St.

Paul University Philippines

Tuguegarao City, Cagayan

School of Business, Accountancy and Hospitality Management

Fundamentals of Accounting Part 1

1ST SEM S.Y. 2020-2021

Topic: Introduction to Accounting

Lesson objectives: At the end of the discussion, the students must be able to

1. know the different types of business organizations.

2. know the advantages/disadvantage of each type of business organization.
3. understand what accounting is.
4. discuss the purpose/objectives of accounting.
5. identify the users of financial statements.
6. discuss the branches of accounting.
7. enumerate and discuss the different steps in accounting.

Lesson Proper

There are three major types of companies as to type of operations:

1. Service companies - those that do not sell a physical product but instead provide services to their
customers.
2. Merchandising companies - those which sell products but do not make products. Merchandising
companies are broken up into two different types: retailers and wholesalers.
3. Manufacturing companies – are those companies that buy raw materials and convert these into a
finished product.
Service companies

Service companies are those that do not sell a physical product but instead provide services to their
customers. Service firms include accounting firms, law firms, marketing firms, IT services firms, banks, dry
cleaners, health care organizations, educational institutions and many other businesses we interact with on a
daily basis.

One major difference between service companies and the other two types is that service companies do not
have the cost of goods sold because there is no product being sold. Service firms also do not have inventory,
also because no physical product is being sold. There may be direct costs associated with providing the
service, but no physical product.

Merchandising companies

Merchandising companies are those which sell products but do not make products. Merchandising companies
are broken up into two different types: retailers and wholesalers.

Retailers sell products directly to the end user. Staples, Wal-Mart, Target, American Eagle, GAP, and Home
Depot are all retailers. They sell products that consumers and businesses use, rather than resell.

Wholesalers buy products from manufacturers and sell them to other merchandising companies, usually
retailers. For example, most small breweries will use a distributor to help get their beers into stores and
restaurants. These distributors have established relationships with local stores and restaurants, making easier
for small breweries to get their beers to the public. A distributor is a wholesaler. Wholesalers are sometimes
referred to as “middlemen” because they act as an intermediary between a manufacturer and a retailer.

Merchandising companies purchase inventory (an asset) and sell that inventory. When inventory is sold, the
asset is considered used up, and the cost of that inventory is transferred from the balance sheet to the income
statement as an expense. This expense is called cost of goods sold. For merchandising companies, the
inventory account can also be referred to as merchandise inventory.

Manufacturing companies

Manufacturing companies are companies that make a product. Monster Beverages, Dell Computers, Boeing,
and General Motors are all companies that produce a product. These companies use labor and machinery to
turn materials into a product. Some manufacturing companies sell their products directly to the end user, like
Boeing. Some companies like Dell, sell their product directly to consumers and to retailers. Monster
Beverages and General Motors sell their products to retailers who sell the product to the end user.
The 4 Major Business Organization Forms as to Ownership

a. Sole Proprietorship
b. Partnership
c. Corporation
d. Cooperative

Sole Proprietorship

The simplest and most common form of business ownership, sole proprietorship is a business owned and run
by someone for their own benefit. The business’ existence is entirely dependent on the owner’s decisions, so
when the owner dies, so does the business.

Advantages of sole proprietorship:

 All profits are subject to the owner.

 There is very little regulation for proprietorships.
 Owners have total flexibility when running the business.
 Very few requirements for starting—often only a business license (easy to form).

Disadvantages:

 Owner is 100% liable for business debts (unlimited liability).

 Equity is limited to the owner’s personal resources (limited financing).
 Ownership of proprietorship is difficult to transfer.
 No distinction between personal and business income.
 Easy to dissolve (limited life).

Partnership

An association of two or more person who binds themselves to contribute money, property, or industry
to a common fund for the purpose of dividing profits among themselves.

These come in two types: general and limited. In general partnerships, both owners invest their money,
property, labor, etc. to the business and are both 100% liable for business debts. (Unlimited liability). In
other words, even if you invest a little into a general partnership, you are still potentially responsible for all
its debt. General partnerships do not require a formal agreement—partnerships can be verbal or even implied
between the two business owners.

Limited partnerships require a formal agreement between the partners. They must also file a certificate of
partnership with the state. Limited partnerships allow partners to limit their own liability for business debts
according to their portion of ownership or investment. (Limited liability)

Advantages of partnerships:

 Shared resources provide more capital for the business.

 Each partner shares the total profits of the company.
 Similar flexibility and simple design of a proprietorship.
 Inexpensive to establish a business partnership, formal or informal.

Disadvantages:
  Each partner is 100% responsible for debts and losses (unlimited liability).
 Selling the business is difficult—requires finding new partner.
 Partnership ends when any partner decides to end it (easy to dissolve/limited life).

Corporation

Corporations are, for tax purposes, separate entities and are considered a legal person. This means, among
other things, that the profits generated by a corporation are taxed as the “personal income” of the company.
Then, any income distributed to the shareholders as dividends or profits are taxed again as the personal
income of the owners.

Advantages of a corporation:

 Limits liability of the owner to debts or losses (limited liability).

 Profits and losses belong to the corporation.
 Ownership can be transferred to new owners fairly easily.
 Personal assets of shareholders cannot be seized to pay for business debts (limited liability).
 Continuity of existence (unlimited life).

Disadvantages:

 Corporate operations are costly.

 Establishing a corporation is costly.
 Start a corporate business requires complex paperwork.
 With some exceptions, corporate income is taxed twice.

Cooperatives – non-profit business organizations

Business organization is the single-most important choice you’ll make regarding your company. What form
your business adopts will affect a multitude of factors, many of which will decide your company’s future.
Aligning your goals to your business organization type is an important step, so understanding the pros and
cons of each type is crucial.

Your company’s form will affect:

 How you are taxed

 Your legal liability
 Costs of formation
 Operational costs

Introduction to Accounting - Meaning, Objectives

Definition of Accounting

Accounting can be defined as a process of reporting, recording, interpreting and summarizing economic data.
The introduction of accounting helps the decision-makers to make effective choices, by providing
information on the financial status of the business.

 Economic Events- It is a consequence of a company has to undergo when the number of monetary
transactions is involved. Such as purchasing new machinery, transportation, machine installation on-
site, etc.
  Identification, Measurement, Recording, and Communication- The accounting system should be
outlined in such a way that the right data is identified, measured, recorded, and communicated to the
right individual and at the right time.
 Interested Users of Information- It is about communicating important financial information to the
customers, according to which they will make the correct decision.

Elements f Accounting = Assets, Liabilities, Equity, Revenues and Expenses

 Assets- The economic value of an item which is possessed by the enterprise is referred to as Assets.
To put it in other words, assets are those items that can be transformed into cash or that generates
income for the enterprise shortly. It is useful in paying any expenses of the business entity or debt.

 Liabilities- The economic value of an obligation or debt that is payable by the enterprise to other
establishment or individual is referred to as liability. To put it in other words, liabilities are the
obligations that are rising out of previous transactions, which is payable by the enterprise, through the
assets possessed by the enterprise.

 Owner’s Equity/Stockholders Equity- Owner’s equity is one of the 3 vital segments of a sole
proprietorship’s balance sheet and one of the main aspects of the accounting equation: Assets =
Liabilities + Owner’s Equity. It depicts the owner’s investment in the trade minus the owner’s
withdrawal from the trade + the net income since the business concern commenced.

Revenues often referred to as sales, is the income received from normal business operations and other
business activities.

Expenses - an expense is the cost of operations that a company incurs to generate revenue. As the
popular saying goes, “it costs money to make money.” Common expenses include payments to suppliers,
employee wages, factory leases, and equipment depreciation.

The Accounting Process

The following attributes or characteristics can be drawn from the definition of Accounting:

(1) Identifying financial transactions and events

 Accounting records only those transactions and events which are of financial nature.
 So, first of all, such transactions and events are identified.

(2) Measuring the transactions

 Accounting measures the transactions and events in terms of money which are considered as a
common unit.

(3) Recording of transactions

 Accounting involves recording the financial transactions inappropriate book of accounts such as
Journal or Subsidiary Books.

(4) Classifying the transactions

  Transactions recorded in the books of original entry – Journal or Subsidiary books are classified and
grouped according to nature and posted in separate accounts known as ‘Ledger Accounts’.

(5) Summarizing the transactions

 It involves presenting the classified data in a manner and in the form of statements, which are
understandable by the users.
 It includes Trial balance, Trading Account, Profit and Loss Account and Balance Sheet.

(6) Analyzing and interpreting financial data

 Results of the business are analyzed and interpreted so that users of financial statements can make a
meaningful and sound judgment.

(7) Communicating the financial data or reports to the users

 Communicating the financial data to the users on time is the final step of Accounting so that they can
make appropriate decisions.

What are the Different Branches of Accounting?

The following are the main branches of accounting:

1. Financial Accounting

Financial accounting involves recording and classifying business transactions and preparing and presenting
financial statements to be used by internal and external users.

In the preparation of financial statements, strict compliance with generally accepted accounting principles or
GAAP is observed. Financial accounting is primarily concerned in processing historical data.

2. Managerial Accounting

Managerial or management accounting focuses on providing information for use by internal users, the
management. This branch deals with the needs of the management rather than strict compliance with
generally accepted accounting principles.

Managerial accounting involves financial analysis, budgeting and forecasting, cost analysis, evaluation of
business decisions, and similar areas.

3. Cost Accounting

Often times considered as a subset of management accounting, cost accounting refers to the recording,
presentation, and analysis of manufacturing costs. Cost accounting is very useful in manufacturing
businesses since they have the most complicated costing process.

Cost accountants also analyze actual costs versus budgets or standards to help determine future courses of
action regarding the company's cost management.

4. Auditing

External auditing refers to the examination of financial statements by an independent party with the purpose
of expressing an opinion as to fairness of presentation and compliance with GAAP. Internal auditing focuses
on evaluating the adequacy of a company's internal control structure by testing segregation of duties, policies
and procedures, degrees of authorization, and other controls implemented by management.

5. Tax Accounting
Tax accounting helps clients follow rules set by tax authorities. It includes tax planning and preparation of
tax returns. It also involves determination of income tax and other taxes, tax advisory services such as ways
to minimize taxes legally, evaluation of the consequences of tax decisions, and other tax-related matters.

6. Accounting Information Systems

Accounting information systems (AIS) involves the development, installation, implementation, and
monitoring of accounting procedures and systems used in the accounting process. It includes the employment
of business forms, accounting personnel direction, and software management.

7. Fiduciary Accounting

Fiduciary accounting involves handling of accounts managed by a person entrusted with the custody and
management of property of or for the benefit of another person. Examples of fiduciary accounting include
trust accounting, receivership, and estate accounting.

8. Forensic Accounting

Forensic accounting involves court and litigation cases, fraud investigation, claims and dispute resolution,
and other areas that involve legal matters. This is one of the popular trends in accounting today.

8. Government Accounting

These involves the accounting of the transactions of government agencies.

Focusing on a Specialization

If you want to focus on a specialization, you may want to consider obtaining an accounting certification in
your chosen field. It will give you an edge over those who are uncertified. Due to the increasing population
and demand for competitive professionals, you need to step it up a little to get recognized.

Some of the most famous certifications include the Certified Public Accountant (CPA), Certified
Management Accountant (CMA), Certified Internal Auditor (CIA), Certified Financial Planner (CFP), and
Certified Information Systems Auditor (CISA).

Users of Financial Information (Decision Makers)

(A) Internal Users

 Owners: Owners contribute capital in the business and thus they are exposed to maximum risk. So,
they are always interested in the safety of their capital.
 Management: Accounting information is used by management for taking various decisions.
 Employees: Employees are interested in the financial statements to assess the ability of the business
to pay higher wages and bonus.

(B) External Users

 Banks and financial institutions: Banks and Financial Institutions provide loans to business. So,
they are interested in financial information to ensure the safety and recovery of the loan.
 Investors: Investors are interested to know the earning capacity of business and safety of the
investment.
 Creditors: Creditors provide the goods on credit. So they need accounting information to ascertain
the financial soundness of the firm.
 Government: The government needs accounting information to assess the tax liability of the
business entity.
 Researchers: Researchers use accounting information in their research work.
  Consumers: They require accounting information for establishing good accounting control, which
will reduce the cost of production.

What Is the Accounting Equation?

The accounting equation is considered to be the foundation of the double-entry accounting system. On a
company's balance sheet, it shows that a company's total assets are equal to the sum of the company's
liabilities and shareholders' equity/owner’s equity.

Based on this double-entry system, the accounting equation ensures that the balance sheet remains
“balanced,” and each entry made on the debit side should have a corresponding entry (or coverage) on the
credit side.

Assets = Liabilities + Owners Equity

Debit = Credit + credit

Assets are a company's resources—things the company owns.

Current assets – includes cash and cash equivalents and other assets that are convertible into cash within
one year or within the normal operating cycle of the business whichever is longer.

 Cash and cash equivalents

 accounts receivable
 inventory
 prepaid expenses
 short term investments

Non-Current Assets – these are assets that do not meet the criteria of currents assets. It includes fixed assets
and long-term assets.

 land
 buildings
 equipment
 machineries
 furnitures and fixtures
 long term investments
 intangible assets

Examples of intangible assets

 Goodwill
 Copyright
 Trademark
 Patents

Liabilities are a company's obligations—amounts the company owes.

 as claims by creditors against the company's assets, and

 a source—along with owner or stockholder equity—of the company's assets.

Current Liabilities - obligations that are payable within a period of one year.

 accounts payable
 short term notes payable
 accrued expenses/ expenses payable
Non-current liabilities- payable for a period of more than one year

 Long term notes payable.

 Loans payable.
 Mortgage payable – a loans in which the asset acquired was pledge as a security to the debt.
 Bonds payable – debt securities issued by companies.

Owner's equity or stockholders' equity is the amount left over after liabilities are deducted from assets:

Part of the owner’s equity is the net income/(loss) of the business.

Net income/ (loss) = Revenues/ Sales – Expenses

Revenues
 Service Revenue
 Sales
 Interest Income
 Rent Income
 Commission Income
 Other income

Expenses – cost of operations

 Cost of Sales/ Cost of goods sold – merchandising/manufacturing.

 Salaries Expenses
 Depreciation of fixed assets
 Bad debts/Uncollectible accounts/ doubtful accounts - Accounts Receivable
 Advertising
 Rent
 Insurance
 Interest
 Commissions
 Repair and Maintenance
 Utilities
 Transportation / Freight
 Others/ Miscellaneous

Analyzing Business Transactions Using Financial Transaction Worksheet

Mrs. Ann Salome opened a laundry shop in the city which specializes on servicing big establishments like
hotels, restaurants, and hospitals. The following are the transactions for the first two months of operations.
Analyze the transactions using transaction analysis worksheet.
1. Invested cash, P400,000 and personal laundry equipments amounting to P120,000 on the business.
2. Acquired loan in the bank, P200,000
3. Acquired delivery van, P150,000 giving cash of P50,000 and the balance on account.
4. Paid for permits and licenses, P11,000
5. Acquired laundry supplies for on cash, P14,000.
 6. Purchase additional laundry equipment P200,000, 25% down payment and the balance on account
from Cagayan Appliances
7. Paid for 3 months advance rent, P15,000
8. Paid for insurance, P60,000.
9. Total cash receipts from laundry services for the week, P59,000.
10. Performed laundry services to a client, cash, P15,000 on account P8,000.
11. Paid salaries of employees, P10,500.
12. Paid ½ of the loan from the bank.
13. Paid 1/2 of the account to Cagayan Appliances.
14. Purchased laundry supplies on account, P5,000
15. Paid utility bills, P2, 750.
16. Paid water expense for the month, P2,400
17. Paid salaries of the employees, P6,000.
18. Made withdrawal of P7,000 for personal use.

Solution: Financial Transaction Worksheet

Note: ( ) means decrease

Transactions that increases or decreases Capital are (+) investment, (-) withdrawals, (+) revenues and (-)
expenses

ASSETS (Debit) = LIABILITIES (Credit) + EQUITY (Credit)

Cash Accounts Laundry Prepaid Furniture Laundry Utility Accounts Loans Salome,
Receivable Supplies Rent and & Fixture Equipment’s Vehicle Payable Payable Capital
Insurance
1 400,000 120,000 520,000

2 200,000 200,000

3 (50,000) 150,000 100,000

4 (11,000) (11,000)

5 (14,000) 14,000

6 (50,000) 200,000 150,000

7 (15,000) 15,000

8 (60,000) 60,000

9 59,000 59,000

10 15,000 8,000 23,000

11 (10,500) (10,500)

12 (100,000) (100,000)

13 (75,000) (75,000)

14 5,000 5,000

15 (2,750) c (2,750) d

16 (2,400) c (2,400) d

17 (6,000) c (6,000) d
18 (7,000) c (7,000) d

Totals 270,350 8,000 19,000 75,000 320,000 150,000 180,000 100,000 562,350

Total assets P842,350 = Total Liabilities 280,000 + Equity 562,350

P842,350 = P842,350

Recording Business Transactions

A transaction is an event that occurs in a business that changes the balance of at least two accounts. Double-
entry accounting states that for every one transaction that occurs, there will be at least two accounts
affected. One account will be debited, and one account will be credited. A debit is an entry made on the left
side of an account. A credit is an entry made on the right side of an account. These dual effects of a single
transaction will either increase or decrease an account balance. That depends on the type of account that it is.

Normal Balances of Account

Accounts Normal Balances (Increase)

Assets Debit
Liabilities Credit
Equity Credit
Revenues Credit
Expenses Debit
Assets = Liabilities + Equity

Account name

Debit Credit

Example of Recording Transactions in a two-column journal

Mrs. Ann Salome opened a laundry shop in the city which specializes on servicing big establishments like
hotels, restaurants, and hospitals. The following are the transactions for the first two months of operations.
Record the transaction using a two-column worksheet.
19. Invested cash, P400,000 and personal laundry equipments amounting to P120,000 on the business.
Debit Credit
Cash 400,000
Laundry Equipment 120,000
Salome, Capital 520,000

20. Acquired loan in the bank, P200,000

Cash 200,000
Loans Payable 200,000

21. Acquired delivery van, P150,000 giving cash of P50,000 and the balance, a promissory note.
Vehicle 150,000
Cash 50,000
Notes Payable 100,000

22. Paid for permits and licenses, P11,000

Permits and licenses 11,000
Cash 11,000

23. Acquired laundry supplies for on cash, P14,000. Un

Unused Laundry Supplies 14,000
Cash 14,000

24. Purchase additional laundry equipment P200,000, 25% down payment and the balance on account
from Cagayan Appliances
Laundry Equipment 200,000
Cash 50,000
Accounts Payable 150,000

25. Paid for 3 months advance rent, P15,000

Prepaid Rent 15,000
Cash 15,000

26. Paid for insurance, P60,000. (use Expense method)

Insurance Expense 60,000
Cash 60,000

27. Total cash receipts from laundry services for the week, P59,000.
Cash 59,000
Service Revenue 59,000

28. Performed laundry services to a client, cash, P15,000 on account P8,000.

Cash 15,000
Accounts Receivable 8,000
Service Revenue 23,000

29. Paid salaries of employees, P10,500.

Salaries Expenses 10,500
Cash 10,500

30. Paid ½ of the loan from the bank.

Loans Payable 100,000
Cash 100,000

31. Paid 1/2 of the account to Cagayan Appliances.

 Accounts Payable 75,000
Cash 75,000

32. Purchased laundry supplies on account, P5,000

Unused Laundry Supplies 5,000
Accounts Payable 5,000

33. Paid utility bills, P2, 750.

Utility expenses 2,750
Cash 2,750

34. Paid water expense for the month, P2,400

Utility expenses 2,400
Cash 2,400

35. Paid salaries of the employees, P6,000.

Salaries Expense 6,000
Cash 6,000

36. Made withdrawal of P7,000 for personal use.

Salome, Withdrawals 7,000
Cash 7,000

Posting to the ledgers

Jericho Rosales (example only)

Date Particulars Debit Credit Balance

9/15/20 Tuition 25,000 5,000 20,000
11/8/20 payment 5,000 15,000
1/25 payment 10,000 5,000
2/5/20 Tuition 30,000 10,000 20,000

Cash

Date Particulars Debit Credit Balance

1/1/2020 Investment by the owner 400,000 400,000
1/2 Bank loan 200,000 600,000
1/3 Purchased of vehicle 50,000 550,000
1/4 Payment for licenses 11,000 539,000

Accounts Receivable

Date Particulars Debit Credit Balance

Simplicity Purposes (use T accounts)

Cash Accounts receivable Laundry Equipment’s

 1/1 400,000 1/3 50,000
1/2 200,000 1/4 11,000
674,000 403,650

1/31 270,350

This is the balance after posting all the cash transactions in the T account.

Vehicle Supplies Prepaid Rent Accounts Payable

Salome Laundry Shop

Trial Balance
January 30,2020

Accounts Debit Credit

Cash P270,350
Accounts Receivable 8,000
Unused Laundry Supplies 19,000
Prepaid Rent 15,000
Laundry equipment 320,000
Vehicle 150,000
Accounts Payable 80,000
Notes Payable 100,000
Loans Payable 100,000
Salome, Withdrawals 7,000
Salome, Capital 520,00
Service Revenue 82,000
Salaries Expense 16,500
Permits and Licenses 11,000
Utilities expense 5150
Insurance Expense 60,000
Total P882,000 P882,000

The financial Statements

 Salome Laundry Shop
Income Statement
For the period ended January 30,2020

Service Revenue P 82,000

Add: other Income -
Total P82,000
Less: Operating Expenses
Salaries Expense 16,500
Permits and Licenses 11,000
Utilities expense 5150
Insurance Expense 60,000 92,650
Net Income/(Loss) P(10,650)

Salome Laundry Shop

Statement of Changes in Equity
For the period ended January 30,2020

Salome, Capital, beg. balance P 520,000

Add: additional investment -
Profit/loss (10,650)
Total 509,350
Less: Withdrawals 7,000
Salome, Capital, ending . balance P502,350

Salome Laundry Shop

Statement Financial Position
As of January 30,2020

Assets
Current Assets
Cash P270,350
Accounts Receivable 8,000
Unused Laundry Supplies 19,000
Prepaid Rent 15,000
Total P312,350

Non-Current Assets
Laundry equipment 320,000
Vehicle 150,000
Total 470,000

Total Assets P782,350

Liabilities and Equity

Accounts Payable 80,000
Notes Payable 100,000
Total 180,000
Non-Current Liabilities
Loans Payable 100,000

Total liabilities 280,000

Salome, Capital ending balance P502,350

Total Liabilities and Capital P782,350