Lesson 1 Review of Accounting Process

Learning At the end of the week, the students should be able to:
Outcomes
- Review the important concepts of basic accounting.
- Refresh their minds as to the importance of journal entries.
- Review of debit and credit analysis.
- Review of basic adjusting entries.
- Compute and journalize depreciation and amortization.
-Identify accounts that are not possible to be collected.
Time Frame
Introduction The author believes that there is a need for the student-beginners to review on
the basics of accounting, for them to feel at ease, develop their self-confidence and
have better take-off on the next subject which they are to face- "Corporation
Accounting". The review should be focused on the following:

(a) the conceptual background of accounting;

(b) the generally accepted accounting principles and accounting standards as well;
(c) components of financial statements;
(d) steps of the accounting process for both merchandising and manufacturing
companies;
(e) inventories of o manufacturing concern;
(f) familiarization of various manufacturing statements.
Activity Choose from the choices below the effect of the transactions listed. Write the letter of
you answer only.

A) Increase in assets – Increase in capital

B) Increase in assets – Increase in liabilities
C) Decrease in assets – Decrease in capital
D) Decrease in assets – Decrease in liability
E) Increase in one asset – Decrease in another form of an asset

1.The owner of the business contributed cash of P200,000.

2. The business entity rendered services to the customers on account – P20,000.
3. Purchase office supplies on account – P3,500.
4. Received proceeds of bank loan from Bank X – P500,000.
5. Paid the salaries of the employees.

Analysis A manager asked his messenger to deliver a letter to his client. Upon the delivery, the
messenger has incurred a jeepney fare of P20. Since this transaction was authorized by
the manager, it is considered as legitimate transaction of the business; therefore, it can
be recorded into the books later. What kind of accounting concept or principle will be
applied to this scenario?

Abstraction HOW IMPORTANT IS ACCOUNTING IN BUSINESS?

Although business is meant for profit, it is of central importance in our economic

society today because as we all know, there are so many people who depend their
means of livelihood on employment in various business establishments. The direction
and future success of its operations depend to a great extent on the ability of the
business owners' or management to render decisions in behalf of the business.

Accounting provides business owners and management with information

essential to the efficient conduct and evaluation of its activities. It gathers data which
are of financial in character, stores these data in the books of accounts and transform
them into a more meaningful source of information concerning the financial position.
performance and cash flows from business operations as well. It is then, that financial
statements are communicated to various users which include employees, lenders,
suppliers and other trade creditors, customers, government and their agencies and
public and analyzed and interpreted through the accountants who are the only
knowledgeable expert professionals in this field where accounting justifies its
importance in the global world of business.

WHAT ARE FINANCIAL STATEMENTS?

The accounting data that were gathered and stored in the books of accounts
when transformed into reports form, these become "financial statements". Financial
statements, therefore, are the "end products" of accounting process. It provides
information about the financial position, performance and cash flows of an enterprise
which is vital in making a sound economic decision. These financial statements can
serve its purpose if prepared and communicated on time. There are six (6) basic
financial statements, namely: Statement of Financial Position or Balance Sheet,
Statement of Comprehensive Income or Income Statement, Statement Of Changes in
Equity, Statement of Cash Flows, Accounting Policies and Notes to Financial Statements
and a Statement of financial Position as at the beginning of the earliest comparative
period when an entity applies an accounting policy retrospectively or makes
retrospective restatement of items in its financial statement or when it reclassifies
items in its financial statements.

1. Statement of Financial Position or Balance Sheet — this shows the financial position
of an enterprise as of a particular or specific date. This measures and evaluates in
terms of the enterprise' liquidity, solvency, financial structure and capacity for
adaptation. Liquidity is the ability of the enterprise to meet currently maturing
obligations. Solvency is the availability of cash over the longer term to meet maturing
obligations. Financial structure is the source of financing for the assets of the
enterprise. It indicates how much is borrowed capital and how much is equity capital.
Capacity for Adaptation is the financial flexibility of the enterprise to use its available
cash for unexpected requirements and investment opportunities.

A statement of financial position or balance sheet shows the Assets, Liabilities and
Owner's Equity. This answers the following questions:

a) How much the business owns? (referring to the assets)

b) How much the business owes? (referring to the liabilities)
c) How much is the business net worth? (referring to the owner’s equity)
2. Statement of Comprehensive Income or Income Statement - this is a financial
statement which shows the performance of the enterprise for a given period of time.
The performance of the enterprise is primarily measured in the level of income earned
by the enterprise through effective and efficient utilization of its resources.

An income statement shows the Revenues, Expenses and the Operating Results which
could either be a "Profit" or "Loss". It answers the following questions:

a) Does the business make profit?

b) Does the business incur loss?

3. Statement of Changes in Equity – this is a financial statement which summarized

the changes in equity for a given period of time. The beginning equity of the owner is
increased by the additional investment and profit. Correspondingly, it is decreased by
withdrawal and loss.

4. Statement of Cash Flows - this is a financial statement which provides information

about the details of changes in cash position of the business during a given period. In
other words, this shows sources and uses of cash. In its simplest description, this the
statement of cash receipts and cash disbursements. Only these are being classified into
the following activities:

a. Operating
b. Investing
c. financing

WHAT ARE "GENERALLY ACCEPTED ACCOUNTING PRINCIPLES" (GAAP)?

These are uniform set of accounting rules, procedures, practices and standards
that are followed in prepar.ng financial statements. The general acceptance of an
accounting principle usually, depends on how well it meets the following
requirements:

1. Principle of Relevance — that the resulting information is meaningful and useful to

those who need to know something about the Status Of a certain organization.

2. Principle of Objectivity — that the resulting information is not influence by the

personal bias or judgment of those who furnish it. Objectivity connotes reliability and
trustworthiness. It further connotes verifiability, which means that there is some way
of finding out whether the information is true and correct.

3. Principle of Feasibility — that it can be implemented without undue complexity or

cost. These criteria are conflicting with one another and to resolve, the one which may
be least objective and lest feasible is favored.

The practice of accounting profession is continuously evolving and developing to

meet the changing needs of time and as time changes, new accounting principle
emerge as business organization progresses.
WHAT ARE THE UNDERLYING ACCOUNTING ASSUMPTIONS?

As we go further with our study in Accounting, we should bear in mind that the
preparation of financial statements is guided by concepts or assumptions. These
concepts or assumptions are the very foundations of the generally accepted
accounting principles governing its preparation. Although the "Framework for the
Preparation and Presentation of Financial Statements" explicitly mentions only two (2)
underlying assumptions, namely: accrual and going-concern, implicit are the basic
assumptions on accounting entity, time-period and unit-of-measure.

1. Accounting Entity Concept or Separate Entity Assumption - first and foremost, you
should understand that from the accounting point of view, the business is considered
as "an entity that is separate and distinct from the owner or management", When the
owner puts money, property or both into the business, these become "not his personal
assets anymore but rather the assets of the business already". In other words, the
ownership of the assets is shifted from the owner to the business. For this reason, a
clear distinction between business transactions and personal affairs of the owner must
be established because only business transactions are recorded in the books of the
business. This enables the owner to properly determine whether his business is
profitable or not. The other term used for this assumption is business entity
assumption in accounting.

This explains why transactions which are of personal in nature are not recorded
in the books of accounts so that financial statements will purely show the financial
condition and performance of the business.
2. Going Concern or Continuity Concept or Assumption - the business is assumed to
have a continuous life of existence. Thus, it will continue to operate for an indefinite
period of time so that financial statements are prepared in a going concern unless
there is specific evidence to its contrary where departure from and abandonment of
this assumption warrants. When a business for example suffered a tremendous or
persistent losses from its operations and has to be discontinued, this assumption is
abandoned.

This justifies the reason why fixed assets or property and equipment (except land)
are depreciated over their useful lives.

3. Time-Period Assumption — because the business has o continuous life of existence,

it is very impractical to wait for several years before its financial position, performance
and cash flows from operations can be known. Due to the duration of its existence, the
life of the business is divided into periods wherein at the end of each period financial
statements are prepared These periods are being referred to as "accounting periods".
This is the "PERIODICITY CONCEPT" in accounting.

4. Unit of Measure Assumption (Monetary Convention) - How will you imagine a

Balance Sheet and Income Statement without any common unit of measure? Hence, in
the Philippines we use the "peso" as unit of measure. As said, our accounting for
business is an accounting for peso. Thus, a peso expense is being deducted from a peso
revenue to arrive at a peso profit as shown in the Income Statement. All assets.
liabilities and owner's equity are also stated in terms of peso as shown in the Balance
Sheet.

5. Accrual Basis Assumption - this assumes that the recording of income and expense
follow the accrual basis of accounting. Under accrual basis, income is recognized when
earned regardless of when received and expense is recognized when incurred
regardless of when paid. In other words, the essence of accrual basis of accounting is
the recognition of accounts receivable, accounts payable, prepaid expenses, accrued
expenses, deferred income and accrued income. This practice results to a proper
matching of revenue and costs and expenses and could therefore show a correct and
meaningful financial statement.

In contrast, cash basis of accounting recognizes income only when actual cash is
received and recognizes expenses only when actual cash is paid. In other words, this is
a comparison of Cash Receipts and Cash Payments.

WHAT ARE THE ELEMENTS OF FINANCIAL STATEMENTS?

There are five (5) elements of financial statements. These are Assets, Liabilities,
Owner's Equity, Revenues and Expenses.

Assets, Liabilities and Owner's Equity are the components of a Balance Sheet while
Revenues and Expenses are the components of an Income Statement.

Assets - are defined as "resources controlled by the enterprise as a result of past

transactions and events and from which future economic benefit are expected to flow
the enterprise".
Liabilities - are defined as "present obligations of an enterprise arising from past
transactions or events, the settlement of which is expected to result in an outflow from
the enterprise of resources embodying economic benefits".

Owner's Equity - is defined as "the residual interest in the assets of the enterprise after
deducting al/ its liabilities. It is increased when there is profit or additional
contributions and decreased when there is loss or withdrawals by the owner."

Revenues - are defined as "the gross inflow of economic benefits during the period
arising in the course of ordinary activities of an enterprise when those inflows result in
increase in equity, other than those relating to contributions from owners".

Expenses - are defined as "the gross outflow of economic benefits during the arising
the course of ordinary activities of on enterprises when those outflow result in
decrease in equity, other than those relating to distribution to owners".

WHATIS ACCOUNTING?

The Accounting Standards Council (ASC) in its old Statement of Financial

Accounting Standards (SFAS) No. 1 defines accounting as follows:
"It is 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.”

The American Accounting Associations (AAA) which comprises primarily of accounting

educators who sponsored the Accounting Change Commission which currently is new
and innovative ways to enhance accounting education defines accounting as:

"It is the process of identifying, measuring and communicating economic information

to permit informed judgments and decisions by users of the information. "

The time-honored and widely accepted definition of accounting is the one formulated
by the Committee on Accounting Terminology of the American Institute of Certified
Public Accountants (AICPA) which is the largest organization of practicing accountants
made the definition of accounting as follows:

"It is an art of recording, classifying, summarizing in o significant manner and in terms

of money transactions, and events which ore, in part at least, of a financial character,
and interpreting the results thereof. "

PHASES OF ACCOUNTING

There are four (4) major phases of accounting which are as follows:

Recording - this is the phase of accounting which involves the routine and mechanical
process of writing down the business transactions and events on the books of accounts
in a chronological manner called Journalizing.
2. Classifying - this is the phase of accounting which involves sorting or grouping of
similar transaction or events into their respective and classes. This is actually the
process of transferring the entries from the Journal to the Ledger called Posting.

3. Summarizing — this is the phase of accounting which involves the completion of the
financial statements and the accounting requirements as well. This starts from the
striking of a trial balance, plotting of adjusting entries in the worksheet, financial
statements preparation and the preparations of closing entries, post-closing trial
balance and reversing entries.

4. Interpreting - this is the phase of accounting which involves the “analytical and
interpretative" works. It is then that when financial statements are analyzed and
interpreted that it could be of great help to management as a basis for making a sound
decision.

WHAT IS THE BASIC ACCOUNTING EQUATION?

The basic accounting equation is as follows:

Assets = Liabilities + Owner's Equity

 This means that the assets of the enterprise can be the claim of both creditors
and the owner. If there are no creditors, the owner has the sole rights of these assets.
Because the creditors' claims are paid before the Ownership claims if the business is
liquidated, liabilities are shown first before the owner's equity.

STEPS OF THE ACCOUNTING PROCESS

Journalizing (1" Step) - is the first step of the accounting process. This pertains to the
recording of transactions and events in the Journal after Identifying the business
documents supporting the transactions which give assurance for the reliability and
verifiability of accounting records such receiving reports, delivery receipts, check
vouchers, etc.

Posting (2nd Step) - the entries in the journal are transferred to the book of final entry
called "Ledger". The process of transferring entries from the Journal to the Ledger is
called POSTING which is the second step of the accounting cycle.

Trial Balance (3rd Step) - After footing the accounts in the General Ledger, a list of
accounts with open balances are prepared. When this summary of account balances is
shown in a report form, this becomes a "Trial Balance". A trial balance is defined as "a
statement listing the debit and credit balances of accounts in the general ledger
remaining open at the end of the accounting period". This is being referred to as "Trial
Balance of Balances”. The other form of a Trial Balance is the "Trial Balance of Totals".

ADJUSTING ENTRIES (4th STEP) - the preparation of Adjusting Entries is the fourth Step
of the accounting cycle. Adjusting entries are journal entries which are to be recorded
the General Journal. The primary purpose of an adjusting entry is to update the
balances of some accounts and to split a mixed account into its real and nominal
components. Errors and omissions are likewise corrected and recorded in the book of
the business. The adjustments are made to conform with one of the governing
principles of accounting which requires the proper matching of revenues and
expenses. his is the "Matching Principle”.

Adjustments are grouped into: ACCRUALS, DEFERRALS (Prepayment and Pre-

collection), PROVISION FOR ESTIMATED UNCOLLECTIBLE ACCOUNTS, PROVISION FOR
DEPRECIATION and INVENTORY VALUATION AND ESTIMATION and ACCRUED INTEREST
ON NOTES.
ACCRUALS
(Accrued Expense and Accrued Income)

Accrued Expense — is an expense that is already incurred but not yet paid when the
accounting period ends. The purpose of the adjusting entry is to record the expense
incurred and recognize the corresponding liability (payable) account while Accrued
income is an income that is already earned but not yet collected when the accounting
period ends. The purpose of the adjusting entry is to record the income earned and
recognize the corresponding asset account (receivable).
 DEFERRALS
PREPAYMENT OF EXPENSES AND PRE-COLLECTED INCOME ADJUSTMENTS

PREPAYMENT OF EXPENSES

a) Prepaid Expense – this is an expense that is already paid but not yet incurred. This is
the opposite of Accrued Expense. There are two methods of recording prepayment.
These are the “Expense method” and the “Asset Method”. Regardless of which
method is used, the amount of prepayment will become a “mixed account” at the end
of the period. Thus, an adjusting entry is necessary to split the Asset and Expense
accounts which are the components of this mixed account.

PRECOLLECTION OF INCOME

b) Pre-collected Income - this is an income already collected but not yet earned when
the period ends. This is the opposite of Accrued Income. There are two methods of
recording pre-collected income. These are the "Income Method" and "Liability
Method", Regardless of which method is used, the amount collected in advance will
become a mixed account at the end of the period. Thus, an adjusting entry is necessary
to split the Income and Liability accounts which are the components of a mixed
account.

PROVISION FOR UNCOLLECTIBLE ACCOUNTS

The anticipated loss that the business may incur arising from doubtful account is
known as doubtful account expense or uncollectible account expense. There are two
methods of recognizing uncollectible accounts depending upon the intention of the
preparer of the financial statements whether such statement is for general purpose or
income tax reporting which is to be submitted to the Bureau of Internal Revenue. If it is
for general purpose reporting, the allowance method shall be used but if it is for
income tax purposes, we use the direct write-off method.

1. Allowance Method — recognized uncollectible account expense based on estimates

even though not being collectible has not been ascertained yet by passing through the
valuation account known as "Allowance for Uncollectible Accounts", "Estimated
Uncollectible Accounts" or "Allowance for Doubtful Accounts" which is a reduction
from Accounts Receivable account. The estimate is usually done based the company's
past experiences of not being able to collect the accounts.

2. Direct Write-Off Method — recognized uncollectible account expense when

uncertainty of collecting the account has already been ascertained or when the
account is ascertained to be "worthless". The entry is made by directly charging to
Uncollectible Account Expense without passing through the required Allowance for
Doubtful
Accounts.

PROVISION FOR DEPRECIATION

Property, Plant and Equipment - Fixed Assets or Property, Plant and Equipment help in
generating more revenues. The expense that will be matched for these revenues is the
expired cost of the fixed assets which is called "Depreciation". All fixed assets except
land are depreciable assets. Land is not subject to depreciation because it is expected
to be useful for an indefinite period of time.

There are two kinds of depreciation; Physical Depreciation and Functional or

Economic Depreciation.

Physical Depreciation — results to the ultimate retirement of the property or

termination or the service of the asset because of wear and tear due to frequent use,
passage of time due to non-use, action of the elements, such as wind, sunshine, rain or
dust and others.

Functional or Economic Depreciation — arises from obsolescence or inadequacy of

the assets to perform efficiently. The asset is said to be obsolete when there are
already new models or inventions and that the business desires to replace the old
asset that can no longer produce the desired production result due to growth in
business. For example, the production capacity of the machine is only 50,000 units
whereas the sales volume requirements is 100,000 units.

One of the common methods of computing depreciation is the "Straight-line Method"

which follows the basic formula:

(Cost of Fixed Asset – Scrap Value) / Annual Depreciation = Estimated Life in Years

WORKSHEET (5th STEP) - The preparation of a worksheet is the 5th step of the
accounting cycle. A worksheet is a working paper that facilitates the preparation of
financial statements which is actually "optional". When we say optional, we mean "it
may or it may not be prepared". The adjusting entries are plotted in this working paper
before formal recording is done in the General Journal. The results of business
operations can already be determined through the worksheet without preparing a
formal Income Statement. Same holds true for its financial condition.

FINANCIAL STATEMENTS (6TH STEP) - The preparation of financial statements is the

6th step of the accounting cycle. Through the worksheet financial statements can
easily be prepared. The Statement of Comprehensive Income is prepared by using all
the data found in the Income Statement section of the worksheet and Statement of
Financial Position is prepared by using the data found in the Balance Sheet section of
the Worksheet.

CLOSING ENTRIES (7TH STEP) - The preparation of Closing Entries is the 7th step of the
accounting cycle. This is done at the end of the accounting period of usually one year
compliance with an accounting requirement of closing the books of accounts. All
nominal accounts found in the Income Statement section are closed by debiting the
accounts with credit balances and crediting the accounts with debit balances to
temporary account called “Income g Expense Summary". The Income & Expense
Summary balance will then be closed to equity and finally to drawing account.
 POSTING TRIAL BALANCE (8TH STEP) - After recording the closing entries in the
General Journal, these are posted to the General Ledger. The general ledger is then
ruled. In ruling the ledger, the nominal accounts are ruled while the real accounts are
balanced. A list is then prepared showing all real or balance sheet accounts with open
balances to prove the equality of both debit and credit amounts remaining open after
closing all the nominal accounts. Thus, this report is called "Post-closing Trial Balance".

REVERSING ENTRIES (9TH STEP) - Reversing Entries are journal entries that are prepare
at the beginning of the next accounting period. It usually occurs at the beginning of the
second up to the rest of the accounting periods but never at the beginning of the first
accounting period in the life of the business. This is because what are to be reversed
are the adjusting entries. However, not all adjusting entries are reversed.

Aplication Journalize the following selected transactions of ABBA Services for the month of
February 2020.

Feb. 1 ABBA made an additional investment of P150,000 cash.

Feb. 4 Rendered services on account to Edna, customer, amounting to P65,000; terms

of 10% down and the balance at the end of the month.

Feb. 6 Paid the rental for the month – P5,000.

Feb 10 Purchased office supplies from National Bookstore with cash amounting to
P1,500.

Feb. 15 Paid the salary of employees – P15,000

Lesson 2 Accounting for Corporation

Learning At the end of the week, students should be able to:
Outcomes
-Define and understand the concept and characteristics of Corporation.

-Distinguish Corporation from Partnership and Sole Proprietorship.

- Attain basic knowledge and understanding on its nature and the legal requirements
set by Securities and Exchange Commission with regards to its formation and existence
as embodied in the Corporation Code of the Philippines.

-Understand the classification of shares

-Know the methods in recording share capital transactions and the necessary journal
entry.
 -Understand the accounting for no par value shares.

Introduction In our study with sole proprietorship, we assumed that the business is regarded
as an entity that is separate and distinct from the owner(s). in a corporate form of
business organization, this assumption turns into a reality because a corporation is an
artificial person. It has a legal personality and as such, it can transact business under its
own name, can hold and dispose property, can sue and can be sued to court.
Activity 1. Distinguish a corporation from a partnership and corporation in terms of the
following:
a) owner’s equity
b) transferability
c) continuity of existence
Analysis 1. When can a share certificate be issued to subscriber?
2. Differentiate artificial from natural person.
3. Differentiate the following:
a) stock corporation from a non-stock corporation
b) par value share from no par value share
Abstraction DEFINITION OF A CORPORATION

Corporation is defined as:

"An artificial being created by operation of law, having the right of Succession and the
powers, attributes and properties expressly authorized by low or incident to its
existence".

CHARACTERISTICS OF A CORPORATION

1) SEPARATE LEGAL ENTITY - this means that a corporation as an "artificial person”

has a legal personality, separate and distinct from its shareholders. As such, under its
own corporate name, it may take, hold, or dispose property under its corporate
capacity. It may enter into contract, can sue and can be sued to court. As creation of
law, it cannot be established by a mere agreement of parties like in the case of
partnership. For them, to come into existence, authority has to be granted by the
state.

2) TRANFERABLE UNIT OF OWNERSHIP - the ownership of a corporation is divided into

units called "shares" which can be transferred from one person to another without the
consent of other shareholders.

3) LIMITED LIABILITY OF SHAREHOLDERS - this means that the shareholders are liable
only of the corporation's debts on the extent of their capital contributions. The
creditors of the corporation cannot run after the personal properties of the
shareholders in satisfaction of their claims.

4) CONTINUITY OF EXISTENCE - this means that a corporation has the capacity for
continued existence because it has the right of succession as evidence by the
transferability of its shares. Initially, the life of a corporation may not exceed fifty (50)
years, but the Articles of Incorporation may be subsequently amended to not more
than fifty (50) additional years at a time. This explains why there are corporations that
exist more than one hundred (100) years.

5) GOVERNING BODY - because there will be hundreds if not thousands of

shareholders, it will be difficult for each one of them to partake in managing the
business. Thus, they elect among themselves to form a governing body called "Board
of Directors" who will formulate the policies of the corporation. The corporation law
provides that the number of Board of directors be not less than five but not more than
fifteen.

DISTINCTIONS BETWEEN PARTNERSHIP AND CORPORATION

Partnership Corporation
1. Created by mere agreement of parties. 1. Created by operation of Law,

2.Requires at least (2) two persons to 2. Requires at least (5) five

incorporators form a partnership to form a
corporation.

3. Begins to acquire juridical personality 3. Begins to have a corporate existence

from the moment the partners have and juridical personality at the time
the executed the contract. certificate of incorporation is issued
by c
SEC.

4. May exercise any power authorized by 4. Can exercise only the powers
expressly the partners provided it is not contrary authorized by law or incident
to its to law, morals and public order. existence.

5. Creditors can run after the personal 5. Creditors cannot run after the
personal assets of a general partner (except assets of a shareholder in
Case of limited partner) in case of liquidation. liquidation.

6. An interest of a partner cannot be trans- 6. A share can be transferred without

ferred without the consent of other the consent of other shareholders.
partners.

7. It may be dissolved at any time by the7. It can only be dissolved with the
will of any or-all of the partners. consent of the state.

ADVANTAGES OF A CORPORATION

1. Greater source of capital because there can be as many shareholders as there are
authorized shares to be issued.

2. Shareholders are not liable to corporate obligations in excess of their contribution.

This is however, a disadvantage on the part of the creditors
.
3. Death of any of the shareholders will not dissolve the corporation because of the
transferability of shores.

4. The created governing body is composed of "top calibered" shareholders who direct
the corporate affairs. More success can be attained.

DISADVANTAGES OF A CORPORATION

1. It is not easy to organize because of complicated legal requirements.

2. A limited credit line may be extended by creditors to a corporation because
creditors cannot run after the personal assets of the shareholders in case a corporation
cannot pay its obligation.
3. Since management of a corporation is vested on Board of Directors who may
happen to be the majority shareholders, abuse of powers is possible.
4. Subject to strict governmental control.

CLASSIFICATION OF CORPORATION
1. AS TO PURPOSE

a) Public Corporation - is one that is formed or organized to govern a portion of the

state. Examples are barangays, municipalities, cities and provinces.
b) Private Corporation - is one that is formed for some private purpose, benefit, aim or
end.
c) Quasi-public Corporation - is a private corporation which is given a franchise to
perform public duties but is organized for profits like bus and airlines, light and power,
telephone companies, etc.

2. AS TO LAW OF CREATION

a) Domestic Corporation - is one that is organized under the Philippine laws,

b) Foreign Corporation - is one that is organized under any law other than the
Philippines.

3. AS TO MEMBERSHIP HOLDINGS

a) Stock Corporation - is a private corporation organized for profit. Its capital is divided
into share of stock and is authorized to distribute corporate profits on the basis of
shares held.
b) Non-Stock Corporation - is a private corporation organized "not for profit". If by
incident it generates profits, such profit should be spent to continue attaining the
objectives of its creation. Examples are civic, religious, social, charitable institution, etc.

4. AS TO ADMISSION OF SHAREHOLDERS

a) Open Corporation - is one in which any person is welcomed to become a

shareholder,
b) Closely-Held Corporation - is one in which ownership is limited to selected persons
or members of the family. Any corporation may be incorporated as close corporation,
except mining or oil companies, stock exchanges, banks, insurance companies, public
utilities, educational institutions and corporations declared to be vested with public
interest.

5. ASTO OTHER PURPOSE

a) Ecclesiastical Corporation - is one which is organized for religious purposes.

b) Lay Corporation - is one which is organized for a purpose other than religious
purposes.

COMPONENTS OF A CORPORATION

1. CORPORATORS - are those who composed the corporation whether as shareholders

or members. Hence, corporators include incorporators, shareholders or members
(Shareholders to a stock corporation and members to a non-stock corporation).

2. INCORPORATORS - are those who originally formed the corporation who executed
and signed the Articles of Incorporation. They must be natural persons as distinguished
from artificial persons.

3. SHAREHOLDERS - are owners of stock in a corporation. Shareholders may be natural

persons or artificial persons. A corporation being an artificial person is allowed by law
to acquire shares of another corporation.

4. MEMBERS- they are corporators of a non-stock corporation.

5. PROMOTERS - they are the one who undertake to form a group of persons
interested in organizing a corporation. They procure subscriptions or capital for the
corporation.

6. BOARD OF DIRECTORS - a governing body formed out of the shareholders. This acts
as the policy-making body of the corporation. This is composed of not less than five (5)
but not more than eleven (11) shareholders or members duly elected from among
themselves. This is headed by the Chairman of the Board who is considered to be the
most powerful and influential person in the corporation.

7. SUBSCRIBERS - they are natural or artificial persons who have agreed to buy original
and unissued stocks of the corporation. Upon full payment of its subscription, share
certificates are issued to them. Thus, they become shareholders.

WHO MAY FORM A CORPORATION?

Only natural persons (not artificial) of not less than five (5) but not more than fifteen
(IS), all of legal age and majority of whom are residents Of the Philippines may form a
private corporation for any lawful purpose or purposes. Each Of the incorporators of
stock corporations must own or be subscribers to at least one (1) share capital of the
corporation.
HOW TO FORM A CORPORATION?

The formation of a corporation usually constitutes three (3) basics stages.

Organization Stage - this is the stage where persons who do the preliminary
arrangements made by the incorporators will come in. They will set-up a tentative
working organization and procure subscriptions and capital for the corporation. These
persons are referred to as "Promoters".

Incorporation Stage - the Corporation Code of the Philippines provides that the
Securities and Exchange Commission (SEC) shall not accept registration of Articles of
Incorporation of any share corporation unless notarized and accompanied by affidavit
executed by the Corporate Treasurer that at least twenty-five (25%) percent of the
authorized share capital has been subscribed and at least twenty-five (25%) percent of
the total subscription has been fully paid in actual cash and/or property, the fair
valuation of which is equal to at least twenty-five (25%) percent of said subscription. In
no case, shall the paid up by capital be less than Five thousand Pesos (P5,OOO). This is
the pre-incorporation requirement.

When the twenty-five (25%) percent of the subscription payment is made in cash, an
additional requirement by Securities and Exchange Commission on bank certificate t
attest that deposit has been made through that bank in favor of said corporation.

The minimum requirement of subscription and payment is determined and calculated

as follows:

Assume: Aggregated value of the corporation's authorized share capital of P1,000,000

at par value of P100.

C A L C U L A TI O N S:
Equivalent in Shares
Authorized Share Capital P1,000,000 10,000 shares
x Subscription Requirement 25% 25%
Subscribed Share Capital P250,000 P2,500 shares
x Paid-up Requirement 25% 25%
Paid-in-capital P62,500 625 shares

Once the pre-incorporation requirements are already complied with and after paying
the required incorporation fees, the Securities and Exchange Commission will now
approve the Articles of Incorporation and issue the "Certificate of Incorporation". This
is the birth of a Corporation. On this date, the corporation acquires its own juridical
personality.

Commencement Stage - during its first organizational meeting, the shareholders

formulate and adopt the by-laws of the corporation. Said by-laws shall be filed with the
Securities and Exchange Commission within one (1) month after the Certificate of
Incorporation has been issued. Shareholders then elect among themselves their Board
of Directors. The election of corporate officers such as President, Treasurer, Secretary
and other officers is entrusted to the Board of Directors as may be provided for in the
by-laws. The corporate officers will actually manage or run the affairs of the
corporation under the supervision of the Board of Directors or Board of Trustees. The
corporation should start with its regular business activities within two (2) years from
the date of the incorporation. If it does not, its corporate powers cease and the
corporation shall be deemed dissolved. However, if the corporation has started
operating already but subsequently it failed to operate for the period of least 5 years,
it could also be a valid ground for suspension or revocation of its Certificate of
Incorporation.

ARTICLES OF INCORPORATION

As provided for by Section 14 Of the Corporation Code, the Articles of Incorporation

must contain the name of the corporation, specific purpose or purposes for which the
corporation is formed, location or principal place of business, term of which a
Corporation is to exist, names, nationalities and residences of incorporators and
directors, authorized share capital with number of shares into which it is divided and
par value, etc.

BY-LAWS

By-laws refer to the "rules and regulations adopted by the corporation administering
its internal government". By-laws as provide for by section 47 of the Corporation Code
includes among others the following:

1. Time, place and manner of calling and conducting regular and special meetings of
directors or trustees and of shareholders and members
2. The manner of voting and use of proxies
3. The manner of electing the Board of Directors
4. Qualifications, duties and compensation of directors or trustees, officers and
employees
5. Procedure of amending Articles of Incorporation and By Laws, etc.

CORPORATE NAME

The Securities and Exchange Commission has adopted some guidelines to safeguard
public interest and to avoid conflict as to the corporate names as follows:

1.The proposed corporate name should not be identical with or similar to one already
registered with SEC.

2. The name of the corporation must have at its suffix the word "INC." Or
"Incorporated" unless it includes the word "corporation" as port of its corporate name.

3. If o proposed company is 0 subsidiary of a foreign corporation, the word (PHIL.) or

(PHILIPPINES) in parenthesis should be affixed to the corporate name; the written
consent of the mother company should likewise be obtained.

4. No corporation or partnership should be allowed to use the word "Maharlika" or

"Barangay" as part of its business name, the same is being reserved for the
government.

CORPORATE RECORDS

A corporation used and kept the same books of accounts as other form of business
organizations are using. These are General Journals, Cash Receipts Book, Cash
Disbursements Book, Sales Book, Purchase Book, General and Subsidiary Ledgers. In
addition to the above-mentioned, a corporation keeps the following records:

1. Minutes Book - the minutes of all meetings of shareholders or members and that of
Board of Directors or Board of Trustees are recorded by the Corporate Secretary in this
book. Some recorded events in this book are the sources of entries in the accounting
records such as declaration of dividends, purchase and sale of treasury shares, etc.

2. Stock and Transfer Book - this book principally records the stock issuances and
cancellations. It consists three (3) books, viz:

a) Subscriber's Ledger - this is actually a subsidiary ledger for the controlling account,
subscription Receivable in the General Ledger.

b) Shareholder's Journal - this shows the list of shareholders with the corresponding
share certificate number in numerical sequence and shares issued to them including
share certificates that were cancelled.

c) Shareholder's Ledger - this is a subsidiary ledger for Share Capital account in the
General Ledger. The total number of shares indicated in the shareholder's Journal and
the Share Capital account in the General Ledger.

ORGANIZATION COSTS

Organization Cost are expenditures incurred while in the process of organizing a

corporation. These include expenses during promoter's meeting with other
prospective incorporators, attorney's fees, filing and publication fee, cost of printing
stock certificate, stock and transfer book, corporate seal, accounting and legal fees
related to stock issuances before the start of corporate operations. Under Philippine
Accounting standards (PAS) No. 38, Intangible Assets, organization costs or pre-
operating costs are charged to expense in the period incurred.

RIGHTS OF SHAREHOLDERS

The owners of share in a corporation are called "'Shareholders". Shareholders have

four
(4) basic rights namely:
1. To vote and attend annual shareholder's meeting

2. To share in distribution of corporate profit (dividends out of earnings).

3. To share in distribution of assets upon corporate liquidation (liquidating dividends).

4. TO purchase additional shares in the event the corporation issues additional share
capital. This is to maintain the percentage ownership of the shareholders. The right of
a shareholder to be given priority to acquire additional shores is called "Preemptive
Right".

SHARE (STOCK) CERTIFICATE

Ownership in a stock corporation is represented by its share capital which is divided

into units called "shares". A shareholder’s ownership in the corporation is determined
by the number of shares he owns. So as, if an individual shareholder owns 200 shares
of the corporation's 1,000 shares outstanding, he has a 1/5 interest in that
corporation. His Ownership is evidenced by a document called "Share (Stock)
Certificate". This Certificate can only be issued to the individual shareholders who have
fully paid his subscription.

This certificate is signed by the president or Vice-President Of the corporation, counter

Signed by the Secretary and sealed with the seal of the corporation.
LEGAL CAPITAL OF A CORPORATION

Legal capital of a corporation is that portion of the paid-in capital arising from issuance
of share capital which must remain untouched and unimpaired in protection to
corporate creditors and cannot be returned to shareholders in any form during the
lifetime of the corporation, except when a liquidation happens and only after the debts
have been paid. In case of a par value shares, legal capital is the aggregate par value
shares of all issued and subscribed shares. In case of a no-par value share, it is the
total consideration received by its corporation for the issuance or its share to the
shareholders including the excess of issue price over the stated value.

TRUST FUND DOCTRINE

The "trust fund doctrine" is a legal principle that prohibits a private corporation to
distribute its legal capital to the shareholders for the protection of corporate creditors
during the lifetime of a corporation. However, a corporation can declare and pay
dividends to the shareholders out of its "free" or "unappropriated accumulated profits
(losses)".

SHAREHOLDER’S EQUITY

Shareholder’s Equity is defined as “residual interest of the owners in the assets of the
corporation as a business entity, measured by the excess of assets over liabilities”. In its
simplest language, it refers to the capital section of a corporation, thus, follows the
modified basic accounting equation as:
 Shareholder’s Equity = Total Assets Minus Total Liabilities

If you recall, there are three (3) sections that comprises the Statement of Financial
Position under corporate form of business organization. They are: Assets, Liabilities
and Shareholder’s Equity.

COMPONENTS OF SHAREHOLDERS' EQUITY

The following are the components of the shareholder’s Equity.

1. Share Capital
2. Subscribed Share Capital
3. Share Premium or Additional Paid-in
4. Revaluation Surplus or Reserve
5. Accumulated Profits or Losses or Retained Earnings
6. Treasury Shares

Term "Share Capital" has so many connotations. They are as follows:

Authorized Share Capital - refers to the maximum amount fixed by the corporate
charter or articles of incorporation to be subscribed and paid in by the shareholders,
either in money or property, labor or services at the organization of a corporation or
afterwards upon which it is to conduct its operation. The equivalent numbers of shares
of the authorized share capital are called "Authorized Shares". A corporation may
increase its authorized shares by amending the articles of incorporation.

Subscribed Share Capital - this represents the amount of shares which have been
subscribed but not yet fully paid. The equivalent numbers of shares are called
"Subscribed Shares".

Issued Share Capital - this represents the amount of shares which have been fully paid
and the share (stock) certificates have been issued. The equivalent numbers of shares
called "Issued Shares". Remember, share (stock) certificates cannot be issued unless
subscribed shares are paid in full.

Unissued Share Capital - this represents that part of a corporation authorized share
capital for which share (stock) certificates have not yet been issued but are available
for issuances in the future. The equivalent numbers of shares are called "Unissued
Shares”.

Treasury Share - this represents a corporation's own share which has been issued but
later reacquired not for the purpose of cancellation or retirement. This share is issued
but not outstanding. The equivalent numbers of shares are called "Treasury Shares”.

Outstanding Share Capital - this refers to the Issued Share Capital and still on the
hands of the shareholders. The equivalent shares are called "Outstanding Shares".
Issued share may not be the same shares outstanding when there are treasury shares.
Treasury shares are deducted from the Issued shares to arrive at the Outstanding
Shares. If there are no Treasury shares, however, the shares issued is equal to the
shares outstanding.

Based on the Current Philippine Accounting Standards (PAS) No. 1. Shareholder's

equity is composed or three (3) sub-sections. These are, namely: Share Capital,
Reserve and Accumulated Profits (Losses).

1. Contributed Capital — this is the first sub-section of shareholders' equity consist the
following elements.

a. Share Capital - this refers to the portion of the paid-in capital representing the
amount of the total par or stated value of the shares issued.

b. Subscribed Share Capital - this refers to the portion of the share capital that a
prospective investor agreed to subscribe but not yet paid-in full and therefore, still
unissued. Subscribed share capital is to be deducted by the subscription receivable
before the difference is added to share capital.

c. Subscription Receivable - this refers to the unpaid portion of the share capital that
the prospective investor has agreed to subscribe.

2.Reserve - this is the second sub-section of shareholders' equity. This is one of the
most recent development in the presentation of shareholders' equity. This consisted of
the following.
a. Share Premium Reserve - it is otherwise known as "additional paid in capital"
representing the paid in capital in excess of the par value or stated value, excess of the
sales proceeds of treasury stock over cost donated capital and other premiums in
relation to the retirement of shares.

b. Revaluation Reserve - also called "Revaluation Increment in Property" or "Asset

Revaluation Reserve". This is the excess of value of plant assets as a result of appraisal
over net book value. This topic is discussed thoroughly in Financial Accounting under
Revaluation and Impairment of Assets.

c. Accumulated Profits (Losses) Reserve - it is the portion of the Accumulated Profits

and Losses that is appropriated for plant expansion, purchase of Treasury Shares, etc.
Unless reverted back to unappropriated accumulated profits and losses where it can
be available for dividend declaration.

3. Accumulated Profits (Losses) — previously known as Retained Earnings, this

account represents the cumulative income and expense from the start it operates up
to the present. This account has been increased or decreased due to results of periodic
income or loss, prior period adjustments known as fundamental errors, dividend
distribution, changes in accounting policies, etc. This refers to the undistributed
balance of accumulated profits and losses (Unrestricted, unappropriated or free) or a
portion of Accumulated Profits and Losses that can be declared as dividends.
 The Accumulated Profits (Losses) are computed as follows:

Accumulated Profits (Losses), Beginning

Add (Deduct): Prior Periods Adjustments:
Fundamental Errors
Effect of Change in Accounting Policy
Equals:
Accumulated Profits (Losses) as Restated
Add (Deduct): Profit (Loss) for the period Total
Less: Dividends Declared
Equals:
Accumulated Profits (Losses), Ending

The Cost of the Treasury Shares that has been deducted from Accumulated Profits and
Losses to arrive at the Shareholders' Equity has first appeared in the reserve section
under the account "Appropriated Accumulated Profits (Losses) for Treasury Shares".

Application True or False

1. A corporation is not real or natural person but the law assume it as a person, so that
it can perform practically business functions.
2. A corporation is formed by at least five (5) but not more than fifteen (15) members.
3. A corporation is like an artificial being. It can transact business under its own name,
hold or disposed property but it can never be sued to court.
4. A corporation can be formed by mere agreement among shareholders.
5. Authority of the corporation to operate has to be granted by the state.
6. Shareholders are not liable to corporate obligations in excess of their legal capital.
7. Share cannot be transferred without the consent of the other shareholders.
8. If a corporation failed to operate within 2 years from the date of incorporation, its
corporate powers ceased and the corporation is deemed dissolved.
9. A corporation acquires its own juridical personality by the time SEC issues the
Certificate of Incorporation.
10. Death of a shareholder will dissolve the corporation.

Lesson 3 Accounting for Dividends, Earning & Book Value per Share
Learning At the end of the week, students should be able to:
Outcomes
-Compute the share capital of Stockholders

-Compute the earnings per share and book value per share

-Understand the nature and rules of declaring dividends

-Obtain adequate knowledge on Dividends Distribution; its computation and entries

necessary as well.
 - Understand the concept of cash dividends when there are two classes of shares.
Time Frame
Introduction A corporation may be a "Stock" or "Non-Stock". This textbook deals Only On "Stock
Corporation". A stock corporation is a private corporation organized for profit. Its legal
capital is divided into units called "shares”, the total of this capital is known as "Share
Capital". It may issue one or two classes of shares. These are "preference" and
"ordinary" shares. When there is only one class of stock issued, it is understood to be
ordinary shares. Ordinary shares are "With Par Value" or "No Par Value" shares. NO
Par Value shares may be "With Stated Value" or "No Stated Value". Preference Shares
will always have a stated par value as required by law.
Activity 1. Distinguish the two methods of accounting for share capital.
2. Give the proforma entries to record each of the four (4) basic corporate transactions
under the memo entry and journal entry methods as in AUTHORIZATION,
SUBSCRIPTION, COLLECTION and ISSUANCE OF CERTIFICATE.
Analysis Choose the letter of the correct answer.

1. Share certificate are issued to subscriber upon-

a. full payment subscription c. authorization
b. date of subscription d. partial payment of subscription

2. The Share Premium Account is recorded as a credit when-

a. shares are sold higher than par value c. shares are sold at par value
b. shares are sold less than par value d. none of these

3. If Share capital is issued for tangible or intangible property, the value of share capital
is equal to the following value in order of priority:
a. fair market value of the property received c. par value of the share capital issued
b. fair market value of the capital issued d. all of the above priority

4. Organization cost when incurred during the organizational stage shall be charged to-
a. Organization Expense c. Accumulated profit (loss)
b. Corporate Income d. all of the above

5. Under journal entry method, the issuance of share capital should be credited to-
a. unissued share capital c. authorized capital
b. share capital d. subscribed share capital

6. When shares are subscribed in an installment basis, the credit to Share Premium
Account is recorded at-
a. the time of issuance c. the time of subscription
b. the time of payment d. the time of authorization

7. When shares are subscribed at par value, the debit to Subscription Receivable
should be at-
a. subscription price c. fair market value
b. par value d. all of the above.
 8. Under memo entry and journal entry methods of recording share capital
transactions, both differ in the recording of:
a. authorization and issuance of certificate c. collection and subscription
b. subscription and issuance of certificate d. authorization and subscription

9. The share is considered “watered share” when-

a. assets are overvalued c. assets are not affected
b. assets are understated d. none of these

10. The cost of organizing a corporation should be-

a. reported as intangible asset c. expense in the year of organization
b. reported as tangible asset d. deduction from share capital.
Abstraction SHARE CAPITAL

Share Capital, previously known as "Capital Stock" refers to the maximum amount
fixed by the corporate charter or articles of incorporation to be subscribed and paid-in
by the shareholders, either in money or property, labor or services at the organization
of the corporation.

CLASSES OF SHARE CAPITAL

A corporation may issue two (2) classes of share capital, namely, Ordinary and
Preference Shares.

ORDINARY SHARE

When a corporation issued a single class of share, it is understood to be ordinary or

common shares. These are called ordinary (common) shares because shareholders
have the same rights and privileges and enjoy no preference over one another in terms
of distribution of profits (dividends out of earnings) and distribution of assets
(liquidating dividends). Ordinary shareholders are assured of equal pro-rata
distribution of dividends.

Although it is considered risky shareholding, in the event that corporation succeeded'

greater earnings await for the ordinary shareholders.

PREFERENCE SHARE

To attract more investors, a corporation may issue another class of share which is
preference share. Preference shareholders are given certain privilege or specific right
that the ordinary shareholders do not enjoy such as preference on dividends.

Preference on dividends does not mean a guarantee or an assurance to receive

dividends but they are given preference over ordinary shareholders when there are
dividends declared by the Board of Directors.

The preferred shareholders are given priority over the ordinary shareholders on the
following:
a) Dividend Preference - This refers to "dividends out of earnings" or "corporations’
profit". Preference shareholders are given priority to receive dividends over ordinary
shareholders based on dividends equal to a certain percent as specified in the
description of preference share. For example, 6% preference on dividends.

b) Liquidation Preference — This refers to "liquidating dividends" whereby the

preferred shareholders are given priority over the ordinary shareholders on net assets
for distribution in case of corporate liquidation.

PAR VALUE AND NO-PAR VALUE SHARES

Share Capital may also be classified into "par value share" and "no par value share". A
"par value share" has a nominal value stated on the face of the share certificate and
fixed in the Articles of Incorporation.

Section 65 of the Corporation Code Of the Philippines prohibits the issuance of a share
less than its par value. When the share is issued for cash at less than par value or
stated value, the share is issued at a discount. The discount is not considered a loss to
the issuing corporation but the shareholder is held liable. When this happens, the
issuance of the share is not cancelled but the shareholder must pay the discount. This
is what we call a "discount liability' of a shareholder.

A "no par value share" has no par or nominal value printed on the Share Certificate or
Stated in the Articles of Incorporation. It may be sold at any of the following amounts:

a) At the amount prescribed in the Articles of Incorporation

b) At the amount fixed by the Board of Directors pursuant to authority conferred in the
Articles of Incorporation
c) At the amount approved by a majority of shareholders entitled to vote at a meeting
called for the purpose.

AUTHORIZED SHARE CAPITAL

Being synonymous to Share Capital, Authorized Share Capital is the maximum number
of shares that ordinary and preference share may issue. These shares are referred to as
"Authorized Shares". When the authorized share is being multiplied by stated value of
the share, it is called "Authorized Share Capital". As mentioned earlier, the Authorized
Share Capital may be increased by amending the Articles of Incorporation.

MEMORANDUM ENTRY AND JOURNAL ENTRY METHODS

There are two (2) methods in accounting for a Share Capital. These are the-

a) Memorandum Entry Method

b) Journal Entry Method

(If the problem is silent of what method will be used, it's the memorandum entry
method).
There are also four (4) basic transactions involved wherein both methods can be
clearly distinguished from each other as far as the recording of these transactions are
concerned. These are:
1) Authorization as to number of shares with par value
2) Subscription to Share Capital
3) Collection of Subscription Receivable
4) Issuance of share (stock) certificate

Comprehensive illustration:

On January 1, 20A, Archers Corporation is authorized to issue 5,000 Shares of 8%

Preference Shares at a par value of PIOO per share and 20,000 shares of Ordinary
Shares at a par value of P50.OO per share.

The following were the incorporators (original shareholders who executed the Articles
of Incorporation) who have made the 25% subscriptions and 25% paid-up
requirements:

25% Subscription 25% Paid-up Requirement

Preference Ordinary Preference Ordinary
Edgar Detoya P25,000 P50,000 P 6,250 P12,500
Aristotle Go 25,000 50,000 6,250 12,500
Marilou Espocia 25,000 50,000 6,250 12,500
Robinson Berhay 25,000 50,000 6,250 12,500
Claro Ventic 25 000 50 000 6 250 12 500
Total P125,000 P250,000 P31,250 P62,500

Note: Authorized share capital for Preference Share is P500,000 (5,000 x P100) and
P1,000,000 for Ordinary Shares (20,000 x P50)

AUTHORIZATION OF SHARE CAPITAL

Upon the corporate formation the corporation records the classes and number of
shares that Securities and Exchange Commission (SEC) has approved to issue as stated
in the Articles of Incorporation.

MEMORANDUM ENTRY METHOD

Notations are made and written across the top of the Share Capital ledger as follows:

Preference Share Capital

Jan 1. Authorized to issue 5,000 shares at par value of P100.

Ordinary Share Capital

Jan 1. Authorized to issue 20,000 shares at par value of P50.
JOURNAL ENTRY METHOD

Jan 1.
Unissued Share Capital (Preference) P500,000
Unissued Share Capital (Ordinary) P1,000,000
Authorized Share Capital (Preference) P500,000
Authorized Share Capital (Ordinary) P1,000,000
To record authorization of 5,000 preference at par value
of P100 and 20,000 shares at par value of P50 per share.

SUBSCRIPTION OF SHARES

Usually, shares are subscribed in an installment basis and seldom paid in cash for the
whole share. Subscription contract is a binding agreement whereby an investor agrees
to acquire certain number of Unissued Shares which may be paid in full or in
installment basis. As a common practice, corporation complies only the subscription
and paid-up requirement so it can operate immediately.

Both the memorandum and journal entry methods record the same as follows:

Subscription Receivable-Preference P125,000

Subscription Receivable-Ordinary 250,000
Subscribed Share Capital-Preference P125,000
Subscribed Share Capital-ordinary 250,000
To record the 25% subscription of the incorporators.

COLLECTION OF SUBSCRIPTION RECEIVABLE

Collection of the 25% pre-incorporation requirement will reduce the Subscription

Receivable account that was previously set-up when subscription entry was recorded.

Both memorandum and journal entry methods record the same:

Cash P 93,750
Subscription Receivable- Preference P 31,250
Subscription Receivable-ordinary 62,500
To record 25% paid up requirement of incorporators.

Let us assume that on January 30, 20A, Mr. Edgar Detoya has paid in full his
subscription balance and collected P56,250 broken down as follows:

Preference Share (P25,000 – P6,250) - P18,750

Ordinary Share (P50,000 – P12,500) - 37,500
Total Collection P56,250

Cash P56,250
 Subscription Receivable- Preference P18,750
Subscription Receivable• Ordinary 37,500
To record full collection from Mr. Detoya's subscription balance.

ISSUANCE OF SHARE CERTIFICATE

Share certificates are issued only upon full payment of subscription. No full payment,
no certificate is issued. Since in our Comprehensive Illustration, only Mr. Detoya has
made a full payment of his subscription, then Archer Corporation will issue a Share
Certificate equivalent to the number of shares he subscribed and a corresponding
entry in the book is made as follows:

MEMORANDUM ENTRY METHOD

Subscribed Share Capital-Preference P25,000

Subscribed Share Capital-Ordinary P50,000
Share Capital-Preference P25,000
Share Capital-ordinary P50,000

JOURNAL ENTRY METHOD

Subscribed Share capital-P P25,000

Subscribed Share Capital-O 50,000
Unissued Share Capital-P P25.000
Unissued Share Capital-O P50,000
To record full payment E. Detoya's subscription
receivable and issuance of share certificate.

As already mentioned, share certificate can only be issued upon full collection of
subscription balance. Mr. Detoya has paid in full his subscription balance on January
30, ZOA, hence a share certificate is issued to him.

Breakdown of E. Detoya's Full Payment

25% Paid-up June 30 payment Total

Preferred Shares P 6,250 P18,750 P25,000
Ordinary Shares 12 500 37,500 50 000
P18,750 P56,250 P75,000
ACCOUNTING FOR ISSUANCE OF SHARE CAPITAL

Share Capital maybe issued for the following considerations:

1. Issued or Sold for Cash

2. Issued or Sold on Subscription Basis
3. Issued in Exchange for Non-cash Assets
4. Issued in Exchange for Services Rendered or Liability Incurred
5. Issued in Exchange for Equity Securities of other Corporation

To illustrate the accounting for issuance of share capital transactions, let us assume
that on Jan. 1, 20A, Metro Marketing Corporation is authorized by its charter to issue
10,000 ordinary shares at par value of P100.00 per share. 25% has been subscribed and
25% of the total subscription has been paid-up.

Authorization Entry (Memo Entry is use)

Jan. 1 Metro Marketing Corporation is authorized to issue 10,000 of its Ordinary Shares
at P100 par value per share.

25% Subscription Entry

Jan. 1
Subscription Receivable-ordinary P250,000
Subscribed Share Capital-Ordinary P250,000
To record 25% subscription
(25% x P1,000,000)
 25% of Subscription were collected

Jan 1
Cash P62,500
Subscription Receivable-Ordinary P62,500
Collected 25% subscription payment
(25% x P250,000)

The following transactions took place:

Jan-5 - Metro Marketing Corporation sold its 200 ordinary shares for cash.

(1) SHARE CAPITAL ISSUED OR SOLD FOR CASH

When share capital is issued or sold for cash, it is measured at the amount of cash
received. When sold at par value, it is debited to Cash and credited to Share Capital.
When sold above par value, it is debited to Cash for the amount received and Share
Capital is credited and the excess is further credited to Share premium or Additional
paid In Capital. Whether it is sold at par value or above par value, a share certificate
will be issued to shareholder concerned because he has already paid the shares in full.

Case 1 Sold its 200 Ordinary Shares at par value, P100.00

JOURNAL ENTRY:

Cash (200 shrs. X P100) P20,000

Ordinary Share (200 shrs. x 100) P20,000
To record sale of 200 shares at par.

Case 2 Sold its 200 Ordinary Shares above par value, P130,

JOURNAL ENTRY:

Cash (200 shrs. x P130) P26,000

Ordinary Share (200 shrs. x P100) P20,000
Share Premium (200 shrs. x 30) 6,000
To record sale of 100 shares above par.

Jan. 3 - Metro Marketing Corporation issued 100 ordinary shares to Nathalyn Alegre on
subscription basis and collected 30% down payment. The balance is payable in three
(3) equal monthly installments.

(2) SHARE CAPITAL SOLD ON SUBSCRIPTION BASIS

A share capital may also be sold on "Subscription Basis" or by lnstallment". As already

mentioned, Subscription Contract is a binding agreement whereby a prospective
investor agrees to acquire on credit a specified number of shares at a specified price
payable in future dates. When subscription is paid in full, a share certificate will be
issued.

When subscribed at par value, it is debited to Subscription Receivable and credited to

Subscribed Share Capital. When subscribed above par value, it is debited to
Subscription Receivable at subscription price and credited to Subscribed Share Capital
at par value and excess is further credited to Share premium or Additional paid-ln
Capital at the time the subscription is recorded rather than when cash is collected.

CASE 1 - SUBSCRIBED AT PAR VALUE, P100

SUBSCRIPTION ENTRY:

Subscription Receivable-ordinary P10,000

Subscribed Share Capital-Ordinary P10,000
Issued 100 shares at par value.

PARTIAL COLLECTION:

Cash P3,000
Subscription Receivable-Ordinary (P10,000 x 30%) P3,000
Collected 30% of Subscription Receivable.

FULL COLLECTION:

Cash P7,000
Subscription Receivable-Ordinary (P10,000 x 70%) P7,000
Collected in full the balance of 70%

ISSUANCE OF CERTI FICATE:

Subscribed Share Capital-Ordinary P10,000

Share Capital P10,000
Issued Share Certificate.

Note: When there is collection in full, automatically there should be an entry to record
issuance of certificate.

CASE2 - SUBSCRIBED AT P120.oo per share (Above par value)

SUBSCRIPTION ENTRY:
Subscription Receivable-Ordinary (100 shrs. x P120) P12,000
Subscribed Shore Capital-Ordinary (100 shrs. x P100) P10,000
Share Premium (100 shares x P20) P2,000
Issued 100 share above par value.

(Subscription Receivable is debited at per subscription price while subscribed Share

Capital is credited at par value and the difference is credited to Share Premium).
 PARTIAL COLLECTION:

Cash P3,600
Subscription Receivable-Ordinary (P12,000 x 30%) P3,600
Collected 30% of Subscription Receivable.

FULL COLLECTION:

Cash P8,400
Subscription Receivable-Ordinary (P12,000 x 70%) P8,400
Collected in full the balance of 70%.

ISSUANCE OF CERTIFICATE:

Subscribed Share Capital-ordinary P10,000

Share Capital (Memo Entry) P10,000
Issued Share Certificate.

FINANCIAL STATEMENT PRESENTATION OF SUBSCRIPTION RECEIVABLE

Subscription Receivable may be presented in the Statement of Financial position in two

(2) ways:

a) As an Asset when there is a due date or a call date.

b) As a deduction from Shareholders' Equity when no due date or call date is set.

DEFAULTED SUBSCRIPTIONS (Delinquent Shares)

Subscriptions may be collected in an installment at stated "call dates". When a

subscriber cannot pay the balance of his subscription after calls have been made or
several notices have been sent to him by the corporation, the subscriber is said to in
default. His total subscribed shares became "delinquent shares". The board of directors
may, by resolution order to sell these delinquent shares in a "public auction” Section
67 of the Corporation Code of the Philippines provides that:

"if within thirty (30) days from the said date, no payments made, all stocks covered by
said subscription shall thereupon become delinquent and shall be subjected to sale..."

The person or the bidder who is willing to pay the unpaid balance of the subscription
plus accrued interest and other expenses incurred to sell these shares of at the "least"
number of shares is called the "highest bidder". The highest bidder wins the bidding.
Thus, the delinquent shares are sold to him. Certificates of shares are issued upon the
receipt of payment from the highest bidder.

Mar. 10 - Let us assume that Nathalyn Alegre defaulted her subscription of 100 shares
at par value after paying 30% down payment. Her 100 shares are considered
delinquent.
1. Journal entry to record subscription (100 shares x PI00)

Subscription Receivable-ordinary P10,000

Subscribed Share Capital-Ordinary P10,000

2. Journal entry to record collection (PI0,000 x 30%)

Cash P3,000
Subscription Receivable-ordinary P3,000

3. Journal entry to record delinquency of Nathalyn Alegre.

Receivable from the Highest Bidder P7,000

Subscription Receivable-ordinary P7,000

Mar. 15 - Metro Marketing Corporation advertises the auction sale of these delinquent
shares and incurs expenses of P200.

4. Journal entry to record payment of expenses

Receivable from Highest Bidder P200

Cash P200

Few days later, three bids were received. Gerry Guiang is willing to pay the
subscription balance of P7,000 (P10,000 less P3,000) plus expenses of P200 in
exchange for 96 shares. Rafael Lopez Ill bids in exchange for 90 shares while Elsie
Olano bids for 94 shares. The highest bidder is Rafael Lopez Ill.

5. Journal entry to record payment of Rafael Lopez lll; the highest bidder

Cash P7,200
Receivable from Highest Bidder P7,200

Inasmuch as the subscription was considered to have been fully paid already, share
certificate good for 100 shares will be issued to both Nathalyn Alegre and Rafael Lopez
lll as follows:

Rafael Lopez Ill 90 shares

Nathalyn Alegre for the balance 10 shares

6. Journal entry to record the issuance of certificates

Subscribed Share Capital-Ordinary P10,000
Share Capital-ordinary P10,000
(Assumed memo entry is used)

In an event wherein there is only one bidder, the board of directors may or may not
accept the bid offered. The corporation may itself bid for the delinquent shares. The
shares acquired by the corporation under this circumstance are considered as
"Treasury
Shares"

The journal entry to record the acquisition of 100 delinquent shares by the corporation
is:

Treasury Shares P7,200

Receivable from Highest Bidder P7,200

The journal entry to record issuance of certificate is:

Subscribed Share Capital-Ordinary P10,000

Share Capital-ordinary P10,000

(3) SHANE CAPITAL ISSUED IN EXCHANGE EOR NON-CASH ASSETS

When share capital is issued in exchange for non-cash assets which is known as non-
monetary exchanges, Philippine Financial Reporting Standards No. 2 (PFRS) on Share-
Based Payment states that "the non-cash asset received shall be measured at its fair
market value. If the fair market value of the non-cash asset received cannot be
estimated reliably or cannot be determined, the non-cash asset is recorded at the fair
market value of the equity instrument. Share Capital is credited at its par value and any
excess of the recorded value of the asset' over the par value of the share capital is
credited to Share Premium.

If issued for non-cash asset, the value of share capital issued is equal to the values
according to the following order of priority.

1. fair value of the property received

2. fair value of the share capital issued
3. par value of the share capital

Whichever of the three (3) cited priorities is more clearly determinable must be used in
recording the transaction.

Apr. 1 - Metro Marketing Corporation issued its 1,200 shares to Mr. Henry Sy with par
value Of P100 in exchange for a parcel of Iand. Assuming that equity per share has a
fair market value of P130 and the land has fair market value of P200,000, the journal
entry to record the issuance of share capital would be -

Journal Entry:
Land P200,000
Shore Capital (P100 x 1,200 shrs.) P120,000
Share Premium P80,000
Issuance Of share capital for land.

Note: The fair market value of the land is given, hence the fair market value and par
value of the share shall not be used as the basis for its valuation.

(4) SHARE CAPITAL ISSUED IN EXCHANGE FOR SERVICES RENDERED

When share capital is issued for services rendered, specifically during the incorporation
stage, the fair market value of services received is debited to Organization Expense and
credited to Share Capital for its par value and the difference if any is further credited to
Share Premium or Additional paid-In Capital. Share Capital shall not be issued for
future services.

If the fair market Value of services is not clearly determinable, the fair market value of
the share capital shall be used.

Apr. 5 - Metro Marketing Corporation issued 500 shares to Atty. Richard Opinion at
PI100 par value per share in payment of legal services rendered which has a fair
market value of P75,OOO. The fair market value of the share is P120.

Journal Entry:

Organization Expense P 75,000

Shore Capital-Ordinary p 50,000
Share Premium-ordinary 25,000
Issued share capital for services rendered.

Note: The fair market value of services is given, hence the fair market value and par
value of the equity shall not be used as the basis for its valuation.

If ordinary share is issued for an outstanding liability, the amount of liability set-off
measured for recording.

(5) SHARE CAPITAL ISSUED IN EXCHANGE FOR EQUITY SECURITIES

When share capital is issued in exchange for equity securities of other corporations,
the measurement is the fair market value of the equity share which is debited to
Investment in Other Corporation's Equity and credited to Share Capital at par value
and the excess is further credited to Share premium or Additional Paid-ln Capital.

Apr. 10 - Metro Marketing Corporation issued its 900 shares at par value of P100 in
exchange for Orange, Inc. 1,000 equity shares. The fair market value of the share is
P120 while that of Orange, Inc. is P110. The entry to record the issuance of share
capital is –

Journal Entry:

Investment in Share-Orange, Inc. P110,000

Share Capital P90,000
Share premium 20,000
Issuance of 900 shares in exchange for 1,000 Orange, Inc.'s equity.
Note: The fair market value of Orange, Inc. share of P11O is used.

ACCOUNTING FOR NO-PAR VALUE SHARES

As already mentioned, "NO-PAR VALUE" shares are shares without any nominal value
printed in the share certificate. However, NO-PAR VALUE share may be assigned with
nominal value that is stated in the Articles of Incorporation but not on the face of the
share certificate. Hence, these are called "NO-PAR, WITH STATED VALUE" as being
differentiated from a true "NO-PAR VALUE" share.

Banks, trust companies, insurance companies and loans associations shall not be
permitted to issue "NO-PAR VALUE" shares. Also, preference share which entitles the
holder to preference in assets in case of liquidation shall not be issued a "NO-PAR
VALUE" shares.

Accounting for NO-PAR VALUE shares will be through the use of memorandum entry
only.

ISSUANCE OF NO-PAR, WITH STATED VALUE SHARES

NO-PAR, WITH STATED VALUE may be issued at Stated Value or above Stated Value
but like a PAR VALUE SHARE, the Corporation Code of the Philippines prohibits original
issuance share at a discount.

The same rules in accounting for issuance of share capital with PAR VALUE and NO-
PAR, WITH STATED VALUE SHARE are followed:

To illustrate:

The Orchids Corporation was organized on March 1, 20A and was authorized to issue
10,000 shares, no-par shares with stated value of P1.00. On May 1, 20A 8,000 shares
were issued for cash at P9.00 per share. On June 20, 3,000 shares were subscribed to
by Mr. Roberto Rebucas, at P12.00 per share. A 30% down payment was received. On
August 31, he made full payment of the subscription and was received by the
corporation.

Mar. 1 Memorandum entry; Authorized to issue 10,000 shares of no-par, with Stated
Value of P7.00 of P70 per share.

May 1 Cash (8,000 No-par x P9) P72,000

Ordinary Share with stated Value of P7 P56,000
Additional Paid-ln Capital, No-par, Ordinary Share 16,000
To record cash sales and issuance of 8,000 shares.
June 20 cash (3,000 No-par value shares x P12 x 30%) P10,800
Subscription Receivable — No-Par, Ordinary 25,200
(3,000 x P12 x 70%)
Ordinary Shares Subscribed-No-Par P21,000
(3,000 x P7.00)
Additional Paid-ln Capital, No- Par, Ordinary 15,000
(3,000 X P5)
Received subscription on ordinary, No-Par shares with 30% down
payment.
Aug. 31 - Cash 25,200
Subscription Receivable, No-Par, Ordinary 25,200
(3,000 x P12x 70%)
Full collection on subscription.

Ordinary Share Subscribed, No-Par 21,000

Subscription Receivable - (3,000 x 7) 21,000
Issuance of share certificate for full payment of shares.

ISSUANCE OF TRUE "NO-PAR VALUE"

When true "NO-PAR VALUE" or "NO-PAR, NO STATED VALUE" is issued, no Ordinary

Share Capital in excess is being recognized. In case of cash sales, the entire amount
received on the sale of said shares shall be credited to the "Ordinary Share Capital"
account.

No par value shares are shares without any nominal value printed or appearing in the
face of the share certificate. The Corporation Code of the Philippines provide that:

"shares without par value (NO PAR) may not be issued for a consideration less than the
value of five pesos (P5.00) per Share, the entire consideration received by the
corporation for its par value shares shall not be treated as capital and shall not be
available for distribution as dividends'.

To illustrate:

pomelo Corporation issued 500 shares of No-par, No Stated Value. Assume it is issued
for P10.00 per share.

Journal Entry:

Cash P5,000
Ordinary Share Capital P5,000
Issued 500 shares at P10.00 per share.

DIRECT ISSUE COSTS FOR SHARE CAPITAL ISSUANCE

 Share issuance costs are direct expense incurred in selling share capital. They normally
included printing costs, legal fees, documentary stamps, cost of promoting the issue,
registration and other regulatory fees. These costs are treated as reduction in Share
Capital through a debit to Share Premium or Additional paid- in Capital.

The excess of direct share issuance expense over the share premium or related
Additional paid- in Capital (APIC) shall be charged to current expenses.

To illustrate:

Mt. Apo Corporation issued 1,000 ordinary shares with par value of P100 for P130 per
share. Direct costs related to the issuance of the share is P20,000.

Journal Entry:
1) Cash (P130 x 1,000) P130,000
Ordinary Share Capital (P100 x 1,000 shrs.) P100,000
Share Premium (P30 x 1,000 shrs.) 30,000
To record Issuance of share capital.

2) Share premium or APIC P20,000

Cash P20,000
To record direct issue cost.

In an event wherein the direct share issuance expense exceeds over the related
Additional Paid-in Capital or Share Premium, the excess will be chargeable against
current expense.

To illustrate:

Using the same illustration, if direct issue cost is P40,000 and the share premium or
additional-paid in capital is P30,000 the P10,000 difference will be charged to Current
Expense.

Journal Entry:

Share Premium P30,000

Legal Expense 10,000
Cash P40,000
To record direct Issuance expense in excess of share premium
Application Sarangani Marketing Corporation is authorized to issue 10,000 ordinary shares at P100
par value per share. On July 2, 20A the Six (6) incorporators have subscribed t0 2,500
shares at par value and paid P62,500 of the subscription. Other transactions follow:

July 15- On this day, incorporation fees, printing cost of share certificates and other
incidental cost of its incorporation that were paid are recorded, PI5,000.

16 Neria Asperga subscribed to 100 ordinary shares at P105 per share and made
 down payment Of P4,500.

18 Narvin Lachica subscribed to 100 ordinary shares at P110.

20 Rogelio Macabenta purchased for cash ISO ordinary shares at par.

25 Elizabeth Palma Gil, one of the incorporators, paid her subscription balance in full
and a share certificate for 200 shares was:
200 shares subscribed at P100 P20,000
Less: 25% subscription payment 5,000
Balance 15,000

27 Issued 300 ordinary shares to Alex Jandoc in exchange for a piece of land which
has a fair market value of P40,000.

29 Issued 100 ordinary shares to Atty. Gilbert Abellera in exchange for his
professional services in the process of its incorporation. The fair market value of the
services, P35,000.

30 Received cash of P35,000 from the incorporators as partial payment of their

subscription balances.

31 Neria Asperga paid the subscription balance in full and a share certificate is
issued.

Required:
1. Record the foregoing transactions including authorization by using Journal Entry
Methods.

Lesson 4 Costing systems

Learning At the end of the week, students should be able to:
Outcomes
- Obtain knowledge about the strategies in setting price to the product.
-Understand the types of cost behavior patterns.
-Understand the importance of controlling cost.
- Determine whether the product and its parts can be manufactured economically in
the plant itself or to be purchased from outside.
-Determine the most economical, material, tooling method to manufacture the
product.
Time Frame
Introduction Cost is the expenditure required to create and sell products and services, or to acquire
assets. When sold or consumed, a cost is charged to expense. In the case of an asset,
the charge to expense could be significantly deferred. The cost concept underlies the
transition of assets from the balance sheet to expenses in the income statement.
Activity Discuss the importance of cost behavior as to planning and control.
Analysis What are the types of cost behavior? Explain thoroughly and cite an example.
Abstraction Definition of Cost Behavior
Cost behavior means how a cost will react as changes take place in the level of
business activity. Managers who understand how costs behave are better able to
predict what costs will be under various operating circumstances. An understanding of
cost behavior under varying conditions is essential to adequate decision making in the
planning and control of firm activity.

Importance of Understanding Cost Behavior

Planning requires that management make decisions based in part on expectations as

to the future. These expectations should be based on data relevant to the decision
objectives, gathered and analyzed in a competent, unbiased fashion. Failure in this
activity could mean displacement costs due to unexpected events. Control is process
of using feedback information for comparison with expectations and the
implementation of actions on the basis or that comparison.

Cost Analysis is an integral part of the planning and control function. The key to
effective cost prediction lies in an understanding of cost behavior patterns.

Types of Cost Behavior Patterns

1. Variable Costs

Variable costs are those costs that change in total as the level of activity changes in the
short run and within the relevant range. To the economist, the short run is the time
period long enough to allow management to change the level of production or other
activity within constraints of current total productive or operating capacity.
Furthermore, the estimates of variable and other costs are applicable only if the
contemplated level pf activity is within the relevant range. Relevant range is the range
activity within which assumptions relative to variable cost and fixed cost behavior are
valid. Variable cost per unit is assumed to remain constant within this range. For a cost
variable, it must be variable with respect to its activity base. An activity base is a
measure of whatever causes the incurrence of variable costs. An activity base is
sometimes referred to as a cost driver. Some of the most common activity drivers are
units sold, unit produced, direct labor-hours and machine hours.

2. Fixed costs

Fixed costs are costs that remain constant in total regardless of changes in level of
activity within the relevant range. Fixed costs however may change due to some
outside force, such as price changes. Fixed cost per unit will react inversely with
change in activity. Fixed costs decrease per unit as the activity level rises and increase
per unit as the activity fall.

Types of Fixed Costs

Fixed costs are sometimes referred to as capacity costs, since they result from outlays
made for buildings. equipment, skilled professional employees, and other items
needed to provide the basic capacity for sustained operations. For planning purposes,
fixed costs can be viewed as being either committed or discretionary.

Committed fixed costs relate to the investment in facilities, equipment, and the basic
organizational structure of a firm. Examples of such costs include depreciation of
buildings and equipment, taxes on real estate, insurance and salaries of top
management and operating personnel. The two key characteristics of committed fixed
costs are that (1) they are long term in nature, and (2) they can't be significantly
reduced even for short periods of time without seriously impairing the profitability or
long-run goals of the organization. Even if operations are interrupted or cut back, the
committed fixed costs will still continue largely unchanged.

Discretionary fixed costs (often referred to as managed fixed costs) usually arise from
annual decisions by management to spend in certain fixed cost areas. Examples Of
discretionary fixed costs include advertising, research, public relations, management
development programs, and internships for students. The most important
characteristic of discretionary fixed costs is that management is not locked into a
decision regarding such costs. They can be adjusted from year to year or even perhaps
during the course of a year if circumstances demand such a modification.

Fixed Costs and the Relevant Range

The concept of relevant range is also important in understanding fixed costs –

particularly discretionary fixed costs. The levels of discretionary fixed costs are typically
decided at the beginning of the year and depend on the support needs of planned
programs such as advertising and training. The scope of these programs will depend, in
turn, on the overall anticipated level of activity for the year. At very high level of
activity, programs usually broadened or expanded.

For example, if the company hopes to increase sales by 25% it would probably plan for
much larger advertising costs than if no sales increase were planned. So, the planned
level of activity might affect total discretionary fixed costs. However, once the total
discretionary fixed costs have been budgeted, they are unaffected by the actual level
of activity. For example, once the advertising budget has been decided on and has
been spent, it will not be affected by how many units are actually sold, therefore, the
cost is fixed with respect to the actual number of units sold.

Example of costs that are Generally fixed:

Rent, insurance, property taxes, supervisory salaries, straight-line depreciation,
administrative salaries and advertising.

3. Mixed costs

Mixed costs are one that contains both variable and fixed elements. Mixed costs are
also known as semivariable costs. Examples: Maintenance costs, Electric Utility costs.

Cost Estimation

The Analysis of Mixed Costs

The fixed portion of mixed costs represents the basic, minimum cost of just having a
service ready and available for use while the variable portion represents the cost
incurred for the actual consumption of the service. The variable element varies in
proportion to the amount of service that is consumed.

How does management go about in estimating the fixed and variable components of a
mixed costs?

The basic idea in cost estimation is to estimate the relation between costs and the
variables (factors) affecting the costs.

Account Analysis Method – is considered a very useful and easier way to estimate
costs. It makes use of the experience and judgment of managers and accountants who
are familiar with company operations and the way costs react to changes in activity
level.

This involves two steps:

1. review each cost account used to record that are of interest. Each cost is identified
as either fixed or variable depending on the relationship between the costs and some
activity.

2. Each major class of manufacturing overhead or other mixed cost is itemized. Each
cost is then divided into its estimated variable and fixed components. This is done on
the basis of the experience and judgment of accounting and other personnel.

Industrial Engineering Method - estimates cost functions by analyzing the relationship

between inputs and outputs in physical forms. Engineering estimates indicate what
costs should be. This method is so named because it was first used in estimating
manufacturing costs from industrial engineers’ specifications of the required input to
the manufacturing process for a unit of manufactured output.

Conference Method – cost functions are estimated based on the analysis and opinions
about costs and their drivers obtained from various department of an organization
such as purchasing, process engineering, manufacturing, employee relations and so on.
This information is used to determine the selling price oof the product, optimum
product mix and evaluate cost improvement over time.

High-Low Method

The high-low method of analyzing mixed costs is based on costs observe at both high
and low levels of activity within the relevant range.

Step in Applying the High-Low Method

1. obtain relevant data on past costs and related actual activity levels.
2. estimate the variable cost per unitor rate using the following equation.
 Variable cost per unit = (cost at high activity – Cost at lowest activity) / (highest
activity- , lowest activity)

Compute fixed cost as follows:

Fixed costs = Total cost at highest activity – (variable costs per unit * highest activity
, stated in units)

Application 1. Explain the 4 ways of estimating mixed costs.

2. Choose the best way of estimating mixed costs and explain the reason of choosing it.

Lesson 5 Cost-Volume-Profit Analysis

Learning At the end of the week, students should be able to:
Outcomes
-Understand the relationship between cost, volume, sale and profit.

- Obtain knowledge CVP analysis as a tool for profit and product planning.

- Ascertain of no profit and no loss level.

- Ascertain the optimum product mix.

- Understand CVP analysis as an important tool in the phase of making economic
decisions.
Time Frame
Introduction The Basics of Cost-Volume-Profit (CVP) Analysis

Managers are constantly faced with decisions about selling prices. variable costs and
fixed costs. To be able to choose from among the alternative actions. it is necessary to
have a good estimate of the probable costs that would result from each choice.
Furthermore, management needs to know the costs that are likely to be incurred
under normal operating conditions and how they might vary if conditions change.

Among the most frequently asked questions that require cost estimates and short-run
decisions are:

1) How many units will be manufactured?

2) What is the company's break-even sales?
3) Should the selling price be changed?
4) Should the company spend more on advertising?
5) What profit contribution can be realized if the organization performs as expected for
the period?
6) Should the product be sold as is or should it be processed further?
7) What would be the effects of the following changes in the next period?
a) Increase or decrease in the cost ff materials?
b) Increase or decrease in the efficiency of production?
 Long-run decisions such as buying new plant and equipment will also hinge on
predictions of the resulting cost-volume-profit relationships.

Managers, in making their decisions affecting the business operations must understand
the interrelationship of cost, volume and profit through the use of the information and
analysis that the cost accounting department will provide to them. They need to
understand which costs would stay the same.

Activity Define or give the meaning of the following concept.

1. CVP
2. Break-even point
3. Contribution margin
4. Margin of Safety
5. Operating Leverage
Analysis 1. What is the relationship of contribution margin and sales?
2. What would be the effect if the company fail to compute its margin of safety?
Abstraction Significance of Cost-Volume-profit Analysis

Cost-volume-profit (CVP) analysis is one of the most powerful tools that managers
have at their command. It helps them understand the interrelationship between cost,
volume, and profit in an organization by focusing on interactions between the
following five elements:

1. Prices of products
2. Volume or level
3. Variable costs per unit
4. Total Fixed costs
5. Mix of products sold

If the above items are known, the following relationships may be established:

a) Contribution Margin per unit or marginal income per unit

This is the excess of unit selling price over unit variable costs and the amount each unit
sold contributes toward

1) covering fixed costs and

2) providing operating profits.

Formula:
CM per unit = Unit selling price — unit variable costs

b) Contribution Margin ratio

This is the percentage of contribution margin to total sales. This ratio is computed as
follows:
CM ratio = Contribution Margin / Sales

The CM ratio is very useful in that it shows how the contribution margin will be
affected by a given peso change in total sales. For instance, if a company's CM ratio is
40%, it means that for each peso increase in sales, total contribution margin will
increase by P0.40. Net income likewise will increase by P0.40 assuming that there are
no changes in fixed costs.

CVIS Analysis for Breakeven Planning

The starting point in many business plans is to determine the break-even point.

Break-even point is the level of sales volume where total revenues and total expenses
are equal, that is, there is neither profit or loss. This point can be determined using
CVP analysis. Break-even point can be computed as follows:

1) Break-even point (unit) = Total fixed Costs / Contribution Margin per unit

2) Break-even point (peso) = Total fixed Costs / Contribution Margin ratio

CVP Analysis for Revenue and Cost Planning

CVP analysis can be used to determine the level of sale needed to achieve a desired
level of profit. In revenue planning, CVP analysis assists managers in determining the
revenue required to achieve a desired profit level. The equation that may be used to
compute for target sales follows:

Sales (units) = (Total Fixed Costs + Desired profit) / Contribution Margin per Unit

Sales (P) = (Total Fixed + Costs Desired Profit) / Contribution Margin Ratio

Assumptions and Limitations of CVP Analysis

Assumptions and Limitations Comment

1. The analysis is valid for limited range 1. Failure to observe these limits would
of values - the "relevant" and a limited lead to working with unrealistic data.
period of time.
2. All costs can be categorized as fixed or 2. Semi-variable costs present a problem
variable. that can be solved by segregating fixed
and variable portion.
a. Variable costs change proportionately
with volume within the relevant volume a. There is a danger that linear cost and
range revenue relationship may be used when
nonlinearities are significant.
b. Fixed costs are constant within the
relevant volume range. b. Non-linear curves often have optimum
 quantities; linear ones do not.
3. Revenues change proportionately
with volumes with selling price 3. Price is constant for all volumes within
remaining constant. the relevant range.

4. There is a constant product mix.

4. Data should be adjusted for any shifts
5. Changes in volume alone are in product mix.
responsible for changes in costs and 5. There are other factors affecting costs
revenues. and revenues, but they are lessened if
narrow time and volume limits re
6. There is no significant change in applied.
inventories (i.e., physical units, sales
volume equals production volume.) 6. Data should be adjusted if inventories
change markedly.
7. Operation leverage questions can be
dealt with in the CVP framework.
7. This should be supported with capital
8. The analysis is deterministic and budgeting approaches that consider the
appropriate data can be found. time value of money.
8. Uncertainly and a probabilities
approach can be introduced. This will
change decisions in some cases.

Illustrative Problem. CVP Analysis with Changes in Cost Structure

Don Company sold 100,000 units of its product at P20 per unit. Variable costs are P14
unit (manufacturing costs of P11 and marketing costs of P3). Fixed costs are incurred
uniformly throughout the year and amount to P792,000 (manufacturing costs of
P500,000 and marketing costs of P292,000).

REQUIRED: Compute

1. The break-even point in units and in pesos.

2. The number of units that must be sold to earn an income of P60,000 before icome
tax.
3.The number of units that must be sold to earn an after-tax income of P90,000.
Income tax rate is 40%.
4.The number of units required to break-even if there is a 10% increase in wages and
salaries. Labor cost constitutes 50% of variable costs and 20% of fixed costs.

Solution: Don Company

(a) BEP (unit) = 792,000 / 6 = 132,000 units

BEP (peso) = 792,000 / 30% = P2,640,000

(b) Desired net income P 60,000

Add: Fixed costs 792,000
Contribution margin 852,000
Divided by: Contribution margin per unit 6
Total number of units 142,000

(c) Desired income before tax

(90,000 divided by 60%) 150,000
Add: Fixed costs 792,000
Contribution margin 942,000
Divided by: contribution margin per unit 6
Total number of units 157,000

(d) BEP [792,000+[(20%*792,000) * 10%]] / 5.30 = 152,423 units

Computation of Contribution margin/unit:

Selling price per unit 20.00
Less: Variable cost per unit:
Materials, overhead and marketing
(50% x P14) 7
Labor (50% x P14 x 110%) 7.70 14.709
Contribution margin per unit 5.30
Sensitivity Analysis of CVP Results

To examine the sensitivity of profits to changes in sales, either of the measures may be
used: the margin of safety or operating leverage.

Margin of Safety

Margin of safety measures the potential effect of the risk that sales will fall short of
planned levels. This is the excess of actual or budgeted sales over break-even sales
and indicates the amount by which sales could decrease before losses are incurred.

The margin of safety can also be used as ratio, a percentage of sale:

Margin of safety ratio = Margin of Safety / Actual or Planned Sales

The margin of safety ratio is useful for comparing the risk of two alternative products,
or assessing the riskiness in any given product. The product with a relatively low
margin of safety ratio is the riskier of the two products and therefore usually requires
more of management's attention.

Illustrative Problem. Margin of Safety

Amflor Manufacturing Company’s budget for the coming year revealed the following
unit data:

Budgeted net income for the year P875,000

Unit costs:
Variable Fixed
Manufacturing cost P14.00 P12.00
Selling cost 2.50 5.50
General cost 0.25 7.00

Unit selling price P50

REQUIRED:

1. Determine the budgeted sales volume in units.

2. Determine the margin of safety in peso amount and percentage.

Solution: Amflor Manufacturing Company

1. Budgeted sales volume (units) = Total Budgeted net income / Net income per unit
= P875,000 / 8.75
= 100,000 units

Supporting Computations for Net income per Unit:

Unit selling price 50.00

 Less: Unit variable costs:
Manufacturing 14.00
Selling 2.50
General 0.25
Contribution margin/unit 33.25
Less: Unit Fixed costs 24.50
Net income unit 8.75

2. a. Margin of Safety = Budgeted sales — Break-even sales

= 5,000,000 – ((24.50*100,000) /66.5%)
= 5,000,000 – 3,684,211
= 1,315,789

b. Margin of Safety ratio = Margin of Safety (P) / Budgeted Sales

= 1,315,789 / 5,000,000
= 26%

Operating Leverage
The potential effect of the risk that sale will fall short of planned level as influenced by
the relative proportion of fixed to variable manufacturing of planned costs levels can
be measured by operating leverage. Operating leverage is the ratio of the contribution
margin to profit or

Operating Leverage = Contribution Margin / Profit or Net Operating Income

A higher value of operating leverage indicates a higher risk in the sense that a given
change in sales will have a relatively greater impact on profit. When sales volume is
strong, it is desirable have a high level of leverage, but when sales begin to fall, a lower
level of leverage is preferable.
Application John Company sold 100,000 units of its product at P30 per unit with the following
costs:

a. Variable manufacturing costs of P10

b. variable marketing costs of P2
c. Fixed manufacturing costs of P500,000
d. Fixed marketing costs of P200,000.

REQUIRED: Compute

1. The break-even point in units and in pesos.

2. The number of units that must be sold to earn an income of P50,000 before income
tax.
3.The number of units that must be sold to earn an after-tax income of P80,000.
Income tax rate is 40%.
4.The number of units required to break-even if there is a 10% increase in wages and
salaries. Labor cost constitutes 50% of variable costs and 20% of fixed costs.