Quarter 2, Week 1 – Fundamentals of Accountancy, Business and

Management 1

Accounting Concepts and Principle and Accounting Equation

[FLA1.1] Accounting Concepts and Principles

• BUSINESS ENTITY PRINCIPLE – a business enterprise is separate and distinct from its
owner or investor.

Examples:
- If the owner has a barber shop, the cash of the barber shop should be reported
separately from personal cash.

- The owner had a business meeting with a prospective client. The expenses
that come with that meeting should be part of the company’s expenses. If the
owner paid for gas for his personal use, it should not be included as part of the
company’s expenses.

• GOING CONCERN PRINCIPLE – business is expected to continue indefinitely.

Example:

- When preparing financial statements, you should assume that the entity will
continue indefinitely.

• TIME PERIOD PRINCIPLE – financial statements are to be divided into specific time intervals.

Example:
- Philippine companies are required to report financial statements annually.
- The salary expenses from January to December 2015 should only be reported
in 2015.

• MONETARY UNIT PRINCIPLE – amounts are stated into a single monetary unit

Example:

- Jollibee should report financial statements in pesos even if they have a store in
the United States.

- IHOP should report financial statements in dollars even if they have a branch
here in the Philippines

• OBJECTIVITY PRINCIPLE – financial statements must be presented with supporting

evidence.

Example:
- When the customer paid Jollibee for their order, Jollibee should have a copy of
the receipt to represent as evidence.

- When a company incurred a transportation expense, a voucher should be

prepared as evidence.

• COST PRINCIPLE – accounts should be recorded initially at cost.

Example:
- When Jollibee buys a cash register, it should record the cash register at its
price when they bought it.

- When a company purchases a laptop, it should be recorded at the price it was

purchased.
• ACCRUAL ACCOUNTING PRINCIPLE – revenue should be recognized when earned
regardless of collection and expenses should be recognized when incurred regardless of
payment. On the other hand, the cash basis principle in which revenue is recorded when
collected and expenses should be recorded when paid. Cash basis is not the generally
accepted principle today.

Example:
- When a barber finishes performing his services he should record it as
revenue. When the barber shop receives an electricity bill, it should record it
as an expense even if it is unpaid.

• MATCHING PRINCIPLE – cost should be matched with the revenue generated.

Example:

- When you provide tutorial services to a customer and there is a transportation

cost incurred related to the tutorial services, it should be recorded as an
expense for that period.

•DISCLOSURE PRINCIPLE – all relevant and material information should be reported.

Example:
The company should report all relevant information.

• CONSERVATISM PRINCIPLE – also known as prudence. In case of doubt, assets and

income should not be overstated while liabilities and expenses should not be understated.

Example: In case of doubt, expenses should be recorded at a higher amount. Revenue

should
36 be recorded at a lower amount.

• MATERIALITY PRINCIPLE – in case of assets that are immaterial to make a difference in the
financial statements, the company should instead record it as an expense.

Example:
A school purchased an eraser with an estimated useful life of three years. Since
an eraser is immaterial relative to assets, it should be recorded as an expense.

FORMATIVE ASSESSMENT
[FA1.1] Matching Type: Match the following words according to their definition.

WT=10
[FLA.1.2] The Accounting Equation

Basic Accounting Equation

ASSETS = LIABILITIES + EQUITY

Equity
Assets it
represents the
represents the A liability residual interest
company’s own represents the of owner’s
claims of the entity
entity’s
creditors.

ELEMENTS OF ACCOUNTING EQUATION

ASSETS

Assets are resources that an entity owns to derive some future benefits. These assets
are used by the company in its normal operations such as the manufacture of goods and
services. The main feature of these assets is their capability to give benefits to entity. These
benefits are usually in the form of their ability to directly or indirectly increase by the inflow of
cash to the entity or a reduction of its outflows.

Example of Assets:

1. CASH
Generally, the money that we use comprising of the bills and coins we use in our
everyday lives to buy the goods that we want and also avail services that we
need.

2. ACCOUNTS RECIEVABLE
This represents that are collectible from customers. They arise when a business
sell its good or services on account or credit.

3. INVENTORIES

Inventory refers to all the items, goods, merchandise, and materials held by a
business for selling in the market to earn a profit.

4. EQUIPMENT

Equipment is a tangible long-term asset that benefits a business over several

years of use. Computers, trucks and manufacturing machinery are all examples
of equipment.

5. LAND AND BUILDING

Land and buildings are tangible, long-term assets companies use and benefit
from over time.
 6. INTANGIBLE ASSETS

An intangible asset is an asset that is not physical in nature, such as a patent,

brand, trademark, or copyright. Businesses can create or acquire intangible
assets.

LIABILITIES

Liabilities are one of the claims of external parties from the entity. 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 form of obligations to do some service or even give something. These
liabilities can take from in the following;

1. ACCOUNTS PAYABLE

Accounts payable (AP) represents the amount that a company owes to its
creditors and suppliers (also referred to as a current liability account). Accounts
payable is recorded on the balance sheet under current liabilities.

2. UNEARNED REVENUE

Unearned revenue is money received by an individual or company for a service

or product that has yet to be provided or delivered. It can be thought of as a
"prepayment" for goods or services that a person or company is expected to
supply to the purchaser at a later date.

In accounting, unearned revenue is prepaid revenue. This is money paid to a

business in advance, before it actually provides goods or services to a client.
Unearned revenue is a liability, or money a company owes.

[FLA.1.3] The Accounting Equation – Continuation…….

EQUITY

The equity meaning in accounting refers to a company's book value, which is the
difference between liabilities and assets on the balance sheet. This is also called the owner's
equity, as it's the value that an owner of a business has left over after liabilities are deducted.

Generally, equity comes from two sources. The first one comes directly from the owners
in the form of investment of capital. The ither comes from the income of the business from its
normal operations. The net income or net loss of the business from its operation can be
determined by using the following equation:

REVENUES - EXPENSES = NET INCOME OR NET LOSS

*A business will have net income if its revenues if its revenues exceed expenses and will have a
net loss if revenues are less that its expenses

1. REVENUE

Revenue is the money generated from normal business operations, calculated as

the average sales price times the number of units sold. It is the top line (or gross
income) figure from which costs are subtracted to determine net income.
Revenue is also known as sales on the income statement.

2. EXPENSES

Businesses incur various types of expenses. An expense is a type of expenditure

that flows through the income statement and is deducted from revenue to arrive
 at net income. Due to the accrual principle in accounting, expenses are
recognized when they are incurred, not necessarily when they are paid for.

Types of Expenses

 Operating
o Cost of Goods Sold (COGS)
o Marketing, advertising, and promotion
o Salaries, benefits, and wages
o Selling, general, and administrative (SG&A)
o Rent and insurance
o Depreciation and amortization
o Other
 Non-operating
o Interest
o Taxes
o Impairment charges

 Fixed
o
Rent
o
Salaries, benefits, and wages (sometimes fixed and sometimes
variable)
 Variable
o Transaction fees
o Commissions
o Marketing and advertising (sometimes fixed and sometimes variable)
3. CAPITAL

Capital is the money used to build, run, or grow a business. It can also refer to
the net worth (or book value) of a business. Capital most commonly refers to the
money used by a business either to meet upcoming expenses, or to invest in
new assets and projects.

FORMATIVE ASSESSMENT
[FA1.2] Let’s do this: Assessing the learning of the students
WT-10

1. The owner-manager bought a computer for personal use. The invoice was given to the
accountant who recorded it as an asset of the business.

2. The statement of financial position of a company included an equipment purchased from

Japan for 350,000 yen. It was reported at that amount in the statement of financial position while
all the other assets were reported in Philippine pesos.

3. No financial statements were prepared by Michael Go for his business. He explained that he
will prepare the statements when he closes the business, which he predicts to take place after
20 years.

4. Aside from owning a shoe store, Albert operates a canteen. The assets of the canteen are
reported in the statement of financial position of the shoe store.

5. Purchased a hammer at a cost of PHP500. This was recorded as an asset and expense to
decrease its value by PHP50 per year for 10 years.

6. A food company ordered a machine needed in the assembly line of its production
department. Upon order, the machine was immediately listed as one of its assets.

7.Company XYZ had an April 30th year-end to its annual operating activities report.

8. You are a business owner and borrow money from your company to pay for your child's
education.

9. Imagine a company, JKL Corp., which bought a piece of land for $100,000.

10. A school purchased an eraser with an estimated useful life of three years.