepts, premises, or assumptions so that
he could better utilize the information presented to him. The financial statements are
prepared in accordance with two basic accounting assumptions:
A. Accrual Basis Accounting
 When a business enterprise measures its net profit or loss for a certain period of time,
unless otherwise indicated in the financial statements.
 The net profit or loss is determined by deducting the total expenses incurred during
the period from the total income earned for the same time frame.
Understanding the terms
 Total expenses is not synonymous to total cash payments
 Total income is different from total cash receipts.
…deducting the total cash payments from the total cash receipts would give the balance
of cash but not the amount of net profit or loss of the period.
 Accrued expenses a certain expenses have already been incurred but not ye paid or
vice versa.
 Accrued income certain income items that have been earned but not yet collected
from the customers, even though goods or services have already been delivered.
Basic Accounting Assumptions
 Going Concern Assumption also known as continuity assumption
 The primary financial statements of a business enterprise are prepared on the

assumption that the normal operations of the enterprise will continue indefinitely. The
accounting elements and the corresponding amounts reported in the balance sheet
and income statement are determined based on the assumption that the enterprise
has no known intention of curtailing its normal operations.
 For example: the delivery service business of Liza Moreno listed in its balance
sheet an asset in the form of a delivery truck acquired in 2001 at a total cost of
P300,000. currently, the market price of this delivery truck is P250,000. since the
business has no plan of selling its properties, as it is expected to continue
operating indefinitely, the original amount is not to be changed. The balance
sheet must still present the delivery truck at P300,000.
Other Concepts
 Business Entity Principle
 This concept assumes that the business and its owner are separate and
distinct entities. As such there should be separate accounting and
reporting of the transactions, resources, obligations, income, and expenses
of the business and those of the owner. Because of this assumption,
monitoring and reporting of the activities, profitability, and financial
condition of the business enterprise would result,
Other Concepts
 Periodicity Concept
 The assumption that the operating life of the business may be divided into time-
periods is known as the periodicity concept or time-period concept. Timely
financial information is needed to become the basis for decisions and actions of
the decision-makers, financial statements should be prepared periodicity, at least
yearly. The need for periodic reports calls for the need to divide the life of the
business into reporting periods. The use of equal time-periods for reporting
purposes is helpful so that the reported information would have the qualities of
timeliness and comparability.
Other Concepts
 Concept of Equality of the Value Received and Value Given Up
 The recording and reporting of the business transactions are based on the
assumption that for every value received, there is an equal value given up.
 Examples:
 A form of property is parted with in exchange for money received.
 Use of property, or hire of services, of another person is received in

exchange for money parted with.
 Use of property, or hire of services, of another person is parted with in exchange for money
received.
 An oral promise (from an individual or entity) to pay is received in consideration for a thing of
value parted with.
 An oral promise (by an individual or entity) to pay is parted with in consideration for a thing of
value received.
 An oral promise (from an individual or entity) is received in consideration for the hire of services
by the entity.
 An oral promise (by an individual or entity) to pay is the value parted with in consideration for
the hire of services of another.
 An oral promise (from an individual or entity) to pay is the value received in exchange for the
hire (or use) of the property.
 An oral promise (by an individual or entity) to pay is the value parted with in exchange for the
hire (or use) of the property.
 Monetary Concept
 It is assumed that the business transactions can be objectively measured or

qualified in terms of “peso”. Because of this concept, the transactions recorded in
the books of accounts and the elements reported in the financial statements are
expressed in terms of a common unit of measurement, the peso. The use of this
concept allows for a more systematic aggregation and analysis of the reported
data.
 it is easier to assign peso values to those transactions that involve cash inflows or
cash outflows.
Cont…
 Transactions that do not involve cash are assigned a fair peso value or acceptable
substitute peso value.
 If the certain transaction cannot be assigned an objective and reliable peso value, it
will not be taken up in the records and not be included in the financial statements of
the business.
 The assumption that peso values assigned to the accounting elements are not
materially affected by inflation.
 Objectivity Principle
 These requires that financial data entered in the records must be verifiable substantiated by
documents such as invoices, vouchers or official receipts.
 Matching Concept
 Under this concept, it is assumed that the results of business operations could be measured if
there is a proper matching of income and expenses within a reporting period.
 There should be a simultaneous recognition of income and the corresponding expenses that
are directly or indirectly contributory to the earning of such income.
Qualitative Characteristics of Financial
Information
1. Understandability
 It should be readily understood by the data-users. Presented data should

be arranged and formatted in a manner that adds to the usefulness of the
financial reports as a tool for decision-making. Information that is not
understandable is not irrelevant.
Information
2. Relevance
 Financial information considered relevant if it has feedback value and/or

predictive value. Feedback value exists if the reported information could
be used to assess the outcome of past activities and transactions.
Predictive value of the reported financial information exists if this could be
used as a basis for forecasting what may happen in the future. Timeliness
financial information must be available on time so that it will be relevant.
Information
3. Reliability
 Financial information is considered reliable if it is verifiable, neutral, and if it

represents that which it is intends to represent (representational faithfulness).
 Verifiability assuming there are several independent accountants who will

repeat a method, they will obtain basically the same results.
 Neutrality exists when the recognition and measurement of the reported
financial information are not intended to favor only a certain chosen group
of decision-maker or data-users.
 Financial information is a faithful representation of the situation if it is not

biased.
Bias exists if the accountant did not use the measurement method properly or
if the reported information is consistently too high or too lo in order to
intentionally favor certain interest groups.
4. Comparability
 The quality of comparability allows the data –users to assess the similarities and
differences either for he same enterprise over different time periods or among
different enterprises for the same period of time.
 Consistency in the application of the accounting methods will contribute to

the comparability of the financial information. To be consistent is to use the
same procedures, systems, and methods from one period to another.
However, a change to a more preferred method is allowed if the result of
the change is disclosed in the financial statements.
Other guides that accountant may use in his attempt to report financial data:
A. Prudence
 If situations wherein two or more equally acceptable alternative methods could

be suitably applied.
 An accountant exercise prudence by choosing to apply the method that will tend
to make the profit smaller, thus, the method that has a less favorable effect on the
balance of the owner’s equity. This is only practiced during situations of
uncertainty or doubt. Abuse in the use of prudence results biased reporting, and
conflicts with the qualitative characteristics of reliability and comparability.
B. Materiality
 It is important enough to have an effect on the data-user’s decision-making process.
 Material information should be reported on the face of the financial statements, or among
the supplementary notes that are attached to the financial statements.
 The materiality of an item of information depends on its relative size, its nature, the precision
with which it can be estimated, and also how large the business enterprise is.
 For example: a donation to charity of P100,000 coming from a multinational corporation may
be considered as an immaterial amount
C. Cost vs Benefits
 Financial information provides the data-users with certain benefits in their decision-
making process.
 The costs of gathering and providing the information should be compared and
associated with the benefits to be derived from it.
 The general rule is that financial information should be gathered or provided to the
data-users only if the benefits to be derived from it exceed the costs of collecting
and providing such information.
Responsibilities and Opportunities of
an Accountant
 Ethical Standard
 Ethics is a set of moral principles and values which guides one to distinguish
between right or wrong and to act and conduct oneself accordingly.
- Financial statements must be audited and certified by accountants as

being fairly presented in accordance to generally accepted accounting
principles.
- Enable information to be reliable, the one preparing it must be trustworthy or

credible.
 Competency requires one to have adequate knowledge, skills and experience in the
practice of his profession.
 Integrity is a highly professional characteristics which requires one to be honest and

trustworthy.
 Objectivity requires one to be fair, to avoid bias and always to maintain an impartial
attitude in all matters.
 Independence in mental attitude requires a practitioner to avoid compromising

relationships that may impair his objectivity.
 Confidentiality of records is another ethical consideration which practitioner should adopt.

Responsibilities and Opportunities of
an Accountant
 Social Responsibility
 Responsible citizenship, requires all firms and professional to provide

opportunities to people to improve their standard of living through
economic growth and development and through environmental
management.
THE END
References:

THE ACCOUNTING
EQUATION

LEARNING OBJECTIVES
The learners shall be able to:
 Illustrate the accounting equation
 Enumerate and explain the elements of the accounting equation,
 Perform operations involving simple cases with the use of

accounting equation
The Accounting Equation
 These three elements, are systematically classified, arranged, and reported in the body of
the balance sheet. These are also called balance sheet accounts, permanent accounts
or real accounts.
 The assets, liabilities and owner’s equity are always expressed in an equation:
Assets = Liabilities + Owner’s equity
 This equation could be stated in another way:
Assets = Owner’s Equity
Note: Assets must always be equal to owner’s equity, if there are no liabilities, then assets are
claimable by the owner.
Assets
 Assets are resources that an entity owns in order to derive some future benefits.
These assets are used by the company in its normal operations such as the
manufacture of goods or delivery of services.
Some examples of Assets
1. Cash
- it is the money that we use comprising of the bills and coins we use in our everyday lives in order to buy
the goods that we want and also avail the services that we need.
2. Accounts Receivable
- this represents amounts that are collectible from customers. They arise when a business sells its goods or
services on account or on credit.
3. Inventories
- when going to sari-sari store, you would notice piles of assorted products being offered to be sold. One
can easily find various items such as food and household items to satisfy whatever he or she needs.
Some examples of Assets
4. Equipment
- Pandesal shops would need ovens and furnaces in order to properly and actually create
their goods. The product of these ovens is the pandesals which would be sold later on and
eventually increase the cash of the shop.
5. Land building
- a physical store necessary for them to operate.
6. Intangible
- we normally think of tangible things or those that can be seen and touched. However, assets
also encompass intangible things that can neither be seen or touched.
Liabilities
 Liabilities are one of the claims of external parties from the entity. Basically, they are
the debts of the entity to external creditors. These debts do not always have to be
paid in money. Some of these liabilities are in the form of obligations to do some
service or even give something.
 Liabilities = Assets - Owner’s equity

Example Liabilities
1. Accounts payable
- when a local supermarket or convenience store like 7-Eleven buys its goods, it is
unusual for it to immediately pay cash for such goods.
2. Unearned revenue
- telecommunication companies such as Globe and Smart normally offer prepaid to

customers. These load credit can be later on used by customers for text messages or to
call other people.
Equity
 The equity reflects the residual claims or net assets of the owners of an entity. This is
similar to the net worth part of the SALN of our public servants. Take note that these
are only residual claims of the owners since the creditors get their share of the entity
first before the owners are given their share. This is only why the net worth of
individuals is computed by subtracting their liabilities from their assets.

Equity
Revenues – Expenses = Net Income/(Net Loss)
1. Revenues
2. Expenses
3. Capital
Using Accounting Equation
 Recall that the accounting equation is as follows:
Assets = Liabilities + Equity

Cash Accounts Equitable Accounts Unearned Owner’s Revenue Expenses
Receivable Land and Payable Revenue Capital
Building
Inventories Intangible
Assets
Manang Rosie’s Famous Barbecues
1. Initial Investment. Manang Rosie has Rosie has been well known for her delicious
variety of barbecues. As such, she decided to open up a barbecue store in her
neighborhood. The store would be a sole proprietorship business. In order to do so,
she investment P25,000 initial capital.

Cash Owner’s Capital
(1) + P25,000 (1) + P25,000
2. Purchase of equipment. To actually create her famous barbecue, she would need
the proper equipment to cook it. Thus, she went to the local hardware store and
bought the necessary equipment such as grills and utensils for P20,000.

Cash Equipment Owner’s Capital
P25,000 P25,000
(2) –P20,000 (2) + P20,000
P5000 P20000 P25000
P25000 P25000
3. Purchase of inventories through credit. Manang Rosie’s barbecue require only the freshest
meat which can be bought from Ate Shayne’s store in the market. Since they cost P10,000,
Manang Rosie does not have enough money to purchase this. Despite that, Manang Rosie
is already a trusted suki of this store. As such, Ate Shayne decided to give the met to
Manang Rosie on the condition that she will have to pay her in 30 days.
Cash Equipment Inventories Accounts Payable Owner’s Capital
P5,000 P20,000 (1) + P10,000 (3) P10,000 P25,000
P5000 P20000 P10,000 P10,000 P25000

P35000 P35000
4. Payment of expenses. To actually set up a business, one of her friends told her that she has
to obtain business and other permits from the local government. As such, she paid P1000 to
obtain such permits.
Cash Equipment Inventories Accounts Owner’s Capital Expenses
Payable
P5,000 P20,000 (1) + P10,000 (3) P10,000 P25,000
(4) – P1,000
(4) –P1,000 P25000
P4,000 P20000 P10,000 P10,000
P34,000 P34,000
5. Sale of barbecues. With everything on place, Manang Rosie can now sell her famous
barbecues. During the first day of her new business venture, she was able to sell 1,000
barbecues with a selling price of P20,000. Half of which was paid cash. The other half was
to be paid in 5 days.
Asset = Liabilities + Equity
Cash Accounts Equipment Inventories Accounts Owner’s Revenues Expenses

Receivable Payable Capital
P4,000 P20,000 P10,000
(5)+P10,000 (5) +P10,000 10,000 (4)- P1,000
P14,000 P10,000 P20,000 P10,000 10,000 P25,000 (5)+20,000 -P1,000
P54,000 P54,000
As illustrated by this transaction, there can be transactions which affect five asset
accounts but only one liability account. Correspondingly, the 1,000 barbecues account
for half of the total supply of barbecue of Manang Rosie.
Asset = Liabilities + Equity
Cash Accounts Equipment Inventories Accounts Owner’s Revenues Expenses

Receivable Payable Capital
10,000
P14,000 P20,000 P10,000 10,000 P25,000 P20,000 - P1,000
(5)-P5000 (5)-P5,000
P14,000 P10,000 P20,000 P5,000 10,000 P25,000 P20000 -P6,000
P49,000 P49,000
Simple Computation
 Compute for the unknown in each given case:
Case 1 Case 2 Case 3
Assets 100,000 350,750 ?
Liabilities 45,500 ? 232,750
Owner’s equity ? 210,320 522,325

 Check your Answers:
 Case 1: Owner’s equity = Assets – liabilities
P54,500 = P100,000 – P45,500
 Case 2: Liabilities = Assets – Owner’s equity
P140,430 = P350,750 – P210,320
 Case 3: Assets = Liabilities + Owner’s equity
P755,075 = P232,750 + P522,325

Temporary accounting Elements
Profit or loss Income Expenses

of the = (revenues - (expenses
period and gains) and losses)
The term income is used in connection with the inflow of assets and/or outflow of liabilities that
are related to the activities of the business.
The term expenses is used in connection with the outflow of assets and/or inflow of liabilities
that are directly or indirectly related to the activities of the business enterprise.
Simple Computation
 Compute for the unknown in each given case.
Case 1 Case 2 Case 3
Income (revenues and gains) 850,450 950,320 ?
Expenses and losses 887,454 ? 450,450
Profit (loss) ? (125,750) (45,350)

 Check your answer:
 Case 1: Profit = Revenues and gains – Expenses and losses
(P37,004) = P850,450 – P887,454
 Case 2: Expenses and losses = Revenues and gains – Profit
P1,076,070 = P950,320 – (P125,750)
 Case 3: Revenues and gains = Expenses and losses + Profit
P405,100 = P450,450 + (P45,350)

Ending Balance of the Proprietor’s Equity
Additional
Equity of the owner, +
investments less =
Equity of the owner,
beginning personal withdrawals ending
add Profit (loss)
In order to remember equations in computing for the equity at the end of the reporting period,
you may use WIN.
W stands for Withdrawal for personal use

I stands for Additional Investments
N stands for Profit or Net loss (loss)
Simple Computation
Case 1 Case 2 Case 3 Case 4 Case 5

Owner’s equity, 100,000 325,444 245,850 150,653 ?
beginning
Additional investment 75,000 50,000 80,000 ? 20,000
Withdrawals for 60,000 120,000 ? 90,000 120,000
personal use
Profit (loss) 75,375 ? (98,750) (85,344) 95,750
Owner’s equity, ending ? 275,350 180,200 190,691 325,750
Check your Answer
 Case 1: EE = EB – W + I + N
P190,375 = P100,000 – P60,000 + P75,000 + p75,375
 Case 2: N = EN + I - W – EE
P325,444 + P50,000 – P120,000 – P275,350
 Case 3: W = EB + I + N –EE
P46,900 = P245,850 + P80,000 + (98,750) – P180,200
 Case 4: I = EB – W + N – EE
P215,382 = P150,653 – P90,000 + (85,344) – P190,691
 Case 5: EB = EE – I + W – N
P330,000 = P325,750 – P20,000 + P120,000 – P95,750
Mental Calisthenics:
Based on the given formula in previous slide, prepare an equation to compute the
following:
1. Original investment, or equity of the owner as of the beginning of the period.
2. Additional investments
3. Profit of the period
4. Personal withdrawals
Check your answers!
1. Original investment = equity of the owner as of the end of the period – Additional
investments – profit of the period + personal withdrawals
2. Additional investments = equity of the owner as of the end of the period – original
investment – profit of the period + personal withdrawals
3. Profit of the period = equity of the owner as of the end of the period – original
investment – additional investments + personal withdrawals
4. Personal withdrawals = original investment + additional investments + profit of the

period – equity of the owner as of the end of the period
Income and Expenses equation
 Income
Total income – Total expenses = Profit or loss of the period
Based on the given formula compute for:

1. Income during the period
2. Expenses during the period
Answers:
1. Total income = Profit or loss of the period + total expenses
2. Total expenses = Profit or loss of the period + total income
THE END
References:

Financial Ratios
Item
# Indicators of Profitability
Formula Significance
1 Rate of Return on Sales Net Income Indicates the amount of net income per peso of sales
Net Sales or the profitability based on sales.
Rate of Return on Total Return on sales x Asset Turnover

2 Assets or Indicates the profitability in the use of the total assets
Net Income or total capital, both borrowed and invested.
Average Total Assets
3 Asset Turnover Net Sales

Average Total Assets or Total
Investment in the business
Indicates the efficiency in the use of total resources.
4 Gross profit ratio Gross Profit Indicates the gross margin per peso of sales. Used in
Net Sales determining the adequacy of gross margin to cover
operating expenses and provide desired profit.
Cost of Sales + Operating Indicates what portion of sales in absorbed by
5 Operating Ratio Expenses operating costs.
Net Sales
Rate of Return on Current
6 Assets Net Income
Average Current Assets Indicates the profitability in the use of current assets.
Cost of Sales + Operating

Expenses (excluding charges not
7 Current Asset Turn-over requiring current assets) Indicates the rate at which current assets are being
Average Current Assets used.
Rate of Return per Current
8 Asset Turn-over Rate of Return on Current Assets
Indicates the percentage of profit every time current
Current Asset Turnover assets are used.
Rate of Return on Working
9 Capital Net Income
Average Working Capital indicates the profitability in the use if working capital
Cost of Sales + Operating

Expenses (excluding charges not Indicates the rate at which working capital is being
10 Working Capital Turn-over requiring working capital) used
Average Working Capital
Rate of Return per Working
11 Capital Turn-over Rate of Return on Working Capital Indicates the percentage of profit every time working
Working Capital turn-over capital is used.
12 Invested Capital Turnover Net Sales Indicates the rate at which owners' capital is being
Average Owner's Equity used or the rate at which assets provided by owners
are being used.
Rate of Return on Owners' Indicates profitability in the use of invested capital or
13 Equity 1. Net Income the amount of return per peso of owners' equity
Ave. Owners' Equity
2. Rate of return on Sales x

Invested Capital Turnover
Net Income less preferred stock

14 Earnings per Share dividend requirement Indicates the amount of returns o each share of
common stock and the ability to pay dividends.
Ave. No. of Common Shares
Outstanding
Net Income less preferred stock Indicates the amount of returns on each share of
15 Price – earnings ratio dividend requirement common stock and the ability to pay dividends.
Ave. No. of Common Shares
outstanding
Capitalization Rate or
Earnings per share
16. Earnings/Price ratio Indicates the rate at which the stock market is
Market price per share apparently capitalizing the value of current earnings.
17. Dividends per share Dividends paid or declared

Common shares outstanding Shows the amount of distributed earnings per share.
18. Yield on Common Stock Dividends per share Shows the percentage of distributed earnings based
Market Value per share of on market value.
common stock
19. Payout ratio Dividends per share Indicates the percentage of distributed earnings based
Earnings per share on earnings made per share
Retained Earnings
20. Retained Earnings to Capital Indicates the profitability of dividend declaration
Stock Capital Stock
21. Market Price to book value per Market price per share
Indicates whether the stock is undervalued or not.
share Book value per share
Indicators of Liquidity or Short-term Solvency
Formula Significance
Current Assets
1. Current Ratio Current liabilities Indicates the ability to pay current obligations
Quick assets
2. Acid test ratio Current assets Indicates the liquidity of the total assets.
Current assets
3. Current assets to Total Assets Total assets Indicates the liquidity of the total assets.
Ratio if each current asset item to Each current asset item Indicate the liquidity of the total current assets and
4.
total current assets Total current assets the distribution thereof.
Indicates the number of times average amount of

Net credit sales
5. Receivable turn-over receivables is collected during the period and the
Average receivables
efficiency in collection
360 Indicates the average age of receivables or the

6. Average collection period
number of days to collect average receivables.
Receivables turn-over
Indicates the number of times average inventory
Merchandise inventory (or Finished
7. Cost of goods sold was sold during the period and over/under
goods) turnover
Average inventory investment in inventory.
Cost of goods sold + operating
expenses (excluding charges Indicates the rate at which current assets are being
8. Current asset turn-over
requiring current assets) used and adequacy of current assets.
Average current assets
Net credit purchases Indicates the number of times the amount of

9. Payable Turn-over
average payables is being paid.
Average payables
Measures of Stability or Long-term Solvency
Total liabilities Measures the proportion of borrowed capital to

1. Debt/Equity ratio
invested capital
Owner’s equity
2. Equity/debt ratio Owner’s equity Indicates the margin of safety to creditors.

Total liabilities
Proprietary (Equity) Ratio or Owner’s equity Indicates what portion of total assets is provided by
3.
Owner’s equity to total assets owners or stockholders.
Total assets
Debt ratio or total liabilities to total Total liabilities Indicates what portion of total assets is provided by
4.
assets creditors.
Total assets
Indicates the portion of owners’ equity invested in
5. Fixed assets to total owner’s equity Fixed assets
fixed assets.
Total owner’s equity
Fixed assets to total equity (or total Fixed assets Indicates the portion of long term debt secured by
6.
assets) fixed assets
Total liabilities and owners’ equity
Common stock equity Indicates the book value of net assets for every
7. Book value per share
Number of common shares outstanding share of common stock.
outstanding
8. Number of times interest is earned Income before interest and taxes Indicates the company’s ability to pay fixed interest
Annual interest charges

Introduction to Accounting Fundamentals

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Introduction to Accounting Fundamentals

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INTRODUCTION TO

PREPARED BY : PROF. JONAH C. PARDILLO

After reading this chapter, you should be able to:

 Describe the nature of accounting;

 Explain the functions of accounting in business;

 Narrate the history/origin of accounting.

 The main purpose of accounting is to ascertain profit or loss during a specific

 American Accounting Association defines accounting as “the process of identifying,

 Recording: it is concerned with the recording of financial transactions in an

 Classifying: it is concerned with the systematic analysis of the recorded data

 Summarizing: it is concerned with the preparation and presentation of the classified

 Book-keeping is a part of accounting and is concerned with the recording of transactions

 Accounting as a service activity

 Accounting is a service activity. Its function is to provide quantitative information, primarily

 Professional Regulation Commission (PRC)

 Financial Reporting Standard Council (FRSC)

 Accounting Standard Council (ASC)

 Philippine Financial Reporting Standard (PFRS) formerly Statement Financial

 Under PICPA umbrella

 Association of Certified Public Accountants Education (ACPAE) – for

 Government Association of Certified Public Accountant(GACPA) – for

 Association of Internal Auditors(AIA) – for internal auditors

 All private and public members (ACPACI)

 International Accounting Standard Council (IASC) – tacked to set up

 Objective is to formulate and publish accounting standards for financial

 Accounting as a profession as social force

 Accounting as a language of business

 Science is a systematized body of knowledge. It establishes a relationship of cause and effect in

 Accounting as an information system

The following are the main objectives of accounting :

1. To keep systematic records :

 Accounting is done to keep a systematic record of financial transactions. In the absence of

2. To protect business properties:

ii. The amount of the proprietor's funds invested in the business.

ii. How much the business have to pay to others?

iii. How much the business has to recover from others?

4. To ascertain the financial position of the business:

5. To facilitate rational decision making:

 Accounting functions as an information system for collecting and communicating economic

Accounting token made of clay, from

Globular envelope with a

 It became necessary to improve the process of recording and reporting financial

Kimwell, M.B., “Fundamentals of Accounting”

PREPARED BY : PROF. JONAH C. PARDILLO

After reading this chapter, you should be able to:

 Differentiate the branches of accounting;

 Explain the kind/type of services rendered in each of these

 is a branch of accounting that is primarily concerned with the measurement

 The art of recording financial transactions and events in a systematic manner in

 Financial accounting provides, as objectively as feasible the diverse information needs

 Important requirement of financial accounting is that, the information should be

 The object of management accounting is to supply relevant information

 Management accounting, it is a useful tool to achieving the functions of

o to make both short-range and long-range plans

o To measure the success in carrying out these plans

o To identify the areas that require special attention

o To choose from among the available alternative courses of actions

 Government accounting which uses “Fund Accounting”, deals with the

 Government accounting is another career field where one works as

 Deals with independent verification and examination of the accounting

 An auditor is a person who is licensed to make an independent review of the

 an internal auditor is an employee of the business enterprise.