ACCOUNTING
comprehension to the users of financial
M1L1: FUNDAMENTAL CONCEPTS AND PRINCIPLES
OF ACCOUNTING
ACCOUNTING – the systematic process of measuring
and reporting relevant financial information about
an economic organization or unit’s activities. Its
underlying purpose is to provide financial
information. It is capable of being expressed in
monetary terms.
American Institute of Certified Public Accountants
(AICPA) – defines accounting as the art of recording,
classifying, and summarizing in a significant manner
under terms of money, transaction, and events,
which are in part at least a financial character and
interpreting the result thereof.
Philippine Institute of Certified Public Accountants
(PICPA) – defines accounting as a service activity. Its
function is to provide quantitative information,
primarily financial in nature, about economic entities
that are intended to make economic decisions.
Accountants – expert professionals in the field of
accounting. They prepare financial statements,
analyze and interpret data.
History of Accounting
Luca Pacioli – father of accounting. i. Pacioli
described double-entry bookkeeping in his “Summa
de Arithmetica, Geometria, Proportioni et
Proportionalita” back in 1494. While that may sound
like a long time ago, accounting may have roots that
trace back even earlier.
Fours Aspects of Accounting
1. Recording – writing down of business
transactions chronologically in the books of
account as they transpire.
2. Classifying – sorting similar and related
business transactions into three categories
of assets, liabilities, and owner’s equity.
3. Summarizing – preparing the financial
statements from the transactions recorded
in the books of account designed to meet its
users’ information needs.
4. Interpreting – representing the qualitative
and quantitative financial information about
the business transactions in a language
statements. By interpreting the data in the
financial statements, users can determine
the financial standing of the company as
well as its stability and growth potential.
Users interpret financial information
relating to specific business decisions. This
makes accounting the language of business.
Three Types of Business Organization
1. Sole/Single Propiertorship – a business
owned and managed by only person.
2. Partnership – a business organization
owned and managed by two or more
people who agree to contribute money,
property, or industry to a common fund
for the purpose of earning a profit.
3. Corporation – a form of business
organization managed by an elected
board of directors. The investors are
called stockholders and the unit of
ownership is called share of stock.
Generally Accepted Accounting Principles Recording
(GAAP) – these are broad, general statements or
“rules” and “procedures” that serve as guides in the
practice of accounting.
These are standards, assumptions, and concepts
with general acceptability. These are measurement
techniques and standards used in the presentation
and preparation of financial statements.
Three Types of Business Operations
1. Service – a type of business operation
engaged in the rendering of services.
2. Trading/Merchandising – a type of business
engaged in buying and selling goods.
3. Manufacturing – engaged in the production
of items to be sold. This type of business
operation is involved in the purchasing and
converting of raw materials to finished
goods.
Transaction – a completed action which can be
expressed in monetary terms.
Parties Interested in the Financial Information
 1. Investors/Owners/Stockholders –
provide the financial resources to keep
the business going.
2. Government – financial information is
important for tax purposes and in
compliance with Securities and
Exchange Commission (SEC)
requirements.
3. Financial Institutions/Creditors –
before extending credit, financial
institutions use financial information to
determine the capacity of the business
organization to pay its obligations and
their interests at the appropriate time.
4. Management – Organizational
managers use financial information to
set goals for their companies.
Managers evaluate their progress
towards these goals and use financial
data as a guide for future management
actions.
5. Employees - Financial information
provides information on company
stability, which is important for
employees to determine if they have a
future in the company.
Fundamental Concepts of Accounting
1. Entity Concept – regards the business
enterprise as separate and distinct from its
owners and from other business
enterprises.
2. Periodicity – the concept behind
providing financial accounting
information about the economic
activities of an enterprise for
specified time periods. For
reporting purposes, one year is
usually considered as one
accounting period.
An accounting period may be
classified as either of the following:
a) Calendar Year – a twelve-
month period that starts
on January 1 and ends on
December 31.
b) Fiscal Year – a twelve-
month period that starts
on any month of the year
other than January and
ends twelve months after
the start period. (e.g. A
business whose fiscal year
starts June 1, 2014 ends
its fiscal year on May 31,
2015. This is still a twelve-
month period although it
does not start in January
and end in December
c) An Interim Period – a
financial reporting period
that is shorter than a full
fiscal year. An interim
period is also considered
to be the standard
monthly time that most
organizations use for their
financial reporting.
3. Going Concern – a concept which assumes
that the business enterprise will continue
to operate indefinitely.
Basic Principles of Accounting
• Objectivity Principle states that all business
transactions that will be entered in the
accounting records must be duly supported by
verifiable evidences.
• Historical Cost means that all properties and
services acquired by the business must be
recorded at its original acquisition cost.
• Accrual Principle states that income should be
recognized at the time it is earned such as when
goods are delivered or when services are
rendered. Likewise, expenses should be
recognized at the time they are incurred such as
when goods and services are actually used and
not at the time when the entity pays for the
goods and services.
• Adequate Disclosure states that all material
facts that will significantly affect the financial
statements must be indicated.
• Materiality means that financial reporting is
only concerned with information significant
enough to affect decisions. This refers to the
relative importance of an item or event. An item
is considered significant if knowledge of it would
 influence prudent users of the financial
statements.
• Consistency means that approaches used in
reporting must be uniformly employed form
period to period to allow comparison of results
between time periods. Any changes must be
clearly explained.
M2L2: TYPES OF FINANCIAL STATEMENTS FOR A
SERVICE BUSINESS
Financial statements – collection of summary-level
reports about an organization’s financial results,
financial position, and cash flows. They are useful for
the following reasons:
• To determine the ability of a business to
generate cash, and the sources and uses of
that cash.
• To determine whether a business has the
capability to pay back its debts.
• To track financial results on a trend line to
spot any looming profitability issues.
• To derive financial ratios from the
statements that can indicate the condition
of the business.
• To investigate the details of certain
business transactions, as outlined in the
disclosures.
Types of Financial Statements
1. Statement of Financial Position or Balance
Sheet – shows the financial condition/position
of a business as of given period. Consists of
ASSETS, LIABILITIES, and CAPITAL/OWNER’S
EQUITY (real or permanent accounts).
FORMS OF BALANCE SHEET
• ACCOUNT FORM – follows the
accounting equation where assets are
listed on the left-hand column of the
report with the liabilities and owner’s
equity listed on the right-hand column.
• REPORT FORM – shows in one straight
column the assets, followed by the
liabilities and owner’s equity.
• Sub- classification is as follows:
o Assets are sub-classified as
current and non- current
assets
o Liabilities are either current
liabilities
2. Statement of Comprehensive Income or
Income Statement – shows the result of
operations for a given period. Consist of the
REVENUE, COST, and EXEPENSES.
International Accounting Standards 1 – Total
Comprehensive Income as the “change in
equity during a period resulting form
transactions and other events, other than those
changes resulting form transactions with
owners in their capacity as owners.”
3. Statement of Changes in Owner’s Equity or
Statement of Owner’s Equity – show the
changes in the Capital or Owner’s Equity as a
result of additional investment or withdrawals
by the owner, plus or minus the net income or
net loss for the year.
4. Statement of Cash Flows – summarizes s the
cash receipts and cash disbursements for the
accounting period. It summarizes the cash
activities of the business by classifying cash
inflows (receipts) and cash outflows (payments)
into operating, investing, and financing
activities. It shows the net increase or decrease
of cash in a given period and the cash balance
at the end of the period. This allows
management to assess the business’ ability to
generate cash and project future cash flows.
Components of the Statement of Cash Flows
classified according to activities:
• OPERATING ACTIVITIES – cash inflows
(receipts) and the cash outflows (payments)
arising from the normal operations of the
business.
o Receipts of Cash
▪ Collections from
customers for the
performance of services
or sale of goods
▪ Royalties, fees,
commission received
▪ Interest, dividends and
other income received
o Payments of Cash
 ▪ To suppliers for services
and goods acquired
▪ Employees’ salaries
▪ Government licenses and
taxes Interest expense
▪ Other operating expenses
• FINANCING ACTIVITIES – cash inflows
(receipts) and the cash outflows (payments)
from the owners and creditors of the
business.
o Receipts of Cash
▪ Original and additional
investments by owner
▪ Proceeds of loan
o Payments of Cash
▪ Cash withdrawal
▪ Payment for the principal
balance of loan
• INVESTING ACTIVITIES – cash inflows
(receipts) and the cash outflows (payments)
from the purchase and sale of property and
equipment, investment in debt or trading
securities.
M1L3: FAMILIARIZING ACCOUNT TITLES
ACCOUNT TITLE – unique name assigned to an
account in an accounting system. An account title is
essential when the accounting staff needs to identify
an account, since the title conveys the purpose of
the account.
Typical Account Titles Used
Balance Sheet
Balance Sheet accounts, namely Assets, Liabilities,
and Owner’s Equity, are classified as real or
permanent accounts. These are accounts that do not
close at the end of the accounting year.
1. Assets – economic resources owned by the
business expected for future gain. They are
property and rights of value owned by the
business.
2. Liabilities – include debts, obligations to pay,
and claims of the creditors on the assets of the
business.
3. Owner’s Equity or Capital – includes the
interest of the owners on the business; claims
of the owners on the assets of the business; and
the investment of the owner plus or minus the
results of operations. Owner’s equity or capital
comes from two main sources- investment of
owners and earnings of the business
The Fundamental Accounting Equation:
Assets = Liabilities + Owner’s Equity
Assets
Classification of Assets
1. Current Assets - Improvements to International
Accounting Standards 1 (December 2003)
classifies assets as current assets when it is:
a. Expected to be realized in, or is
intended for sale or consumption
in, the entity’s normal operating
cycle;
b. Held primarily for the purpose of
being traded;
c. Expected to be realized within
twelve months of the balance
sheet date; or
d. Cash or cash equivalent unless it is
restricted from being exchanged or
used to settle a liability for at least
twelve months after the balance
sheet date.
Classification of Current Assets
Cash – includes coins, currencies, checks, bank
deposits, and other cash items readily available for
use in the operations of the business.
Trade and other receivables include the amounts
collectible from any of the following accounts:
a) Accounts Receivable – is the amount
collectible from the customer to whom
sales have been made or services have been
rendered on account or credit.
b) Notes Receivable – is a promissory note
issued by the client or the customer in
exchange for services or goods received as
evidence of his/her obligation to pay.
c) Interest Receivable – amount of interest
collectible on promissory notes received
from customers and clients.
 d) Advances to Employees – certain amount
of money loaned to employees payable in
cash or through salary deductions.
e) Inventories – represent the unsold goods at
the end of accounting period. This is
applicable only to merchandising business.
f) Prepaid Expenses – include supplies bought
for use in the business or services and
benefits to be received by the business in
the future paid in advance.
g) Contra- Asset Accounts – these are
accounts deducted from the related asset
accounts.
h) Allowance for Bad Debts – losses due to
uncollectible accounts. This is deducted
from the accounts receivable account to get
the net realizable value. This is in line with
the financial statements’ qualitative
characteristic of conservatism wherein no
profits would be anticipated but still
probable or estimable losses should be
provided.
i) Accumulated Depreciation – represents the
expired cost of property, plant and
equipment as a result of usage and passage
of time. This is deducted form the cost of
the related asset account to get the carrying
value or book value of the asset.
2. Non-current Assets
Classification of Non-current Assets
Property, Plant, and Equipment are tangible
assets that are held by an enterprise for use in
the production or supply of goods or services,
or for administrative purposes and which are
expected to be used for more than one period.
Examples of Property, Plant, and Equipment
Land – a piece of lot or real estate owned by the
enterprise on which a building can be constructed
for business purposes.
Building – an edifice or structure used to
accommodate the office, store or factory of a
business enterprise in the conduct of its operations.
Equipment – includes typewriter, air- conditioner,
calculator, filing cabinet, computer, electric fan,
trucks, cars used by the business in its office, store or
factory. Specific account titles may be used such as
Office Equipment, Store Equipment, Delivery
Equipment, Transportation Equipment, Machinery
Equipment.
Furniture and Fixtures – include tables, chairs,
carpets, curtains, lamp and lighting fixtures, and wall
decors. Specific account tiles maybe used such as
Office Furniture and Fixtures and Store Furniture and
Fixtures.
Intangible Assets – identifiable, non- monetary
assets without physical substance held for use in the
production or supply of goods or services, for rental
to others, or for administrative purposes. These
includes goodwill, patents, copyrights, licenses,
franchises, trademarks, brand names, secret
processes, subscription lists and non- competition
agreements.
Liabilities
Current Liabilities
It is a current liability when it is:
• Expected to be settled in the entity’s
normal operating cycle;
• Held primarily for the purpose of being
traded;
• Due to be settled within twelve months
after the balance sheet date; or the entity
does not have an unconditional right to
defer settlement of the liability for at least
twelve months after the balance sheet date.
Classification of Current Liabilities
• Trades and other Payables- includes
payables from any of the following
accounts:
o Accounts Payable- includes debts
arising from purchase of an asset
or acquisition of services on
account.
o Notes Payable- includes debts
arising from purchase of an asset
or acquisition of services on
account evidenced by a promissory
note.
o Loan Payable- is a liability to pay
the bank or other financing
 institution arising from funds
borrowed by the business from
these institutions payable within
twelve months or shorter.
o Utilities Payable- is an obligation
to pay utility companies for
services received from them.
Examples: telephone services to
PLDT, electricity to Meralco, water
services to Maynilad
o Unearned Revenues- represent
obligations of the business arising
from advance payments received
before goods or services are
provided to the customer. This will
be settled when certain goods or
services are delivered or incurred.
o Accrued Liabilities- include
amounts owed to others for
expenses already incurred but not
yet paid. Examples: salaries
payable, utilities payable, taxes
payable, interest payable
Classification of Non- Current Liabilities
Non- current Liabilities - are long term liabilities or
obligations which are payable for a period longer
than one year.
• Mortgage Payable- is a long- term debt of
the business with security or collateral in
the form of real properties.
• Bonds Payable- is a certificate of
indebtedness under the seal of corporation,
specifying the terms of repayment and the
rate of interest to be charged.
OWNER’S EQUITY
Capital – an account bearing the name of the owner
representing the original and additional investment
of the owner of the business increased by the
amount of the net income earned during the year. It
is increased by the cash or other assets withdrawn
by the owner as well as the net loss incurred during
the year.
Drawing – represents the withdrawals made by the
owner of the business either in cash or other assets.
Income Summary – a temporary account used at the
end of the accounting period to close income and
expense accounts. The balance of this account shows
the net income or loss for the period before it is
closed to the capital
Income Statement – accounts namely revenue
(income) and expense are classified as nominal or
temporary accounts.
Forms of Income Statement
1. Natural Form – otherwise called the nature
of expense method, presents expenses
according to nature. This is used in a service
business.
2. Functional Form- otherwise known as the
cost of sales method, presents expenses
according to function (e.g. cost of sales,
selling expenses, administrative expenses).
This type is used in a merchandising
business.
Service Income - includes revenues earned or
generated by the business in performing services for
a customer or client.
Salaries or Wages Expense - Includes all payments
made to employees or workers for rendering
services to the company. Examples are salaries or
wages, 13th month pay, cost of living allowances and
other related benefits given to them.
Utilities Expense - is an expense related to the use of
electricity, fuel, water and telecommunications
facilities.
Supplies Expense- covers office supplies used by the
business in the conduct of its daily operations.
Insurance Expense - is the expired portion of
premium paid on insurance coverage such as
premiums paid for health or life insurance, motor
vehicles or other properties.
Depreciation Expense - is the annual portion of the
cost of a tangible asset such as buildings,
machineries and equipment charged as expense for
the year.
Uncollectible Accounts Expense/ Doubtful Accounts
Expense/ Bad Debts Expense - means the amount of
receivables charged as expense for the period
because they are estimated to be doubtful of
collection.
Interest Expense - is the amount of money charged
to the borrower for the use of borrowed funds.
M2L1: THE ACCOUNTING EQUATION
The following will illustrate the effect of transactions
on the accounting equation. The abbreviations in the
examples shall mean the following:
▸ INC – increase
▸ DEC- decrease
▸ No change- no change
OWNER INVESTS CASH
ASSETS – INC
LIABILITIES – NO CHANGE
CAPITAL/OWNER’S EQUITY – INC
EXPLANATION: An entity separates and distinct from
the owner is created. The cash investment of the
owner increases the cash of the business and the
capital of the owner.
M2L2: THE ACCOUNTING CYCLE
THE DOUBLE- ENTRY SYSTEM OF RECORDING
TRANSACTIONS – Recording transactions in
accounting is based on double- entry system. The
transaction has a dual effect which means that every
transaction affects at least two accounts. For every
debit, there is a corresponding credit. The total
amount of the accounts debited must equal to the
total amount of the accounts credited.
THE ACCOUNTING CYCLE
1. Identifying and analyzing the events
recorded
2. Recording transactions in the journal
3. Posting journal entries to the ledger
4. Preparing the trial balance
5. Preparing the worksheet and adjusting
entries
6. Preparing the financial statements
7. Journalizing and posting of adjusting entries
8. Journalizing and posting of closing journal
entries
9. Preparing the post-closing trial balance
10. Journalizing and posting of reversing journal
entries
IDENTIFYING AND ANALYZING THE EVENTS
RECORDED
▸ Identifying and analyzing the transactions to
be recorded through the business
documents.
▸ Business documents- are forms containing
evidence to support a business transaction.
These provide data concerning the parties
involved in the transaction (the exchange
made, the date and the money value for
the exchange)
RECORDING TRANSACTIONS IN THE JOURNAL
▸ Also known as journalizing.
▸ This is the process of recording the
transaction in the first book of account
known as the journal.
POSTING JOURNAL ENTRIES TO THE LEDGER
▸ Also known as posting.
▸ It is the process of transferring the
information found in the journal into the
book of final entry known as the ledger.
▸ Ledger- summarizes the increases or
decreases of individual accounts.
PREPARING THE TRIAL BALANCE
▸ Trial balance- is a list of accounts found in
the ledger together with the account’s
balance or total. This is a proof that for
every debit, there is a corresponding credit.
It also proves that the ledger is in balance.
PREPARING THE WORKSHEET AND ADJUSTING
ENTRIES
▸ Worksheet- a common tool used by
accountants to assemble on a sheet of
paper all the information needed to prepare
the financial statements, adjusting entries,
closing entries and the post- closing trial
balance.
PREPARING THE FINANCIAL STATEMENTS M3L1: THE JOURNAL, T-ACCOUNTS, AND THE
UNADJUSTED TRIAL BALANCE
▸ Four financial statements should be
prepared to provide useful information to Double-Entry System
parties interested in the financial
THE DOUBLE- ENTRY SYSTEM OF RECORDING
information of the business.
TRANSACTIONS
▸ Financial Statements: Statement of
▸ Recording transactions in accounting is
Financial Position, Income Statement,
based on double- entry system. The
Statement of Changes in Owner’s Equity
transaction has a dual effect which means
and a Statement of Cash Flows.
that every transaction affects at least two
JOURNALIZING AND POSTING OF ADJUSTING accounts. For every debit, there is a
JOURNAL ENTRIES corresponding credit. The total amount of
the accounts debited must equal to the
▸ Adjusting entries are prepared at the end of
total amount of the accounts credited.
the accounting period to update the
accounts for internal transactions because THE ANALYSIS OF TRANSACTION
they affect more than one accounting
1. From the business document, determine
period. This will record the accruals,
the kind of transaction or exchange made.
expiration of deferrals, estimation and
other events from the worksheet. 2. Analyze the transaction to determine the
accounts affected. They can either affect
JOURNALIZING AND POSTING OF CLOSING TRIAL
the assets, liabilities, owner’s equity,
BALANCE
revenue or expenses accounts.
▸ Closing entries are prepared at the end of
3. Determine the effect of the transaction on
the accounting period to update the
the accounts affected. The transaction can
owner’s capital account. This will also
either increase or decrease the accounts.
eliminate the balances of nominal accounts
so that they may be ready for the next 4. Apply the rules of debit and credit to
period. identify whether the accounts affected
should be debited or credited to show the
PREPARING THE POST CLOSING TRIAL BALANCE
corresponding increase or decrease.
▸ After the closing entries have been posted,
JOURNAL – is a chronological record of events or
the post-closing trial balance is prepared
business transactions showing all the effects of each
from the general ledger accounts. This is
transaction in terms of debits and credits. Because
necessary to assure that these entries have
transactions are initially recorded in the journal, it is
been correctly posted. This will also check
called the book of original entry. The simplest form
the equality of the debits and credits after
is the general entry.
the closing entries.
A journal entry should contain the ff:
JOURNALIZING AND POSTING OF REVERSING
JOURNAL ENTRIES 1. Date. Write the month on the first
transaction unless there is a change in
▸ Reversing entries are prepared to simplify
month for the succeeding transactions or a
the accounting process. The adjusting
new page is used.
entries are simply reversed on the first day
of the accounting period. Not all adjusting 2. Account Titles and Explanation. Write the
entries are reversed, only accruals and debit account at the extreme left of the first
deferrals that use the nominal accounts. line while the credit account is indented
 half- inch on the next line. The explanation - revenue/income
describing the transaction is written on the
USE OF T- ACCOUNTS
extreme left of the next line below the
credit. Remember to skip one line before ▸ Account- a form of record that summarizes
proceeding to the next transaction. the increases or decreases of any specific
accounting value.
3. P.R. (Posting Reference). Write the
corresponding account number here once ▸ T- Account- the simplest form of an account
the entry is posted. Meanwhile, it is left because the accounting equation is
blank until the posting has been done. represented by a big T.
4. Debit. Under this column, write the debit - An informal tool used to analyze the effect of a
amount for each debit account. transaction in the assets, liabilities, owner’s equity,
revenue and expenses.
5. Credit. Under this column, write the credit
amount for each credit account ▸ The three (3) elements of an account are:
THE SIMPLE AND COMPOUND ENTRY ▹ Account title
▸ Simple entry - only two accounts are ▹ Debit
affected (only one debit account and one
credit account) ▹ Credit

▸ Compound entry - require the use of three

or more accounts for every business
transaction.

▸ Journalizing- the process of recording

transaction in the journal after it has been
recognized and measured.
▸ Normal balance of an account- the side of
▸ The total debits should equal to the total an account where increases are recorded
credits for every transaction. (can be left or right).

RULES FOR DEBIT AND CREDIT

You debit to show:

1. Increase in assets
▸ Trial balance – the schedule of all balances
2. Decrease in liabilities to prove the equality of the debit and
3. Decrease in owner’s equity credit.

- Owner’s Withdrawal ▸ A listing of all account titles with their

respective debit or credit balances taken
- Expenses from the ledger. However, it does not check
or vouch the accuracy of the report.
You credit to show:
POSSIBLE ERRORS IN THE TRIAL BALANCE
1. Decrease in assets
1. Transposition – occurs when order of two
2. Increase in liabilities
number are reversed.
3. Increase in owner’s equity
Example:
- initial investment
 48 was erroneously written as 84

1234 erroneously written as 4321

2. Transplacement or Slide – occurs when a

decimal point has been moved or
misplaced.

Example:

100 was erroneously written as 10

67.89 was erroneously written as 678.9