QUALIFYING EXAM REVIEWER

THEORIES FROM

VARIOUS BASIC ACCOUNTING HANDOUTS

BY OLSU PROFESSORS AND STUDENTS

INTRODUCTION TO ACCOUNTING

Bookkeeping and Accounting Distinguished

Bookkeeping a procedural element of accounting which primarily deals with the systematic
method of recording and classifying financial transaction of business

Accounting-as defined by the American Institute of Certified Public Accountants (AICPA), is the
art or recording, classifying and summarizing in a significant manner and in terms of money,
transactions and events that are, in part at least, of a financial character, and interpreting the
results thereof

 as defined by the Philippine Institute of Certified Public Accountants, is a system that

measures business activities, processes given information into reports, and
communicates those findings to decision-makers

Accounting as the "Language of Business"

Accounting is often referred to as the language of business because it is the medium of

communication between a business firm and various parties interested in its financial activities
by providing quantitative financial information through financial statements.

Major Information needed is as follow:

Financial Condition or Position - amount and kinds of its assets and liabilities

Financial Performance or Results of Operations-whether the operating activities of the

business resulted to net income or net loss
Financing and Investing Activities - sources and applications of fund which are responsible for
the changes in the financial resources of the business during a given period of time

Brief History of Accounting

The development of accounting is a result of Italian merchants' needs of information. In that

commercial climate, Luca Pacioli published the first known description of double-entry
bookkeeping entitled Summa de Arithmetica, Geometria, Proportioni et Proportionalite
(Everything about Arithmetic, Geometry and Proportion) published in Venice in November
1494.

The pace of accounting development increased during the Industrial Revolution as the
economics of developed countries began to mass-produce goods. Merchandise was price-based
on managers hunches about cost until competition required merchants to adopt more
sophisticated accounting system.

The growth of corporation during the 19th century spurred the development of accounting.
Corporate owners were no longer necessary the managers of their business. Managers then,
had to create accounting systems to report to the owners the status of the business.

Accounting supplied the concept of income. When the government started using the income
tax, it further helped accounting develop. Also, government at all levels has assumed expanded
roles in health, education, labor and economics planning. To ensure that the information that it
uses to make decisions is reliable, the government has required strict accountability in the
business community.

At the beginning of third millennium, there would still be a lot of developments in the field of
accounting. The great challenge of globalization and the effects of new technologies pase a shift
in the structure and pattern in this field. More and better information are now being required
and therefore, accounting, being the means in communicating business and financial
information must also evolve into a more efficient level.

Users of Financial Statements

Internal Users those who are directly involve in the business

  Owners - those who provide the money/capital in the business who would need
accounting Information to properly manage and monitor the business and analyze
whether or not they can expect reasonable return from their investment
 Management - uses accounting information to set goals for the organization, to
evaluate the progress made toward those goals and to take corrective actions if
necessary
 Employees - uses accounting information to assess the ability of the enterprise to
comperisate for the services, industry or labor they are contributing to the business, to
provide retirement benefits and other employee opportunities and benefits

External Users-those who are indirectly involved in the business

 Potential Investors - use accounting information to evaluate what income they can
reasonably expect from their investment

 Creditors - use accounting information to determine the business' ability to meet

scheduled payments.
 Customers-use accounting information to know whether the business will continue
operating especially when they have long-term involvement with, or are dependent on
that company's offerings of either services or goods
 Taxing Authorities-use accounting Information to determine the amount of tax that
should be charged to the business
 Government Regulation Agencies - use accounting information to determine regulatory
activities to be imposed to the business
 Nonprofit Organization-use accounting information the same way the profit-oriented
businesses do.
 Other Users-use accounting information to know that amount of income the company is
earning

Forms of Business Organization

According to Ownership-business is classified based on owner/s investing or putting capital on

a business being started

 Sole or Single Proprietorship-only one person makes the investment

 Partnership-two or more persons, who are therefore called partners, agree to operate
the business
  Corporation-a body formed and authorized by law to act as a single person although
constituted by one or more persons, called the stockholders/shareholders, and legally
endowed with various rights and duties

According to Operations of Activity - business is classified based on the nature of its activities

 Service Concern-rendering of services for a fee

 Manufacturing Concern - processing of products or conversion of raw materials into
finished goods goods that are then sold
 Merchandising or Trading Concern-buying and selling of

Basic Accounting Concepts

Generally Accepted Accounting Principles (GAAP)-are concepts which are developed by the
accounting profession over the years to serve as ground rules that govern how accountants
measure, process and communicates financial information and to provide a consistent system
of financial reporting in a constantly changing business environment

 Entity Concept-business is regarded as having a separate and distinct personality from

that of the owner/sgenerating its own revenue, incurring its own expenses, owning its
own assets. and owing its own liabilities thus, personal transactions of the owner/s must
not be combined with the transaction of the business
 Business Transactions-events that can be measured in terms of money that affects the
enterprise.
 Monetary Concept-money is used as the unit of measure in preparing various financial
reports of the company
 Stable Money Concept - assumes that monetary unit does not change overtime, even if
in fact it does
 Time Period/Periodicity Concept-divides the life of the business into regular intervals at
the of which financial statements are prepared (usually one year)

- Calendar Year a twelve-month period beginning with January 1 and ending

December 31

- Fiscal Year-does not start with January 1 and end on December 31

 Revenue Realization Concept-income is recognized when earned regardless whether

cash is received as long as it meets the following conditions:

- when services are fully rendered

 - when goods or merchandise are fully delivered

Income - is the inflow of assets that results from producing goods or rendering
services

 Accrual Concept-income be recorded when earned regardless whether cash is received

and an expense be recognized when incurred
o Accrual Method of Accounting-attempts to record the financial effects on a
company of transactions and other events and circurristances in the periods in
which those transactions, events and circumstances occur rather that only the
periods in which cash is received or paid by the firm
o Cash Basis-records a journal entry upon exchange of cash, typically does not
require many adjusting entries

 Matching Concept-all expenses incurred to generate revenues must be recorded in the

same period that the income are recorded to properly determine net income or net loss
of the period
o Revenues - inflows of resources from providing goods or services to customers
o Expenses-outflows of resources incurred in generating revenue
 Objectivity/Reliability Concept - all transactions must be evidenced by business
documents free from personal biases and independent experts can verify reports
 Cost Concept - assets are acquired in business transactions conducted at arm's length
transactions-transactions between a buyer and a seller at a fair value prevailing at the
time of the transaction
 Going Concern Concept-assumes that the business is to continue its operations
indefinitely meaning, the business will stay in operation for a period of time sufficient to
carry out contemplated operations, contracts and commitments
 Conservatism Concept-assumes that when uncertainty exists, the users of financial
statements are better served by understatement than by overstatement of net income
and assets Consistency Concept-states that once a method is adopted, it must not be
changed from year to year to allow comparability of financial statements between years
and between businesses
 Materiality Concept-refers to relative importance of an item or event
o Material - if knowledge of it would influence the decision of prudent users of
financial statements
 Disclosure Concept-all relevant and material event affecting the financial
condition/position of a business and the results of its operations must be communicated
to users of financial statements in variety of ways:
 o Parenthetical Comments/Modifying Comments - placed on the face of the
financial statement
o Disclosure Notes-conveying additional insights about company operations,
accounting principles, contractual agreements and pending litigation
o Supplemental Financial Statements - report more detailed information that is
shown in the primary financial statements

The Accounting Profession

Public Accountants - are those who serve the general public and collect professional fees for
their work

Private Accountants-work for a single business

Certified Public Accountants (CPA) - professional accountant who earns his title through a
combination of education, qualifying experience and an acceptance score in the written
national examination given by the Board of Accountancy prepares grades and gives results of
the examination to the Professional Regulation Commission (PRC) who then issues licenses
that allow qualifying examinees to practice accounting as CPAS

Ethical Values - provide foundation on which civilized society exists whose purpose in the
business world is to direct business men and women to abide by a code of conduct that
facilitates public confidence in their products and services

 Honesty
 Integrity
 Promise-keeping
 Fidelity
 Fairness
 Caring
 Respect for Others
 Responsible Citizenship
 Pursuit of Excellence
 Accountability

MEASURING AND REPORTING FINANCIAL POSITION

Forms of Statement of Financial Position

Statement of Financial Position - shows what the business is worth in terms of the properties it
owns, the debts it owes and the Investment of its owners

Account Form - assets are listed on the left side of the report and the liabilities and
proprietorship on the right side

Report Form - shows assets on the tope section of the statement and the liabilities and owner's
equity on the bottom section

Parts of the Statement of Financial Position

Statement Heading - name of the business, kind of statement and the date

Asset, Liability and Proprietorship - special captions on which iterns are grouped.

Captions - classifications of each group appearing on the left margin of the statement

Account Titles - individual account titles are indented

Current Assets - listed in order of their liquidity

Plant, Property, Equipment - listed in order of their expected useful life

Note (#) - explaining in detail the aggregated amount presented on the face of the financial
statement.

Current Liabilities - listed in order of due date with the earliest due date appearing first

Captions Indicating Totals - group of items which is indented further

Single Rule Line - last figure in each group

Final Totals - double ruled

Peso Sign - are used (a) to the left of the first amount of a group of amounts being combined
and (b) to the left of each final total

Peso Amount - shown in one column

The Accounting Equation

Total Assets of the business is exactly equal in amount to the sum of the Total Liabilities and the
Capital

ASSETS LIABILITIES + OWNER'S EQUITY

Assets - includes anything owned or possessed by the business which represents the resources
of the business

Current Assets

 Cash
 Investment in Trading Securities
 Notes Receivable
 Interest Receivable
 Accounts Receivable
 Advances to Employees
 Merchandise Inventory
 Accrued Income
 Supplies on Hand
 Prepaid Insurance
 Prepaid Rent

Non-Current Assets

 Land
 Building
 Equipment
 Furniture and Fixtures
 Accumulated Depreciation

Liabilities - economic obligations payable to an individual or an organization outside the

business.

Current Liabilities

 Accounts Payable
 Notes Payable
 Interest Payable
 Deferred Income
  Taxes Payable

Non-Current Liabilities

 Notes Payable Long Term

 Installment Contracts Payable
 Mortgage Payable

Owner's Equity - claim of an owner of a business over the assets of the business after the
claims of the creditors have been satisfied

 Capital
 Withdrawal

MEASURING AND REPORTING FINANCIAL PERFORMANCE

Forms of Income Statement

Income Statement - summary of the results of business operations covered in an interval

known as the accounting period, which shows whether or not the business achieved its primary
objective of earning profit or net income

Natural Form - arranges all income accounts in one group, all expense accounts in another
group and then deducts the total expenses from the total income in a single-step operation of
subtraction to arrive at the final result of net income or net loss

Functional Form - clearly shows specific sections of income, costs and expenses in a series of
arithmetic operations and requires that cost of goods sold and expenses be subtracted in steps
to arrive at the net Income

Income Accounts

Service Income - income from services rendered

Other Income - refers to income from sources other than the principal line of activity of the
business

 Interest Income - revenue to the payee for loaning out a principal amount to a borrower
  Dividend Income - income earned in investing cash in stocks of other businesses.

Expense Accounts

Salaries - cost of services rendered by employees

Rent - rental cost of office space, equipment, etc

Office Supplies - refers to the cost of office supplies used

Utilities - refers to the cost of light, water and telephone facilities used

Taxes and Licenses - refers to all payments required to be made to the Bureau of Internal
Revenue

Transportation - cost incurred by office employees when commuting from the office to the
place of the business of clients

Traveling - used when business trips are made out of town

Gas and Oil - refers to the cast of gas and oil consumed

Representation - cost incurred when entertaining clients or prospective clients

Depreciation - refers to the expense associated with the use of the company's PPE

Bad Debts - allocation or provision for this future uncollectibility of some of the accounts of
credit customers

Donations and Contributions - refers to the contribution made to charitable institutions or any
other worthwhile projects

Miscellaneous - any other costs of operations that may not be sufficiently big in amount to be
classified separately are charged to this account

MEASURING AND REPORTING CHANGES IN EQUITY

Statement of Changes in Owner's Equity/Capital Statement - presents a summary of the

changes that occurred in the owner's equity of the entity during a specific time period
  opens with the owner's capital balance at the beginning of the period, add net income
(deduct in case of net loss), add additional investment, subtract withdrawals and the
statement ends with owner's capital balance at the end of the period

Withdrawals - withdraw assets for personal use

 Temporary Withdrawal - withdraw business assets for personal use in anticipation of

profits
 Permanent Withdrawal - capital withdrawal that is substantial in amount wherein the
owner intends to remove the assets permanently from the business operations

MEASURING AND REPORTING CASH FLOWS

Forms of Statement of Cash Flows

Statement of Cash Flows - reports the firm's receipt and disbursement of cash which are
classified according to the company's major activities:

 Operating - cash effects of revenue and expense transactions.

 Investing - relating to investing activities involving plant assets, intangible assets and
investments
 Financing - result from debt and financing activities

Direct Method - list the receipts of cash from specific operating, investing and financing
activities

Indirect Method - normally used by companies that employ accrual method rather than cash
method in their accounting system

Usefulness of the Statement of Cash Flows

 Company's ability to produce future cash flows.

 Firm's ability to meet current and future obligations
 The reasons for the difference between net income and net cash provided (used) by
operating activities
 The cash investing and financing transactions during the period
ACCOUNTING FOR SALARIES

Recording Salary Expense

Payroll Register - the summary of employees

Net Pay - the remaining cash after deducting the following from the salary:

 Social Security System

 Philhealth
 PAG-Ibig
 Withholding Income Tax

ACCOUNTING FOR PROMISSORY NOTE

Promissory Note - an unconditional promise to pay a definite sum of money on demand or at a

future. date

Components:

 Maker - person who signs the note

 Payee - the person to whom the promise to pay is made
 Principal Amount - the amount loaned by the payee
 Interest - the cost of borrowing the principal amount
 Interest Period - the period of time during which interest is to be computed
 Interest Rate - percentage rate that is multiplied to the principal amount and the term
of note
 Maturity Date - date when payment is due
 Maturity Value - sum of principal and interest
 Place of Issue - locality where maker executed the note

Typical Transactions

 The client receives services of goods and issued promissory note as payment
 The client has an outstanding account and wishes to extend the payment of his account
 A loan is extended to a borrower who issues promissory note
Interest on Note

Promissory note may either be:

Interest Bearing - provides payment for interest so that the amount paid at maturity date is the
maturity value-principal plus interest

Non-Interest Bearing - does not provide any payment for interest so the amount that would be
paid on maturity date is exactly the same as the face value of the note

Discounting a Note Receivable

Discounting a Note Receivable - endorsing a note before maturity during which the payee
would receive lesser amount than the maturity value the price the payee is willing to pay for
wanting to receive cash earlier

Endorsing may either be:

With Recourse - there is a contingent liability on the part of the endorser (payee), which is
equal to the maturity value plus any protest fee, in any case that the bank does not collect any
payment from the payer or maker of the note

Without Recourse - words "Without Recourse" must appear at the back of the note exempts
the endorser for any contingent liability

Contingent Liability may be presented in the Statement of Financial Position as:

 Contingent Liability on the Liability side

 Deduction from Notes Receivable
 Footnote to the Statement of Financial Position with the Notes Receivable reported at
net amount
 Parenthetical Note in the Notes to the Financial Statements

Discounting Own Note Issued

Discounting Own Note - creditor would collect interest the same day the loan was granted

GENERAL JOURNAL, GENERAL LEDGER AND TRIAL BALANCE

Accounting Cycle - a series of sequential steps done every accounting period

 Journalizing - chronological recording of business transactions in the journal-book of

original entries
 Posting to the General Ledger - summary of the journalized accounts in the ledger-book
of final entry which may be posted in two forms:
o Standard Form
o Running Balance Form

Chart of Accounts - lists of account titles being used by the business in its operations

 Preparing Trial Balance - a list of schedule of open accounts in the general ledger with
their corresponding balances
o - prepared to verify the equality of all the debits and credits
 Preparing Worksheet - an optional step in the accounting cycle but greatly aids in
preparation of the financial statements
 Adjusting Entries - done with the purpose of updating some accounts to prevent their
overstatement or understatement

 Preparing Financial Statements - the end points of the whole accounting cycle
 Closing the Books - done with the purpose of closing all the nominal accounts to the
capital
 Preparing Post - Closing Trial Balance-presents only real accounts which will be carried
on to the next accounting period
 Reversing Entries - done with the purpose of bringing back entries to their original
amounts