Basics of Accounting Key Transactions

Accounting Purchase Material and Services - requires the issuance of purchase orders and the payment of supplier
invoices.
 Accounting is the practice of recording and reporting on business transactions.
 The resulting information is an essential feedback loop for management, so that they can see how Sell goods and services to customers - requires the creation of an invoice to be sent to each customer,
well a business is performing against expectations. documenting the amount owed by the customer.
 The following discussion of accounting basics is needed to give you a firm grounding from which
to understand how an accounting system works and how it is used to generate financial reports. Receive payments from Customers - requires matching received cash to open invoices.
systems of record keeping
Pay employees - requires the collection of time worked information from employees, which is then
Systems of Record Keeping used to produce gross wage information, tax deductions, and other deductions, resulting in net pay to
employees.
 Assets
 Liabilities Reporting
 Equity
 Revenue Once all of the transactions related to an accounting period have been completed, the accountant
 Expenses aggregates the information stored in the accounts and reformats it into three documents that are
collectively called the financial statements.
Assets - these are items purchased or acquired, but not immediately consumed. Examples are accounts
receivable and inventory Statements:

Liabilities - these are obligations of the business, to be paid at a later date. Examples are accounts
payable and loans payable.
Equity - this is assets minus liabilities, and represents the ownership interest of the owners of the
business. Examples are common stock and preferred stock.
Revenue - this is the amount billed to customers in exchange for the delivery of goods or provision of
services.
Expenses - this is the amount of assets consumed during the measurement period. Examples are rent
expense and wages expense.
 Income Statement
 Balance Sheet
 Statement of Cashflow
Income Statements - this document presents revenues and subtracts all expenses incurred to arrive at a
net profit or loss for the reporting period. It measures the ability of a business to attract customers and
operate in an efficient manner.
Balance Sheet - this document presents the assets, liabilities, and equity of a business as of the end of
the reporting period. It presents the financial position of an entity as of a point in time, and is closely
reviewed to determine the ability of an organization to pay its bills.

Transactions
The accountant is responsible for producing a number of business transactions, while others are
forwarded to the accountant from other parts of the company. As part of these transactions, they are
recorded within the accounts that we noted in the first point.
Statement of Cashflow - this document presents the sources and uses of cash during the reporting
period. It is especially useful when the amount of net income appearing on the income statement varies
from the net change in cash during the reporting period.
Additional Accounting Topics
The presented basics of accounting only note the barest outline of the functions performed by the
accountant. There are numerous more advanced topics that fall under the umbrella of accounting, such
as:
 Cost Accounting
 Internal Auditing
 Tax Accounting
Cost Accounting - involves the review of product costs, examining operating variances, engaging in
profitability studies, bottleneck analysis, and many other operational topics.
Internal Auditing - involves examining internal records to see if transactions were processed correctly,
and whether the established system of controls has been adhered to by the staff.
Tax Accounting - involves planning to reduce or defer tax payments, as well as filing many types of
tax returns.
Fundamentals of Accounting 1
Why Do We Need Accounting?
So why do we need accounting? Asking that question of an accountant is like asking a farmer why we
need rain. We need accounting because it’s the only way for business to grow and flourish.
Accounting is the backbone of the business financial world. After all, accounting was created in
response to the development of trade and commerce during the medieval times.
Accounting Is The Conscious Of The Business World.
When handled with care and with respect, it performs as expected. When abuse occurs, and the system
is circumvented or overridden because of dishonesty and greed, it doesn’t work correctly.
Accounting is much like all other systems in place, they are only as good as the people using them.
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.
Economic Activities and their Classification. Economic Entity vs. Business Entity

Functions of Accounting

Basic Purpose of Accounting:

To provide quantitative information about economic entities intended to be useful in making economic
decisions.

Types of Information Provided By Accounting

1. Quantitative information – expressed in numbers, quantities or units.

2. Qualitative information – expressed in words or descriptive form

3. Financial information – expressed in terms of money

Branches of Accounting/Area of Specialization

Users of Accounting Information

Internal users are those who make decisions directly affecting the internal operations of the business.

External users are individuals or enterprises that have financial interest in the business but they are
not involved in the day activities of the organization.

Internal Users

Managers are directly involved in operation of the business. They need accounting data to improve the
efficiency of the organization.
External Users Periodicity Concept

Stable Monetary Unit Concept

Basic Principles

Fundamental Concepts

Entity Concept
Objectivity Principle

Accounting records and statements are based on the most reliable data available so that they will be as
accurate and as useful as possible. Reliable data are verifiable when they can be confirmed by
independent observers.
Historical Cost

This principle states that acquired asset should be recorded at their actual cost and not at what
management thinks they are worth as at reporting date.
- the total cost of producing or buying an item, which may include, e.g., its price plus the cost
of delivery or storage.
Revenue Recognition Principle
Revenue is to be recognized in the accounting period when goods are delivered or services are
rendered or performed.
Expense Recognition Principle
Expenses should be recognized in the accounting period in which goods and services are used up to
produce revenue and not when the entity pays for those goods and services.
Adequate Disclosure
Requires that all relevant information that would affect the user’s understanding and assessment of the
accounting entity be disclosed in the financial statements.
Underlying Assumption
Accrual Basis
Financial Statements are prepared on the accrual on the accrual basis of accounting and not as cash or
its equivalent is received or paid. Under this assumption, the effects of transactions and other events
are recognized when they occur and they are recorded in the accounting records and reported in the
financial statements of the periods to why they relate. “Revenue as they earned, even not yet received
and; Expenses as they incurred, even not yet paid.
Cash Basis
Does not record a transaction until cash is received or paid. Generally, cash receipts are treated as
revenues and cash payments as expenses.
Going Concern
Financial statements are normally prepared on the assumption that an enterprise is a going concern and
will continue in operation for a foreseeable future. It is assumed therefore that the enterprise has
neither the intention nor the need to liquidate its operations.

Materiality

Financial reporting is only concerned with information that is significant enough to affect evaluations
and decisions. Materiality depends on the size and nature of the item judged in the particular
circumstances of its omission.

Consistency Principle

The firms should use the same accounting method from period to period to achieve comparability over
time within a single enterprise. However, changes are permitted if justifiable and disclosed in the
financial statements.
  Past events – The event must be past before an asset can rise. (E.g. equipment will only become an
asset when there is the right to demand delivery or access to the asset’s potential. Dependent on
the terms of the contract, this may be on acceptance of the order or on delivery.
Fundamentals of Accounting  Future economic benefits – These are evidenced by the prospective receipt of cash. This could be
cash itself, an account receivable or any item which may be sold. Although, for example, a factory
may not be sold for it houses the manufacturing facility for the goods. When these goods are sold,
the economic benefit resulting from the use of the factory is realized as cash.

Current Assets:

An entity shall classify assets as current when:

a. It expects to realize the asset, or intends to sell or consume it, in its normal operating cycle;
b. It holds the asset primarily for the purpose of trading;
c. It expects to realize the asset within twelve months after the reporting period;
d. The asset is cash or cash equivalent unless the asset is restricted from being exchanged or used to
settle a liability for at least months after the reporting period.
Composition of A statement In Financial Position
1. Cash any medium of exchange that a bank will accept for deposit at face value. It includes coins,
Asset currency, checks, money orders, bank deposits and drafts.
These are resources controlled by the enterprise* as a result of past events** and from which future *Money orders is a document which can be bought as a way of sending money through the
economic benefits*** are expected to flow to the enterprise. post.
For example, an asset may be: 2. Cash Equivalents these are short-term, highly liquid investments that are readily convertible to
known amounts of cash and which are subject to an insignificant risk of changes in value.
 Used singly or in combination with other assets in the production of goods or services to be sold
by the enterprise; 3. Accounts Receivable these are claims against customers arising from sale of services or goods on
 Exchanged for other assets; credits. This type of receivable offers less security than a promissory note.
 Used to settle a liability;
4. Notes Receivable A note receivable is a written pledge that the customer will pay the business a
 Distributed to the owners of the enterprise.
fixed amount of money on a certain date.
Assets are should be classified only in two: current assets and noncurrent assets. Operating Cycle is the
5. Inventory or Merchandise Inventory these are assets which are (a) held for sale by the company,
time between the acquisition of assets for processing and their realization in cash or cash equivalents.
(b) in the process of production for such sale, (c) in the form of materials (raw materials) or supplies to
When the entity’s normal operating cycle is not clearly identifiable, it is assumed to be twelve months.
be consumed in the production.
 Controlled by the enterprise – control is the ability to obtain the economic benefits and to restrict
6. Supplies this may be office supplies like bond papers, paper clips and the like or can be also store
the access of others (e.g. an entity being the sole user of its plants and equipment or by selling idle
supplies like boxes, bags, packaging tapes and other related materials.
assets)
7. Prepaid Expenses these are expenses paid for by the business in advance. It is an asset because the
business avoids, having to pay cash in the future for a specific expense. This includes insurance and
rent.

Non-current Assets:

All other assets not classified or does not fall under the criteria of current assets are called non-current Formula:
assets. Annual Depreciation = Cost of the PPE – salvage value* (if any)
1. Property, Plant and Equipment (PPE) these are tangible assets that are held by an enterprise for use Life (n)
in the production or supply of goods or in rendering services, or for rental to other, or for
administrativepurposes and which are expected to be used during more than one period. Accumulated Depreciation = Annual depreciation x age of the PPE

These are: *Salvage value is the value of an asset if sold for scrap and also called as Residual or scrap value.

a. Land To compute:
b. Building
= 500,000 = 50,000 annual depreciation
c. Office Equipment
d. Furniture and Fixtures 10
e. Delivery Equipment
f. Service Vehicle = 50,000 x 2 years = 100,000 Accu. Dep.
g. Store Equipment
(from june 1 2018 to june 1 2020)
2. Accumulated Depreciation applies to property, plant and equipment except land as a contra
3. Intangible
account that contains the sum of periodic depreciation charges. The reflected amount is deducted from
the cost of the related asset to obtain book value. These are identifiable, nonmonetary assets without physical substance held for use in the production or
supply of goods or services, for rentals to others or for administrative purposes. These are:
To illustrate:
a. Goodwill e. Franchises
The Company has an office equipment worth P500, 000 with a useful life of
b. Patents f. Trademarks
10 years acquired last June 1, 2018. c. Copyrights g. Brand names
d. Licenses
Office Equipment P500, 000
Liabilities
Accumulated Depreciation – O/E (100,000)
A present obligation of the enterprise arising from past events, the settlement of which is expected to
Net book value P 400,000 result in an outflow from the enterprise of resources embodying can be measured benefits.

*Obligation – These maybe legal or not. A duty to do something or a debt.

* Transfer economic benefits - This could be a transfer of cash, or another property, the provision of a method). When the goods or services are provided to the customer, the unearned revenue is reduced
service or the refraining from activities which would otherwise be profitable. and income is recognized.

5. Current portion of Long-term debt these are portions of long-term liabilities which are to be paid
within one year from the balance sheet date.

The settlement of a present obligation involving outflow of resources may take the form of:
Non-Current Liabilities
a. Payment of cash
b. Transfer of other assets All other liabilities not classified or does not fall under the criteria of current liabilities are called non-
c. Provision for services current liabilities.
d. Replacement of the present obligation with another obligation
e. Conversion of the obligation to equity 1. Mortgage payable this account records long-term debt of the business entity for which the entity
has pledged certain assets as security to the creditor.
Current Liabilities:
2. Bonds payable is an obligation in connection with the bond, a contract between the issuer and the
An entity shall classify a liability as current when: lender specifying the terms of repayment and the interest to be charged.

a. It expects to settle the liability in its normal operating cycle
b. It holds the liability primarily for the purpose of trading
c. The liability is due to be settled within twelve months after the reporting period; or
d. The entity does not have an unconditional right to defer settlement of the liability for at least
twelve months after the reporting period.
1. Accounts payable this account represents the reverse relationship of the accounts receivable. Due to
suppliers of goods and other assets purchased on credit.
Owner’s Equity
Equity is defined as the residual interest in the asset of an entity that remains after deducting all its
liabilities.
1. Capital this account is used to record original and additional investment of the owner of the
business entity. In partnership, Partners’ Capital is use as its capital account while in corporation is
Shareholders’ Equity.

2. Notes Payable a note payable is like a note receivable but in a reverse sense. The business entity is 2. Withdrawals when the owner of a business entity withdraws cash or other assets, such are recorded
the maker of the note; that is, the entity is the party who promises to pay in a specified amount of in the drawing or withdrawal account rather than directly reducing the owner’s equity account.
money on specified future date. 3. Income Summary It is a temporary account used at the end of the accounting period to close the
3. Accrued Liabilities Amounts owed to others for unpaid expenses. This account includes: income and expenses. This account shows the profit or loss for the period before closing to the capital
account.
a. Salaries payable
b. Utilities payable ASSETS = LIABILITIES + EQUITY
c. Interest payable Financial Performance (reflected by accrual accounting)
d. Taxes payable
Performance of an enterprise – comprise its revenue, expenses, net income or loss for a period of
4. Unearned Revenues when the business entity receives payment before providing its customers with time. It is the level of income earned by the enterprise through efficient and effective use of its
goods or services, the amounts received are recorded in the unearned revenue account (liability resources. Information about performance is primarily provided in an Income Statement or
Statement of Financial Performance or Statement of Comprehensive Income or Statement of
Income and Expenses.
*Accrual Accounting recognizes transactions and other events of a reporting entity in the periods in
which those effects occur, even if the resulting cash receipts and payments occur in a different period.
Composition of Financial Performance
Revenue or Income
These are increases in economic benefits during the accounting period in the form of inflows or
enhancements of assets or decrease of liabilities from delivery or production of goods, rendering of
services, or other activities that constitute the enterprise’s major operations.
1. Service Income Revenues earned by performing services for a customer or client, for e.g.
accounting services by a CPA firm, laundry services by a laundry shop.
2. Sales Revenues earned as a result of sale of merchandise; for e.g. sale of merchandise by General
Merchandise Store.
Expenses
These are decrease in economic benefits during the period in the form of outflows or using up of assets
or incurrence of liabilities that result in decreases in equity, other than relating to distributions to equity
participants.
1. Cost of Sales the cost incurred to purchase or to produce the products sold to customers during the
period; also called as cost of goods sold.
2. Salaries and Wages Expense includes all payments as a result of an employer-employee
relationship such as salaries and wages, 13th month pay, cost of living allowances, other related
benefits.
3. Utilities Expense expenses related to use of telecommunications facilities, consumptions of
electricity, fuel and water.
4. Rent Expense expense for space, equipment or other asset rentals.
5. Supplies Expense expense of using supplies in the conduct of daily business.
6. Insurance Expense portion of premiums paid on insurance coverage which has expired.
7. Depreciation Expense portion of the cost of a tangible asset allocated or charged as expense during
an accounting period.
8. Uncollectible Accounts Expense the amount of receivables estimated to be doubtful of collection
and charged as expense during an accounting period.
9. Interest Expense An expense related to use of borrowed funds.
Changes in Financial Position
It refers to the changes in the economic resources and obligation of an enterprise. In constructing a
statement of changes in Owner’s Equity, funds can be defined in various ways, such as all financial
revenues, working capital, liquid assets or cash.
The Account
The basic summary device of accounting is the account. A separate account is maintained for each
element that appears in the balance sheet (assets, liabilities, and equity) and in the income statement
(income and expense). Thus, an account may be defined as a detailed record of the increases, decrease
and balance of each element that appears in an entity’s financial statements.
The simplest form of the account is known as the “T” account because of its similarity to the letter T.
the account has three parts as shown on the next page.
The Accounting Equation and Debits and Credits-The Double Entry System
The basic tool of accounting is the accounting equation. The left side of the equation shows how
much the business owns, and the right side of the equation shows how much resources do the outside
creditor and owner supplied to the business.
The logic of debiting and crediting is related to the accounting equation. Transactions may require
addition to both sides (left or sides), subtractions from both sides (left and right sides), or an addition
and subtraction on the same side (left or right sides). But in all cases the equality must be maintained
as shown above.

Accounting is based on a double-entry system which means that the dual effects of business are To illustrate:
recorded. A debit side entry must have a corresponding credit side entry. For every transaction, there
must be one or more accounts debited and one or more accounts credited and must be equal both sides. Mr. Wagmalito Kayayan wants to open an accounting firm this year. The following transactions are
Each transaction affects at least two accounts. made during the month.

May 1. Mr. W. Kayayan invested P100, 000 to start an accounting office.

Accounting Events and Transactions The financial transaction is analyzed as follows:

An accounting event is an economic occurrence that causes changes in an enterprise’s assets,  An entity separate and distinct from Kayayan’s personal financial affairs is created.
liabilities, and/or equity. A transaction is a particular kind of event that involves the transfer of
 An economic resource – cash of P 100,000 is invested in the businessentity. The source of this
something of value between two entities.
asset is the contribution made by the owner, which represents owner’s equity. The owner’s equity
Accountants observe many events that they identify and measure in financial terms. A business account is W. Kayayan, Capital.
transaction is the occurrence of an event or a condition that affects financial position and can be  The dual nature of the transaction is that cash is invested and owner’s equity created. The effects
reliably recorded. of this transaction on the accounting equation are as follows: increase in asset – cash from zero to
P 100,000 and increase in owner’s equity from zero to P 100,000.
Financial Transaction Worksheet
May 3. Purchased office supplies worth P20,000 on account.
Every financial transaction can be analyzed or expressed in terms of its effects on the accounting
equation. The financial transactions will be analyzed by means of a financial transaction worksheet
which is a form used to analyze increases and decreases in the assets, liabilities or owner’s equity of a
business entity.

When a specific asset, liability or owner’s equity item is created by a financial transaction, it is listed in
the financial transaction worksheet using the appropriate accounts.
The effect of transaction is increase in asset and increase in liabilities. Take note that the equality of
the two sides of the equation is maintained.

May 5. Purchased additional office supplies for cash, P10,000.

May 10. Rendered accounting services for cash, P25, 000.

The effect of transaction is increase in asset and decrease in another asset form of asset. After posting
the transaction, total asset amounts to P120, 000 and total liabilities and capital amount to P120,000.

May 6. Paid the accounts payable in full.

May 15 Rendered accounting services on account, P 30,000.

May 8. Purchased 2 units of computer with printer for P50, 000, 30 days.

May 15 Paid Meralco bills, P 3,500.

May 15 Paid salaries for the period, P15, 000.

May 27 Mr. Kayayan withdrew P20, 000 for personal use.

May 20 Collected P10, 000 from customer.

May 22 A Short term loan from a local bank was granted in the amount of P50, 000, less P5, 000 May 30 at the end of the month, physical count of the office supplies revealed that P 5,000 had been
financing charges. Mr. W. Kayayan issued 1 year promissory note. consumed.

May 25 Paid telephone bill amounting to P 6,000.

Summary of W. Kayayan in tabular Form

Use of T-Accounts

Analyzing and recording transactions using the accounting equation is useful in conveying a basic
understanding of how transactions affect the business. However, it is not an efficient approach once the
number of accounts involved increases. Double-entry system provides a formal system of classification
and recording business transactions.
 May 22. A short term loan from a local bank was granted in the amount of P50,000, less P5,000
finance charges. W. Kayayan issued 1 year promissory note.