CHAPTER 1 - FUNDAMENTAL CONCEPTS AND PRINCIPLES

What is Accounting?

 Accounting is the systematic process of measuring and reporting relevant financial information
about the activities of an economic organization or unit. It is capable of being expressed in
monetary term.
 Is a service activity that provides quantitative information that is primarily financial in nature
about economic entities that is intended to be useful in decision making/economic decision.
 Is an art of recording, classifying, and summarizing in a significant manner and in terms of
money, transactions, and event which are in part of at least of financial character and
interpreting.
 Process if identifying, measuring and communicating economic information.

3 Components of Accounting

a. Identifying
 Is the process of recognition and non-recognition of business activity as accountable.

Non-accountable – no unit of measure, di nagmamatter sa assets, liabilities and owner’s

equity.

Ex. Hiring of employees, namatay na member ng company.

Economic Activities – Transactions

Types of Transaction:

Internal External
- Within the entity, sa loob. - Two entities exchanging transactions.
Production – the process of making the finish - Both parties may nakukuhang benefits.
product. - Ex. Borrowing money in the bank, sale of
Causality Effect – effect is within the entity. goods.
Effect is caused by natural disasters.

b. Measuring
 Assigning of peso amount.
 Financial statement is impossible without monetary amounts.

Measurement Basis: Historical cost (original cost), current cost (bagong cost), realizable
value, and present value.

c. Communicating
 Process of retailing and distributing accountancy reports to potential users.
4 Aspects of Accounting

a. Recording
 Writing down the business transaction chronologically in the books of account.
 Journalizing – maintain records of business transactions.
b. Classifying
 Sorting similar and relevant business transaction into the 3 categories of A, L and OE.
c. Summarizing
 Preparing the financial statements from the transactions recorded in the books of
accounts designed to meet the information needs of its user.

Types of Financial Statement:

 Statement of Financial Statement Position

 Statement of Comprehensive Income
 Statement of Changes in Owner’s Equity
 Statement of Cash Flows
d. Interpreting
 Representing the quantitative and qualitative financial information about the business
transactions in a language comprehensible to the users of financial statements.

Users of Information - Parties interested in financial information.

1. Investors/Owners/Stockholders
 These people provide the financial resources to keep the business going.
2. Government
 Financial information is important for tax purposes and its compliance with SEC
requirements.
3. Financial institutions/Creditors
 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.
5. Employees
 Financial information provides information of company stability which is important for
the employees to determine if they have a future in the company.
3 Types of Business Organization

i. Sole proprietorship
 a business owned and managed by only one person.
ii. Partnership
 business organization owned and managed by two or more people who agree to
contribute their assets to a common fund for the purpose of earning profit.
iii. Corporation
 business organization manage by an elected BOD. The inventors are called stockholders
and the unit of ownership is called share of stock.

3 Types of Business Operations

I. Service
 business operation engaged in the rendering of service.
II. Trading/Merchandising
 engaged in buying and selling of goods.
III. Manufacturing
 production of items to be sold. It is involved in the purchasing and converting of RM to
FG.

Accounting system

- Comprises of methods used by the business to keep records in financial activities and to
summarize these accounts in periodic activities.

Transaction

- Completed action w/c can be expressed in monetary term.

Generally Accepted Accounting Principles (GAAP)

- A general statement or rules and procedures that serves as a guide in the practice of accounting.
- These are standards, assumptions and concepts with general acceptability.

Accounting vs. Bookkeeping

“why” of accounting. inerpret “how” of the accounting, record
Accounting vs. Accountancy
- used in reference only to a particular field - refers to the profession of accounting
of accountancy such as public accounting, practice.
private accounting and government
accounting.
 Financial Accounting vs. Managerial Accounting
- is primarily concerned with the recording - is the area of accounting that emphasizes
of Business transactions and the eventual developing accounting information for
preparation of financial statements. use WITHIN AN ENTITY
Intended for internal and external users.
- following rules (GAAP) - not following rules
- using past financial statement to come up - Using past and future financial
with a decision. statement.

Fundamental Concept

1) Entity concept
 Regards the business enterprise as separate and distinct from its owner and from other
business enterprise.

2) Money Measurement Concept

 Only expressing monetary terms
 To quantify/measure economic events.
3) Dual Aspect Concept

Debit Credit
- Left side - Right side
- Increase in asset, decrease in liabilities - Decrease in asset, increase in
and owner’s equity.
4) Periodicity
- “time” – annually (required)

Calendar Year – Jan. 1 to Dec. 31

Fiscal Year – any month of the year, 12 month after the start period.

5) Going concern
- a concept which assumes that the business enterprise will continue to operate
indefinitely.

BASIC PRINCIPLES

A. Objectivity principle
- All the business transactions that will be entered in the accounting records must be duly
supported by verifiable evidence. No bias, no manipulation.
B. Historical cost
- all properties and services acquired by the business must be recorded at its original
acquisition cost.
 C. Accrual principle
- states that income should be recognized at the time it is earned such as when goods are
delivered or services have been rendered. Expense is recognize at the time na nagastos
na.
D. Adequate disclosure
- all material facts that will significantly affect the financial statements must be indicated.
E. Materiality
- financial reporting is only concerned with information significant enough to affect
decisions.
F. Consistency
- approaches used in reporting must be uniformly employed from period to period to
allow comparison of results between time periods.
G. Conservatism
- Exercise care and caution, always be prepared.
H. Matching Principle
- irecord sabay ang revenue and expenses para makuha ang income.

CHAPTER 2 – FINANCIAL STATEMENTS FOR A SERVICE BUSINESS AND THE FUNDAMNETAL

ACCOUNTING EQUATION

What is Financial Statement?

 is the key product or the end product of the accounting process.

Types of Financial Statement:

a) Statement of Financial Position (Balance Sheet)

- Shows the financial condition/position of a business as of a given period. It consists of
Assets, Liabilities, and Owner’s Equity.
b) Statement of Comprehensive Income / Income Statement
- shows the result of operations for a given period. It consists of the Revenue, Cost, and
Expenses.
c) Statement of Changes in Owner’s Equity / Statement of Owner’s Equity
- shows 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.
d) Statement of Cash Flows
- summarizes the cash receipts and cash disbursement for the accounting period.
Typical Account Titles Used

Balance Sheet

Asset Liabilities Owner’s Equity

These are economic resources These include debts, This includes the interest of the
owned by the business expected obligations to pay, and owners on the business; claims of the
for future gain. They are claims of the creditors on owners on the assets of the business;
property and rights of value the assets of the business. and the investment of the owner plus
owned by the business. or minus the results of operations.
ASSET = LIABILITIES + OWNER’S EQUITY

ASSET

CURRENT ASSETS

 Expected to be realized in, or is intended for sale or consumption in, the entity’s normal
operating cycle;
 Held primarily for the purpose of being traded;
 Expected to be realized within twelve months of the balance sheet date; or
 Cash or a 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

 coins, currencies, checks, bank deposits, and other cash

Cash Equivalents

 short term investments that are readily convertible to known amounts of cash which are subject
to an insignificant risk to changes in value.

Marketable Securities

 are stocks and bonds purchased by the enterprise and are to be held for only a short span of
time or short duration.

Trade and Other Receivable

 amounts uncollectible from any of the following accounts:

 Accounts Receivable - is the amount collectible from the customer to whom sales made
or services have been rendered on account or credit.
 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.
  Interest Receivable – amount of interest collectible on promissory notes received from
customers and clients.
 Advances to Employees – certain amount of money loaned to employee’s payable in
cash or through salary deductions.
 Accrued Income – income already earned but not yet received.

Inventories

 represent the unsold goods at the end of the accounting period.

Prepaid Expenses

 supplies bought for use in the business or services and benefits to be received by the business in
the future paid in advance.

CONTRA-ASSET ACCOUNT

 these are accounts deducted from the related asset accounts.

 Allowance for Bad Debts – losses due to uncollectible accounts.
 Accumulated Depreciation – represents the expired cost of property, plant, and
equipment as a result of usage and passage of time.

NON-CURRENT ASSETS

 assets that are intended to be held for an extended period of time (more than one year)

CLASSIFICATION OF NON-CURRENT ASSETS

Long-term Investments

 assets held by an enterprise for the accretion of wealth through capital distribution.

Property, Plant, and Equipment

 tangible assets that are held by an enterprise for use in the production or supply of goods or
services, or for administrative purposes.
 Land – is a piece of lot or real estate owned by the enterprise.
 Building – is 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, and Machinery and Equipment.
Furniture and Fixtures

 include tables, chairs, carpets, curtains, lamp and lighting fixtures, and wall decors. Specific
account titles maybe used such as Office Furniture and Fixtures, and Store Furniture and Fixtures.

Intangible Assets

 are 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 ( goodwill,
patents, copyrights, licenses, franchises, trademarks, brand names, secret processes,
subscription lists and non-competition agreements ).

LIABILITIES

 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

Trade and Other Payables

 includes payables from any of the following accounts:

 Accounts Payable – debts arising from purchase of an asset or acquisition of services on
account.
 Notes Payable – debts arising from purchase of an asset or acquisition of services on
account evidenced by a promissory note.
 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.
 Utilities Payable – an obligation to pay utility companies for services received from
them. (e.g. Telephone services to PLDT, electricity to Meralco, and water services to
Maynilad).
 Unearned Revenues – obligations of the business arising from advance payments
received before goods or services are provided to the customer.
 Accrued Liabilities – include amounts owed to others for expenses already incurred but
not yet paid.

NON-CURRENT LIABILITIES

 are long term liabilities or obligations which are payable for a period longer than one year.
CLASSIFICATION OF NON-CURRENT LIABILITIES

Mortgage Payable

 long term debt of the business with security or collateral in the form of real properties. In case
the business fails to pay the obligation, the creditor can foreclose or cause the mortgaged asset
to be sold and the proceeds of the sale to be used to settle the obligation.

Bonds Payable

 a certificate of indebtedness under the seal of a corporation, specifying the terms of repayment
and the rate of interest to be charged.

OWNER’S EQUTY

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 net income earned during the year. It is
decreased 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 net loss for the period before it
is closed to the capital account.

INCOME STATEMENT

 accounts namely revenue and expenses are classified as nominal or temporary accounts

FORMS OF INCOME STATEMENT

Natural Form

 presents expenses according to nature. This type of income statement is used in a service
business.

Functional Form

 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. (Examples: Laundry Services by a laundry shop, Medical Services by a doctor, Dental
Services by a dentist)

Salaries or Wages Expense

 includes all payments made to employees or workers for rendering services to the company.
(Examples: Salaries or Wages, 13th month pay, cost of living allowances, other related
benefits)

Utilities Expense

 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

 the expired portion of premiums paid on insurance coverage such as premiums paid for health
or life insurance motor vehicles or other properties.

Depreciation Expense

 the annual portion of the cost of the tangible asset such as buildings, machineries, and
equipment charged as expense for the year.

Uncollectible Accounts Expense / Doubtful Accounts Expense / Bad Debts Expense

 the amount of receivables charged as expense for the period because they are estimated to be
doubtful of collection.

Interest Expense

 the amount of money charged to the borrower for the use of borrowed funds.

STATEMENT OF FINANCIAL POSITION

 Balance sheet accounts namely Assets, Liabilities, and Owner’s Equity are classified as 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.

Current Assets

 are classified and presented according to liquidity with the most liquid followed by those with
lesser liquidity. Since cash is the most liquid, it is always listed first followed by the other current
assets according to their proximity to cash.

Liabilities

 are classified and presented based on their maturity. Obligations presently due for payment are
listed first.

STATEMENT OF CASH FLOWS

Operating activities

 the cash inflows (receipts) and the cash outflows (payments) arising from the normal operations
of the business.
 Receipts of Cash:
 Collections form customers for the performance of services or sale of goods
 Royalties, fees, commissions received
 Interest, dividends, and other income received
 Payments of Cash:
 To suppliers for services and goods acquired
 Employees’ salaries
 Government licenses and taxes
 Interest expense
 Other operating expenses

Investing Activites

 the cash inflows (receipts) and the cash outflows (payments) from the purchase and sale of
property and equipment, investment in debt or trading securities.
Financing Activities

 the cash inflows (receipts) and the cash outflows (payments) from the owners and creditors of
the business.
 Receipts of Cash:
 Original and additional investments by owner
 Proceed of loan
 Payments of Cash:
 cash withdrawal of owner
 Pay ment for the principal balance of loan

CHAPTER 3. THE ACCOUNTING EQUATION

Assets (what it owns) = Liabilities (what it owes to others) + Owners Equity (the difference between
assets and liabilities)

 The underlying rationale behind the accounting equation is that of equilibrium. Meaning, every
plus should have a corresponding minus and every debit should have a corresponding credit.
Liabilities usually are shown before owner’s equity in the accounting equation because creditors
have first rights to the assets.

ELEMENTS OF THE FUNDAMENTAL ACCOUNTING EQUATION

ASSETS

 Asset is defined as resource controlled by the entity as a result of past event and from which
future economic benefit are expected to flow to the entity.

LIABILITIES

 Liability is present obligation of the entity arising from past event the settlement of which is
expected to result in an outflow from the entity of resources embodying economic benefits.

OWNER’S EQUITY

 Equity is the residual interest in the assets of the entity after deducting all of the liabilities.

INCOME

 Income is increase in the economic benefit during the accounting period in the form of an inflow
or increase of asset or decrease of liability that results in increase in equity, other than
contribution from equity participants
EXPENSE

 Expense is decrease in economic benefit during the accounting period in the form of an outflow
or decrease of asset or increase of liability that results in decrease in equity, other than
distribution to equity participants.

EXPANDED FUNDAMENTAL ACCOUNTING EQUATION

Asset = Liabilities + Owner’s Capital – Owner’s Drawing + Revenues – Expenses

CHAPTER 4. THE ACCOUNTING CYCLE

Again, what is Accounting?

 Accounting is the art of analyzing financial transactions and economic events, recording,
classifying to accounts and summarizing, followed by reporting and interpreting result.

Steps in the Recording Process of Accounting:

Identifying and Analyzing

 Recognizing economic events that have taken place and determining their effects on the
business. These transactions must always be supported by documentary evidences or proofs.

Recording

 The process of writing the effects of the transaction, also known as journalizing that have been
analyzed it can be done manually or encoded using computers or with data processing
machines. The recording includes the inputting of information in the accounting books called
journals.
 These journals are:
o General Journals
o Special Journals
o Cash receipts book
o Cash disbursement book
o Sales book and Purchases book

Classifying

 The sorting or grouping of transactions that are a like to their specific account titles. The
journalized transactions are classified in the following ledgers:
o General Ledger
o Subsidiary Ledger - Shows the details of those transactions classified in the general
ledger.
Summarizing

 The process of grouping together various accounts refered in classifying process. This is where
the accounts are grouped into Assets, Liabilities, Owner's Equity, Revenue and Expenses.

Reporting

 The preparation of the following financial summaries:

o Results of the operation ( Income Statement )
o Financial position ( Balance Sheet )
o Cash Flow Statement
 These are communicated to the users of information and this may be further supported by
schedules.

Interpreting

 The last step in accounting process, this involves the computation of relationship of figures from
the financial reports and schedules. Interpreting is a combination of figures and narrations
based on the figures presented. The relationship may be in percent or in ratios; and may be
within the financial report or one report in relation to another report.

Double Entry System

 The first description of the double entry system appeared in 1494 in mathematics books written
by Fra. Luca Pacioli. The double entry system recognizes the dual effects of every economic
transaction. These effects are analyzed in terms of increases and decreases in Assets, Liabilities
and Owner's Equity for the purpose of grouping the effects of economic transactions, there's a
need to analyze it in terms of debits and credits.

Definitions:

 Double Entry - Value received and value parted with, it means that for every economic event
there are at least two affects the financial position of the entity.
 Accounting Equation - (Assets = Liabilities + Owner's Equity) or (Assets - Liabilities = Owner's
Equity)
 Assets - Thing owned by the entity and where it expects to extract benefits from future
operations.
 Liabilities - The thing owed by the entity to third parties, present obligations of a business to pay
cash, transfer assets or provide services to other entities in the future.
 Owner's Equity - The claims of the owners of a business on the asset of the entity, in other
words it's a residual value after deducting liabilities from assets.
 Debit - The left side of a T-account.
 Credit - The right side of a T-account.
 T-account - Represented by the capital letter T, there's a left and right side to the vertical bar.
On the top of the horizontal bar is where the account title is written.
  Account Title - Descriptive name that indicates the kind of transactionst that are recorded in the
T-account.

The Accounting Equation can be modified to show income and expenses view illustration below:

 ASSETS = LIABILITIES + OWNER'S EQUITY (OWNER’S INVESTMENT + INCOME - EXPENSES)

 The income and expenses are shown in the income statement, the excess of income over
expenses is a net income and excess of expenses over income is net loss.

Rules of Debits and Credits

Debits Credits

Debit Asset account for increase in Asset. Credit Asset account for decrease in Asset.

Debit Liability account for decrease in liability. Credit Liability account for increase in Liability.

Debit Owner’s Equity account for decrease in Credit Owner’s Equity account for increase in
Owner’s Equity. Owner’s Equity.
Debit Income account for decrease in Income. Credit Income account for increase in Income.

Depot Expense account for increase in Expense. Credit Expense account for decrease in Expense.

Steps in Accounting Cycle

1. Journalizing

 Chronological recording of economic transactions showing all the effects of each

transaction in terms of debits and credits.
 journal entry should contain the following:
o Date YYYY/MM/DD
o Account Titles and Explanation
o Posting Reference
o Debit
o Credit
 The Simple and Compund Entry
o Simple entry, only two accounts are affected. But in some cases, a transaction
would require the usage of more than three accounts which we call as a
compound entry
2. Posting

 Transferring journal entries to the ledger accounts is called posting. This phase of the
recording process accumulates the effects of journalized transactions into the individual
accounts. The entire group of accounts maintained by a company is the ledger. The
ledger provides the balance in each of the accounts as well as keeps track of changes in
these balances.
 Chart of Account
o This chart lists the accounts and the account numbers that identify their
location in the ledger. The numbering system that identifies the accounts
usually starts with the balance sheet accounts and follows with the income
statement accounts

3. Trial Balance

 A necessary checkpoint for uncovering certain types of errors. They list accounts in the
order in which they appear in the ledger. Debit balances appear in the left column and
credit balances in the right column. The trial balance proves the mathematical equality
of debits and credits after posting. A trial balance may also uncover errors in journalizing
and posting.
 The steps for preparing a trial balance are:
o List the account titles and their balances in the appropriate debit or credit
column.
o Total the debit and credit columns.
o Prove the equality of the two columns.

4. Adjusting

 Adjust the ledger balances.

5. Financial Statements

 Make income statement and balance sheet from the adjusted trial balance.

6. Closing

 Close or transfer the income and expenses accounts to”Income and Expense Summary
account” and the latter account to Owner’s Equity.

7. Post-Closing Trial Balance

 Make a trial balance of all Assets, Liabilities, and Owner’s Equity accounts after closing
the income and expense accounts.
 8. Reversing

 Reverse some adjusting entries to prepare them for a new accounting period.

Accounting Period

 is a period of time usually one year, generally, this period starts from January 1 and ends on
December 31 referred to as a calendar year. In performing the steps in the accounting cycle the
accountant is always guided by the company’s accounting policies. These accounting policies are
the specific principles, bases, conventions, rules, and practices adopted by an enterprise in
presenting financial statements