Portraying the role as “accountants” in business

There is no way for us to be able to understand and learn accounting other than portraying
ourselves as accountants in business. Basically, this means that we as accountants consider
ourselves as the business, doing its day-to-day transactions, keeping records of such transactions,
and then preparing the periodic financial reports for the business. We also assume the
responsibility of devising systems, procedures and methods to safeguard the properties owned by
the business. Finally, the accountant’s role involves analyzing and interpreting the financial
statements by explaining to the owner or management of what happened to the business for or
during a particular period.

The Accountant’s Report

The accountant’s reports to the proprietor or management, which are considered as the
“endproducts” of the accounting process, are called the “financial statements”.

Financial Statements are the means by which the information accumulated in the financial
accounting system are processed daily and periodically communicated to various users and
decisionmakers, such as the proprietor, management, investors, creditors, government agencies,
customers, the public, labor union, etc.

Financial Statements are usually prepared at the end of the year. When financial statements are
prepared in a period of less than one year, they are called ‘interim financial statements’.

There are five (5) basic financial statements but we will focus our study on the three (3)
statements only, namely: Balance Sheet, Income Statement, and Statement of Changes in Owner’s
Equity.

What are Financial Statements?

Financial Statements are structured representation of financial position and financial

performance of a business entity. The objective of financial statements is to provide information
about the financial position, financial performance, and cash flows of an entity that is useful to a
wide range of users in order for them to make sound economic decisions.
Financial Statements also show the results of the management’s stewardship of the resources
entrusted to them. In layman’s language, financial statements are the “end-products” of the
accounting process. This refers to the accountant’s records based on the data gathered,
accumulated and systematically processed in financial accounting that are periodically
communicated to the various users particularly the owners and creditors.
Knowing and understanding these basic financial statements give us an idea or a clear picture of
what we are expected to accomplish after learning the applications of the various steps and
procedures of the accounting process. We will see the “why” of accounting to make it easier for us
to learn the “how” or the mechanics on the preparation of financial statements.

What is a Balance Sheet (also known as Statement of Financial Position)?

A Balance Sheet is a financial statement which shows the financial position or financial
condition of an enterprise as of a particular date, which is the end of the accounting period. It
consists of three main sections or elements which are the Assets, Liabilities and Owner’s Equity
which are called “accounting values”. These accounting values are considered “permanent
accounts” because these values are carried over the years or life of the business.
Assets – denote things of value that are owned and used by the business in its operations.
Examples are cash and cash equivalents, building, land, machinery, furniture and fixtures,
equipment, linens and uniforms, cleaning supplies, guest supplies, etc. It also includes food and
beverage inventories, prepaid expenses or debts collectible by the business from a guest or
customer which is termed as “Receivable”

Liabilities – denote financial obligations of the business to its creditors and suppliers. It represents
the claims of the creditors over the assets of the business

Owner’s Equity or Capital – denotes the amount of money or value of property put by the
proprietor in the business to start with its operations which is referred to as “initial investment” or
“initial capital”. Capital is synonymous to “Proprietorship”, “Proprietary Interest”, or “Net Worth”.
It is sometimes referred to as “the residual interest” of the owner in the assets of the business after
deducting its liabilities. It is expressed in the equation, Assets – Liabilities = Capital. Capital is
increased by additional investments and profit, and decreased when there are withdrawals by the
owner and losses from operations.

Drawing or Personal – refers to the amount of cash or value of property (assets other than
cash) that the proprietor has invested in the business already but later withdrawn for his
personal use.

Shown below is the Balance Sheet of Vista del Mar Hotel, owned and operated by Mrs. R.
Miranda, as of February 28, 20A prepared under the ‘account form’:
What financial information can we get from a Balance Sheet?

The above Balance Sheet answers the following questions:

How much the business owns? (Referring to its Assets) P3,403,478.00

How much the business owes? (Referring to its Liabilities) 464,683.95

How much is left for the business? (Referring to its Capital) P2,938,794.05

The Balance Sheet measures and evaluates in terms of the business’ liquidity and solvency.
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. In this regard, the following
series of questions can be asked from the business:

1) How much do I owe my creditors and suppliers?

2) Can I pay my financial obligations when they fall due?
In the preceding Balance Sheet of Vista del Mar Hotel, the business tells us further that of the
P3,403,478.00 assets it owns, P464,683.95 represents the claim of the creditors (liabilities) while
the balance of P2,938,794.05 represents the claim of the owner (equity) over the assets of the
business. In other words, the assets of the business are subject to the claims of the creditors at
one hand and the owner on the other hand.

The creditors have a continuous financial interest on the business as long as the business could
not pay its obligations to them. If there are no creditors, the owner has the sole right of the assets
of the business. More importantly, the balance sheet presents the equation:

Assets = Liability + Owner’s Equity

Basic Accounting Equation

At all times, the total assets must equal the total liabilities plus the owner’s equity as
expressed in the following equation:

Assets = Liabilities + Owner’s Equity

Assets are found at the left-hand side of the equation which we termed as “Debit” while
Liabilities and Owner’s Equity are found in the right-hand side of the equation which we termed as
“Credit”. The final rule is that the “total of the left will always equal to the total of the right”. This
is the significance of the double-entry system of bookkeeping.
The Assets of the business can be both claims of the outside creditors and the owner. Because
the creditors’ claims are paid before ownership claim if the business is liquidated (or will already
cease operations), liabilities are shown first before the owner’s equity.

To Illustrate:
Substituting our equation with the Balance Sheet data above, we have this equation:

Assets = Liabilities + Owner’s Equity

P3,403,478.00 = P 464,683.95 + P2,938,794.05

Consequently, if the owner wants to know his proprietary interest in the business, the
accounting equation may be modified and restated as follows:

Owner’s Equity = Assets - Liabilities

P2,938,794.05 = P3,403,478.00 - P 464,683.95
or,
Assets - Liabilities = Owner’s Equity
P3,403,478.00 - P 464,683.95 = P2,938,794.05
This can be gleaned further in the skeleton form (the T-Account) of a balance sheet under
the “account form”:
 Vista del Mar Hotel
Balance Sheet
Left-hand side or Debit side Right-hand side or Credit side

Assets Liabilities and Owner’s Equity

Total Liabilities P 464,683.95
Total Owner’s Equity 2,938,794.05
Total Liabilities and
Total Assets P3,403,478.00 Owner’s Equity P3,403,478.00

In the T-Account shown above, assets are presented at the left-hand side or debit side and
liabilities and owner’s equity at the right-hand side or credit side.

What is an Income Statement (also known as Statement of Operations)?

The Income is a statement which shows the performance of the enterprise for a given period of
time. The performance is measured in terms of income generated through the effective and
efficient use of its assets or resources. Otherwise known as the “results of operations”, the income
statement consists of the revenue or income earned and the costs and expenses incurred which are
considered “temporary accounts” because these items pertain only to a particular period and are
not carried over to the succeeding periods except for the resulting net income or loss which is
transferred to owner’s equity at the end of such period.

The accounting values or permanent accounts when shown together with temporary accounts
are called “accounting elements” or “elements of financial statements”.

Costs and Expenses are deducted from Revenue to determine Net Income; wherein total
income exceeds total expenses or Net Loss in case total expenses exceeds total income.

Revenue or Income – denotes money or proceeds from services rendered by a servicing company
or income from use by other entities of the resources of the enterprise such as Rent Income,
Royalties, Concession Income, etc. and sale of merchandise by a trading firm or proceeds from sale
of food and beverages in a restaurant.

Cost and Expenses – denote the benefit received by the business from its use which had helped in
carrying out its operations, like salaries expense, rent expense, repairs and maintenance, taxes and
licenses, allocated cost of fixed assets like depreciation and amortization. It also includes cost of
foods and beverages sold in a hotel or restaurant.

Profit (Loss) – the excess of revenues over expenses is called ‘profit’, while the excess of expenses
over revenues is ‘loss’.

Basically, the Income Statement features the following:

Revenue or Income P xx
Less, Cost of Sales P xx
Expenses xx_ xx
 Profit (Loss) P xx

Shown below is the Income Statement of Vista del Mar Hotel for the month ended February 28,
20A prepared under the “multiple-step form”.

The Income Statement answers the following questions:

 Does the business make profit?
Does the business incur loss?
Does the business make no profit or incur no loss?

If the business makes profit, the following series of questions can be asked:
1) Can I afford to hire additional employees?
2) What costs can I cut-down to maximize profit? or later,
3) Would I consider expansion of the business or add more products or services?

The information presented in an income statement is usually considered the most important
information provided by financial accounting because profitability is the paramount concern to
those interested in the economic activities of the enterprise.
EXPANDED ACCOUNTING EQUATION

In our study of the Balance Sheet, we learned the basic accounting equation which are all Balance
Sheet components, A = L + OE. This time, we introduce to you the expanded accounting equation
whereby we are putting together the components of the Income Statement which are the Revenues
and Expenses. As we said, Revenue will increase Owner’s Equity and will be decreased by Expenses and
Owner’s withdrawals. Hence, the expanded accounting equation is:

Assets = Liabilities + Owner’s Equity (+ Revenue – Expenses)

Substituting this equation with Balance Sheet and Income Statement data, we have –

Assets = Liabilities + Owner’s Equity (+ Revenue – Expenses)

P3,403,478.00 = P 464,683.95 + P2,938,794.05 (+ P1,084,016.05 – P823,222.00)

Or

Assets = Liabilities + Owner’s Equity

P3,403,478.00 = P 464,683.95 + P2,678,000.00
+ 1,084,016.05 (Revenue)
– 823,222.00 (Expenses)
P2,938,794.05

In short, we again go back to the basic accounting equation as:

Assets - Liabilities = Owner’s Equity

P3,403,478.00 - P 464,683.95 = P2,938,794.05

The amount of Owner’s Equity, beginning of P3,000,000 plus Additional Investment of P28,000 less
the amount withdrawn by the owner of P350,000 is equal to the amount of owner’s equity during the
period of P2,678,000.

What is a Statement of Changes in Owner’s Equity?

It is a financial statement that summarizes the changes in equity for a given period of time.
The beginning equity of the owner is increased by the additional investment and net income and,
correspondingly, is decreased by withdrawal and net loss.

Shown below is the Statement of Changes in Owner’s Equity of Vista del Mar Hotel for the month
ended February 28, 20A.

The statement of Changes in Owner’s Equity answers the following question:

 - What causes the decrease in Owner’s Equity of Mrs. R. Miranda from P3,000,000 to
P2,938,794.05?
Looking at the above statement, the amount of decrease (a change) is calculated as follows:

Owner’s Equity at the end of the period P2,938,794.05

Less, Owner’s Equity at the beginning 3,000,000.00
Increase in Owner’s Equity (P 61,205.95)

This decrease in Owner’s Equity by P 61,205.95 is accounted for as follows (or caused by the following):

Profit for the month (increase in owner’s equity) P 260,794.05

Add, Additional investment (increase in owner’s equity) 28,000.00
Total P 288,794.05
Less, Withdrawal (decrease in owner’s equity) 350,000,00
Net decrease in Owner’s Equity (P 61,205.95)

Of course, in the event wherein the net operating income of the business is greater than the amount of
owner’s withdrawals, there is a Net Increase in Owner’s Equity, hence, the ending Owner’s Equity
balance or amount will also increase.

Preliminary Testing:

Illustration 1 - If assets are P300,000 and owner’s equity is P100,000, how much is the claim from
outside creditors (liabilities)? Answer: P200,000

2 - If financial obligations of the business is P350,000 and the claim of the owner against the
business is P150,000, how much is assets? Answer: P500,000

3 - If assets are P400,000 and the claims from outside creditors over these assets are
P250,000, how much is owner’s equity? Answer: P150,000

WHEN DOES AN ACCOUNTANT PREPARE THE FINANCIAL STATEMENTS?

The business has a continuous life of existence. When it starts, it is assumed that it will continue to
operate for an indefinite period of time. This is the “continuity” or the “going-concern” assumption in
accounting.

Considering the length of time involved in its operations, it is very impractical for the owner to wait
until the business stops to operate before he would be able to know the results of operations and the
financial condition of his business. This is much like in several sports events where an entire game is
divided into rounds for boxing, quarters for basketball, sets for volleyball and bowling, laps for car
racing, etc.

The primary purpose for each is to know the score, to evaluate the game, to plan for the next step
or course of action, to change strategies, to make decisions, and to comply with certain rules or
regulations, etc.

For this reason, the life of the business is then divided into equal periods wherein at the end of
each period, financial statements (reports) are prepared. These periods are being referred to as the
“Accounting Period”. This is the “time-period” assumption or the “periodicity concept” in accounting.

This explains why financial statements are prepared and communicated to the owner of the
business or to various users and/or decision-makers periodically.
 Speaking of accounting periods, it can be a period of:

1 month or monthly basis – financial statements are prepared monthly – the shortest period
3 months or quarterly basis– financial statement are prepared at the end of every three months
6 months or semi-annual basis – financial statements are prepared after every six months
12 months or annual basis – financial statements are prepared at the end of every twelve months
The length of the accounting period chosen depends on the need of the owner for financial information
about his business. Most often, however, the business adapts an accounting periods of one year.

The owner or management has three options to choose from as far as the annual periodic reporting of
financial statements are concerned, these are:

Calendar year – the accounting period begins January 1 and ends December 31 of the same year. This
is the most common accounting period used because this is the nearest period wherein
businesses file their annual income tax returns. The books of the business are closed on
December 31 and the deadline for filing tax returns is April 15 of the following year.
There are four quarters in a calendar year each consisting 3 months. The first quarter covers
January 1 to March 31; the second quarter covers April 1 to June 30; the third quarter covers
July 1 to September 30; and the fourth quarter covers October 1 to December 31.

Fiscal year – the accounting period starts on the first day of any month of the year except
January and will end on the last day of the twelfth month completing one year period. For
example, if the period starts July 1, 20A it will end on June 30, 20B. In such case, the quarters
(consisting of 3 months each) will cover July 1 to September 30 of the same year, October 1 to
December 31 of the same year; January 1 to March 31 of 20B; April 1 to June 30 20B.

Natural business year – a twelve month period that ends on any month when the business is at the
lowest or experiencing slack season. Example, a fiscal year for the hotel industry where the
start is the point of scarcity of visitors and ends up at its peak season where there many
visitors.

An enterprise may adopt any of the above accounting periods but the basic consideration is that
the accounting period chosen must be reflective of the “results of normal operations”.
 Review Activities/Exercises 1
A) Enumerated below are list of business organizations. Identify and classify each based on the nature of
business whether it is a service concern, merchandising concern, manufacturing, agriculture or hybrid
business.
1. Hotel industry 8. Internet café 15. Schools
2. Call center 9. Banana plantation 16. Vegetable stalls
3. Key duplicator 10. Barber shop 17. Beauty parlor
4. Bag factory 11. Auto repair shop 18. Cigarette factory
5. Gasoline station 12. Sari-sari store 19. Bookstore
6. Restaurant 13. Shipping lines 20. Airline business
7. Bus company 14. Pineapple plantation

B) Matching Type: Select from the choices below for your answer to the following items described: Answer
with letters only.
a. Going concern I. Consistency Principle
b. Cost Principle j. Partnership
c. Interim financial statement k. Partners’ Equity
d. Calendar year l. Materiality Principle
e. Objectivity Principle n. Hybrid company
f. Manufacturing concern o. Accounting entity
g. Income Statement p. Balance Sheet
h. Adequate Disclosure q. answer not found

1. Accounting period starts Jan. 1 and ends on December 31 of the same year
2. Capital is provided by two or more persons
3. Business is assumed to have a continuous life
4. This assumes that from the accounting point of view, the business is considered as “an entity that is
separate and distinct from its owner or management
5. A financial statement which shows the performance of the enterprise for a given period of time.
6. Financial statements of less than one year
7. Buys materials and converts them into finished products
8. Engaged in selling of both services and merchandise
9. The capital account title in a partnership business
10. The accounting principle which requires that assets should be recorded at original or acquisition cost.
11. This accounting principle which requires that accounting records should be based on reliable and
verifiable data as evidence of transaction.
12. The accounting principle dictating practicality to rule over theory in determining the valuation of an
item, which is a matter of professional judgment on the part of the accountant.
13. This accounting principle which requires that accounting methods and procedures should be applied on
a consistent basis from period to period to achieve comparability in the financial statements.
14. The accounting principle which requires that financial statements should be free from any material
misstatement; that is, if any, proper disclosure should be made.
15. Its three main sections or elements are the Assets, Liabilities and Owner’s Equity.

C. Multiple Choice. Write A when only the first choice is correct; B when only the second choice is correct;
C when both A and B are correct; and D when both choices are incorrect
1. A service activity the objective of which is to generate financial information about a business to particular
users of such information
a) bookkeeping and accounting b) accounting
2. Business is defined as a/an
a) economic activity engaged in production and selling b) service activity engaged with investors
3. These two items could decrease owner’s equity?
a) withdrawals and net income b) additional investments and net loss
4. The financial statement that shows the financial position of the business as of a particular date
a) income statement and balance sheet b) balance sheet
5. All the resources owned by the business and are in its disposal are known as –
a) assets b) assets and liabilities
6. A financial statement which shows the performance of the enterprise for a given period of time
a) income statement b) balance sheet
7. A twelve-month period that begins on the first day of any given month on a year
a) calendar year b) fiscal year
8. A user of financial information about the business enterprise who needs to know its paying capacity
a) suppliers and creditors b) creditors
9. A type of business which deals primarily on rendering service for a fee
a) service concern b) sole proprietorship
10. They are interested on the business to collect taxes, permits and licenses, or for regulatory purposes
a) the Bureau of Internal Revenue b) government and their agencies

II. The Elements of Financial Statements and its Account Titles

Each of the main elements of the financial statements consists of individual items grouped into the same
kind, class or nature which are accounting values assigned with names or titles called “account titles” or
simply “accounts”. Account titles are identifications or brief descriptions of these items. In recording business
transactions, the elements of financial statements are to be assigned with each individual name. In other
words, it is part of our study in accounting where we are to give or assign names to various accounts included
in the exchanges of accounting elements.

Here are the different account titles we have classified into Balance Sheet and Income Statement accounts.

BALANCE SHEET ACCOUNTS

(Real or Permanent Accounts)

ASSETS – are resources controlled by the enterprise as a result of past transactions and events and from
which future economic benefits are expected to flow the enterprise. Assets are sub-classified into two,
namely: current assets and non-current assets.

1. Current Assets – refer to all assets that are expected to be realized, sold or consumed within the
enterprise’s normal operating cycle. Operating cycle is the interval of time from the date of acquisition
of merchandise inventory; sell the inventory to customers and the ultimate collection of cash from the
sale.

Cash - the account title used to describe money, either in paper or in coins and money substitutes like
check, postal money orders, bank drafts and treasury warrants. When cash in the premises of the
business, the account title is Cash on hand and Cash in bank if deposited in the bank. When the
company has two or more bank accounts, the name of the bank must also be indicated therein, i.e,
Cash in bank-BPI; Cash in bank-LBP.

Petty Cash Fund – money placed and set aside for petty or small expenses. This exist when a business
uses the imprest system of keeping cash

Revolving Fund – amount set aside bigger than the petty cash fund which is used to pay expenses such
as cash and salary advances to employees. This is handled by a trusted employee.
 Cash equivalents – short-term, highly liquid instruments that are readily convertible into cash and they
present insignificant risk of changes in values because of changes in interest rates

Notes Receivable – this is a promissory note that is received by the business from the customer arising
from rendering of services, sale of merchandise, food and beverages, etc.

Credit-Card Receivable – account title for guests or clients who use his/her credit card for paying the
bills, such as Visa Card, Master Card, etc.

Accounts Receivable - the account title for amounts collectible arising from services rendered to a
customer or client or guest for their stay in the hotel including food and beverages consumed. In
some hotels they are named as “guest ledger” or “city ledger” which can simply be distinguished as
the former includes only the amount due from guests occupying the room, while the latter includes
all other amounts due as guest charges.

Allowance for bad debts or Estimated Uncollectible Accounts – this is an asset offset or a contra-asset
account. It provides for possible losses from uncollectible accounts. Although this account is not
actually an asset, it is classified as such because it is shown as a deduction from the Accounts
Receivable, which is a current asset account.

Accrued interest income – the amount of interest earned on a Notes Receivable which is not yet
collected (if the note is interest-bearing)

Advances to employees – amounts collectible from employees for allowing them to make cash
advances which are deductible against their salaries or wages

Inventories – these include food and beverage, guest and cleaning supplies inventory. Guest supplies
inventory includes bath towels, bed sheets, pillows, blankets, pillow cases, etc. Cleaning supplies
include trash bins, carpet sweeper, mops, pails, vacuum cleaners, etc.

Prepaid expenses – account title for expenses that are paid in advance but are not yet incurred or have
not yet expired such as Prepaid Rental, Prepaid Insurance, Prepaid Interest, Prepaid Advertising, etc

Unused supplies or Supplies on hand – an account title for cost of stationery and other supplies
purchased for use but are left on hand and still unused. This should be specified as Unused office
supplies if for office use or Unused shop supplies if for the shop use, etc.

These accounts are normally arranged according to liquidity (ready conversion to cash) in the Balance Sheet

2. Non-Current Assets – all other assets not classified as current should be classified as non-current.

Property and Equipment – are tangible assets which are held by an enterprise for use in production or
supply of goods and services, for rental to others, or for administrative purposes, and are expected to
be used during more than one period, like:

Land – an account title for the site for the site where the hotel and restaurant buildings are
constructed. It is not subject to depreciation because it is usable for an indefinite period of time
and is not subject to wear and tear unlike other material assets that is when exposed to the
elements will deteriorate or degenerate in physical appearance and usage. Land is not necessarily
an element of cost inasmuch as many hotels and restaurants are constructed on land that is leased
from the owner.

Building – for a finished construction owned by the business where operations and transactions took
place
 Machinery and Equipment – includes elevators, standby power-generating sets, air conditioning units,
freezers, refrigerators, cooking equipment, washing machines, frying equipment, etc. Calculators,
adding machines, cash registers, computers, steel filing cabinets and the like are termed as Office
equipment while trucks, jeeps, vans, and other motor vehicles are specified as Delivery equipment or
Transportation equipment when used in delivering goods or ferrying guests.

Furniture and fixtures – includes chairs, tables, counters, display racks or cases are also specified where
they are used as in Office furniture and fixtures or Store furniture & fixtures.

Accumulated depreciation – this an asset offset or contra-asset account. This is called a valuation
account which is shown as a deduction from property and equipment

China, Glass, and Silverwares – include cutleries (knives), fork and spoons, drinking glasses, serving
bowls, cups and saucers, pitcher, plates, etc.

Assets classified as Property and Equipment or Fixed Assets are called Depreciable Assets and are
subject to depreciation except Land.

LIABILITIES – are 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.

1. Current Liabilities – are financial obligations of the enterprise which are (a) expected to be settled in
the normal course of the operating cycle; (b) due to be settled within one year from the balance sheet
date

Accounts Payable – an account title for a financial obligation of an enterprise that constitutes an oral or
verbal promise to pay

Notes Payable – (short-term) same as Accounts Payable in nature but only the obligation is supported
by a promissory note. The enterprise is the one who issues the note
Accrued expenses – these are expenses incurred by the enterprise but are not yet paid when the
accounting period ended

VAT Payable – the excess of Output Tax or Input Tax. This represents the amount of tax payable to the
Bureau of Internal Revenue (BIR)

Pre-collected or Unearned Income – this is an account title for an income (money payment is already
received) collected in advance but is not yet considered as “earned”.

2. Non-Current Liabilities – financial long-term obligations of the enterprise which are due and payable
for more than one year. This usually occurs in a corporate form of business organization

Notes Payable (Long-term) – same nature with that of Notes Payable (short-term) but only, this
requires payment for more than one year

Mortgage Payable – a financial obligation of the enterprise which requires a fixed or tangible property
to be pledged as a collateral to ensure payment
 OWNER’S EQUITY – the residual interest of the owner/s in the assets of the enterprise after deducting all
its liabilities. It is expressed in the equation: Assets – Liabilities = Owner’s Equity

Capital – this is the center of the owner’s concern because this may increase or decrease at any time as
a result of business operation. In the normal course of operation, Owner’s Equity is increased by
income and decreased by expenses. In a sole proprietorship and in partnerships, the owner/s
name/s are used to indicate the ownership by adding the word “Capital” written after the name
which is separated by a comma, as in, Ronaldo Reyes, Capital

Withdrawal (temporary account) – owner’s withdrawals are likewise indicated by the use of the
owner’s name with the word Drawing or Personal also separated by a comma, as in, Ronaldo
Reyes, Drawing or Ronaldo Reyes, Personal

Income and Expense Summary – this is also a temporary account created at the end of the accounting
period where income and expenses are temporarily closed (or transferred) in preparation for
entries for the next accounting period.

Account titles used by a particular form of business vary so as to fit in the type of business
transactions encountered in more specific transactions, such that, in a merchandising business, some
accounts are not used by that of a service-type business.

INCOME STATEMENT ACCOUNTS

(Nominal or Temporary Accounts)

INCOME OR REVENUE

Sales Revenue or Service Income – in general, this represents revenue derived from the sale of
merchandise, food and beverage including room sales, banquet sales, etc., or specified as:

Rental Income – for income earned on buildings, space or other properties owned and rented out by
the business as the main line of its activity

Interest Income – income received by the business arising from borrowed money by a customer and is
usually covered by a promissory note. This is typical of a lending institution.

Miscellaneous income – for income earned by the business which is not the main line of its activity and
could not clearly be classified

COST AND EXPENSES

Cost of Sales or Cost of Goods Sold – a reduction from sales revenue. This represents the cost to
produce and sell the goods. Example, Cost of Sales- Food, Cost of Sales-Beverage, or plainly Cost of
Sales for merchandise sold.

Freight-in – refers to transportation expenses in buying merchandise. It is treated as merchandise

inventory under perpetual inventory system and an addition to the purchases account under
periodic inventory system

Freight-out – refers to transportation expenses in selling merchandise to customers

 Employee Benefits – includes SSS premium for employees, PhilHealth, Workmen’s compensation, cost
of food that were given to employees for free consumption, etc.

China, Glass, and Silverwares Expense – refers to the cost of inventory that were damaged, broken,
stolen, etc. This is a direct service expense and often need not be amortized.

Supplies Expense – this represents cost of supplies that were used and consumed that bears specific
titles as office supplies expense, store supplies expense, guest supplies expense, cleaning supplies
expense, etc.

Interest expense – expense incurred on borrowed money covered by a promissory note; shown
separately from operating income before arriving at Net Income

Rent expense – amount incurred for use of another’s property or premises

Repairs and Maintenance – expenses incurred for repairing or servicing on property and equipment
owned by the business

Salaries expense or Salaries and Wages – for compensation given to employees. It may be specified as
Office Salaries, Salesmen’s Salaries, etc.

Uncollectible accounts or Bad debts – the amount of anticipated loss the business may incur from
uncollectible accounts

Depreciation expense – for the allocated portion of the cost of property and equipment or fixed assets
used in the business

Taxes and licenses – for business permits, licenses and other government dues except income tax

Insurance expense – the expired portion of the insurance premium paid

Utilities expense – for telephone, light and water consumption or use

Miscellaneous expense – any amount paid as expense which is not significant enough to be classified
as it is

WHY IS ACCOUNTING CONSIDERED THE “LANGUAGE OF BUSINESS”?

The business and the owner are being separated and the financial statements became the “bridge of
communication” between them. We would like to mention it here again that the financial statements prepared
by the accountant were used by the business as a tool to communicate to the owner or management and
various users/decision-makers who are interested about these activities, such as investors, employees, lenders,
suppliers, government agencies, etc.

With the help of the accountant, the business was able to tell them what it has accomplished in the course
of its operation in a brief manner but concise and complete by using technical terms or accounting
terminologies which are understandable in the business world. For this reason, accounting is considered as the
“language of business”.
Nature of business. A business firm may be classified in terms of what they offer, sell or produce.

They are as follows:

 Service concern – the business derives its income from rendering of services to clients for a fee.
Merchandising concern – the business is engaged in buying goods or commodities or any form of
finished products and sells these at a profit.
Manufacturing – the business is engaged in buying of raw materials and supplies to be processed
or manufactures, converting them into finished products for sale at a profit, like that of a
furniture shop, manufacturers of cars and home appliances, etc. Bakeries and restaurants are
no exceptions.
Agri-business – the business is engaged in planting crops or raising animals and sells its products
either in raw or finished form at a profit.
Hybrid companies – those involved in more than one type of activity which are manufacturing,
merchandising, and servicing.

Forms of business organization and their capital structures

Single or sole proprietorship – the simplest form of business organization where the capital is
provided and owned by one person called ‘proprietor’ who may manage the business or hire somebody
to do it. The owner has to bear the result of his business whether it succeeds or fails including any
obligations the business may have incurred.
When the business gets bankrupt, the separate entity assumption cease as they are one with the
owner. The owner cannot claim salaries or remuneration from the business himself, but he can make
withdrawals in cash or in kind from his capital. As there is only one owner, the capital account is called
Owner’s Equity.

Partnership – The capital of the business is owned or provided by two or more persons called
partners who sets forth their agreements among themselves which includes, among others, the
investments of each partner, how profit and loss is to be divided, and settlement to be made upon the
death or withdrawal of a partner as embodied in the Articles of Co-Partnership they have executed and
registered with the Securities and Exchange Commission (SEC). As to management, one of the partners
may take charge of the affairs of the business or they may hire another person to do so. As there are
two or more partners in the partnership business, the capital account is called Partners’ Equity.

Corporation – This is the biggest and the most complicated form of business organization formed by
at least five but not more than fifteen natural persons called Incorporators and the corporate charter
registered with the SEC called the Articles of Incorporation. Its capital is called Share Capital which is
divided into units called shares and each share has a designated value called par value. Owners of the
shares of stock are called Shareholders. Shares of stock can be transferred without dissolving the
corporation, so it enjoys unlimited life. As there are hundreds of shareholders in a corporation, the
capital account is called Shareholders’ Equity.

Cooperatives – they operate similar to a corporation but their charter which is called Articles of
Cooperation is registered with the Cooperative Development Authority (CDA). It has its board of
directors who are elected from among its members. However, while the number of voting shares in a
corporation is based on the number of shares that a shareholder holds, in a cooperative, it is on a
‘oneman, one-vote’ basis. Distribution of earnings of a cooperative follows a different manner distinct
from that of a corporation.

Moreover, regardless of the type of business or how it is formed, all businesses employ the same
principles of accounting and follow the same procedures on the necessity of keeping business records
and reporting meaningful and useful information for decision-making purposes and compliance to
regulations.
At this point, it is assumed that you already are aware of, if not, familiar with the financial
statements which are considered as the “end-products” of the accounting process. These are being
presented at this early part of our study in Accounting so that we will have an idea or a clear picture of
 what we are expected to accomplish after learning the applications of various steps and procedures of
the accounting process.

We will then see the “why” of accounting and this will facilitate our learning on the “how” or the
mechanics of the financial statement preparation.

Having this in mind, we will see clearly why accounting, as a process, is known as “the language of
business” because, like a picture, it portrays how the business looks like and how the information it
generates is so important to the various users of such financial information for their decision-making
purposes.

Users of Financial Information

Financial accounting information is used by a variety of groups and diverse purposes. The needs and
expectations of users determine the type of information required. The users of financial statements
and their information needs follow:

Investors – for them to determine whether they should buy, hold or sell their investments in the
Enterprise

Employees – to know the stability and profitability of the enterprise which would affect their
remuneration, retirement benefits, and employment opportunities

Lenders – for them to determine whether their loans to the business will be paid when due

Suppliers and other trade creditors – same need as lenders

Customers – for their continuance or patronage and their dependence on the enterprise

Government and their agencies – for them to regulate business activities, determine taxation
policies and as a basis for national income and similar statistics

Public – for the contribution of business to economy, employment, patronage of local suppliers.
Financial statements may assist the public by providing information about the trends and recent
developments in the prosperity of the enterprise and the range of its activities.

REVIEW EXERCISES 2

I. Identify the appropriate accounts for each of the following items described:

1. the account title used to describe money, either paper bills or coins and money substitutes like
checks, postal money orders, bank drafts, etc.
2. this constitutes an oral or verbal promise to pay arising from services rendered on credit or sale of
goods to customers on account
3. the account title for expenses that are paid in advance but are not yet incurred or have not yet expired
4. these are assets which are acquired and are held for sale in the ordinary course of business, in the
process of production for such sale or in the form of materials or supplies to be consumed in the
production process
5. the account title for an obligation of an enterprise that constitutes an oral or verbal promise to pay
6. the account title generally used by professionals for income earned from the practice of professions
7. the amount paid for telephone, light and water consumptions of the enterprise
8. an account title used for the expired portion of the insurance premium
9. expenses paid for employees’ compensation
 10. the account used for obligations of the business the payment of which is guaranteed with an issuance
of a promissory note

II. Identification and enumeration

1–5 What are the basic accounting principles mentioned in GAAP?

6–8 Name the types or classification of business a person may engage in?
9 – 10 Name the two most common financial statements.
11-13 What are three commonly used accounting periods?
14-16 Name at least three (3) users of financial information generated by accounting

III. Discussion Questions (3 points each). Briefly answer the following questions.

1. When can we say that a business is making profit? Or incurring a loss?

2. Why is keeping of records important in business?

3. Why should business be regarded as an entity separate and distinct from the owner?
4. What are financial statements? (Definition not the types or kind)

5. What information can we get from an Income Statement? From the Balance Sheet?
6. What are Assets? Liabilities?

7. What is Owner’s Equity? What items or factors affect Owner’s Equity?

8. Discuss the accounting entity assumption

9. Define Generally Accepted Accounting Principles (GAAP)

10. In your personal opinion, why do think you should study accounting?

True or False. Write True, if the statement is true and False, if otherwise

1. The professions like engineering and medicine are related to accounting in the sense that said
professions need accounting in pursuit to the practice of their professions.
2. The primary motive of a person engaged in business is to deliver basic services to customers and to
make profit is only secondary.
3. In accounting, a dear distinction between business transactions and personal affairs of the owner
should be made so that financial report will not be distorted.
4. One disadvantage in a sole proprietorship is that the owner cannot be entitled to a salary form his
business.
5. One of the characteristics of a sole proprietorship is that he shares to nobody in case he makes a profit
and bears it all in case of a loss.
6. The separation of the owner and his business is only an accounting assumption which is not true in real
situations.
7. Book of accounts is like a “diary”. It records all transactions and events that took place in the life of his
business.
8. Accounting is considered the language of business because it is used as a medium of communication
understandable in the business world.
9. Financial statements are prepared and communicated to various users “periodically”.
10. Owner’s Equity represents residual interest in the assets of the business after deducting all liabilities as
expressed in the equation A-L=C.
 11. Capital is increased by additional investment and profit while it is decreased by withdrawal and losses
from operation.
12. An enterprise may adopt any of the accounting period as long as the period chosen is reflective of the
results of operation.
13. Basically, the role of an accountant in business is to prepare the financial statement.
14. The sale that will result to “zero” gain or loss is break-even sales.
15. Financial statements that are prepared in less than a year are interim financial statements.

B) Multiple Choice. Answer with letters only.

1. The accounting assumption that gives that business a continuous life of existence.
a. Stable monetary unit c. going concern
b. Periodicity d. accrual
2. It is the simplest form of business organization wherein capital is provided only by a single person.
a. Corporation c. sole proprietorship
b. Partnership d. none of the above
3. The accounting period will begin on the first day of any month of the year except January and ends on
the last day of the month completing the one year period.
a. Calendar c. natural business year
b. Fiscal d. none of the above
4. Capital is synonymous to
a. Net worth c. Owner’s Equity
b. Proprietary interest d. all of these
5. Statement that shows the “financial condition” of the business as of a particular date.
a. Balance sheet c. statement of changes in owner’s equity
b. Profit and loss statement d. statement of cash flow
6. A statement that shows the “results of operations” of the business for a given period of time.
a. Balance sheet c. Income Statement
b. Statement of Cash flows d. Statement of Changes in Owner’s Equity
7. It represents the residual interest in the assets of the business after deducting its liabilities.
a. Capital c. Owner’s Equity
b. Net worth d. all of the above

8. Denote things of value that are owned and used by the business in its operation.
a. Assets c. Capital
b. Liabilities d. Owner’s Equity
9. It is the shortest accounting period wherein financial statements are reported to various users.
a. Quarterly c. semi-annually
b. Monthly d. annually
10. It is an accounting assumption that because of the continuity of business operation, its life is divided into
equal periods wherein results of operation and financial condition of the business can be reported
periodically.
a. Monetary conversion c. time-period
b. Accounting entity d. continuity
11. The business is considered as an entity that is separate and distinct from the owner.
a. Accounting conversion c. separate entity
b. Business entity d. all of the above
12. Primarily, business is established for-
 a. Profit c. free
b. Service d. all of the above
13. What represents the claim of the creditor over the assets of the business-
a. Liability c. assets
b. Owner’s equity d. all of the above
14. It denotes financial obligation of the business to its creditors-
a. Liabilities c. assets
b. Owner’s equity d. all of these
15. It measures and evaluates in terms of liquidity and solvency of the business-
a. Income statement c. owner’s equity
b. Balance sheet d. financial reports
16. Refers to the ability of the enterprise to meet currently maturing obligations-
a. Liquidity c. financial statements
b. Solvency d. none of these
17. It is where the most important information provided by financial accounting because profitability is the
paramount concern to those interested in the economic activities of its enterprise-
a. Income statement c. statement of changes in owner’s equity
b. Balance sheet d. statement of cash flow
18. Which of the following assumptions requires distinction between business transaction and personal
affairs of the owner-
a. Accounting entity c. balance sheet
b. Continuity d. going concern
19. Accounting is the bridge of communication between the owner of the business and various users
through-
a. Financial statement c. balance sheet
b. Income statement d. statement of equity
20. The business derived its income from services rendered to clients or customers-
a. Service concern c. manufacturing
b. Merchandising d. trading
21. The capital of the business is owned and provided by two or more persons who agreed to divide profits
between or among themselves-
a. Sole proprietorship c. corporation
b. Partnership d. cooperative
22. The business is engaged in buying and selling of goods and commodities for profit-
a. Trading c. manufacturing
b. Service concern d. none of these

23. It is the biggest and the most complicated form of business organization. It is organized by at least five
but not more than fifteen persons called “incorporators”
a. Proprietor c. partnership
b. Corporation d. cooperation
24. The capital of the corporation is called-
a. Share capital c. dividends
b. Retained earnings d. par value
25. The owners of the shares of stock of a corporation are called-
a. Incorporators c. shareholders
b. Members d. stock brokers
26. Share capital is divided into units called-
 a. Corporate assets c. par value
b. Corporate shares d. none of these
27. The accumulated profit of a corporation is called-
a. Dividends c. accumulated earnings
b. Par value d. business profit
28. The shares in profit of shareholders is called-
a. Dividends c. retained earnings
b. Par value d. none of these
29. The powers of the corporation are vested by a governing body called-
a. Board of directors c. board of governors
b. Board of judges d. none of these

C. Instruction: Classify each of the following account titles as to Assets, Liabilities, or Owner’s Equity.

Example: Rent Expense Answer: Owner’s Equity

1. Accounts Payable
2. Bob Gelacio, Capital
3. Prepaid Insurance
4. Salaries and Wages
5. Buildings
6. Sales Food and Beverage
7. Unused Supplies
8. Accounts Receivable
9. Room Sales
10. Petty Cash Fund
11. Bob Gelacio, Drawing
12. Unearned Service Income
13. Service Income
14. China Glass and Silverwares
15. Change Fund
16. Uncollectible Accounts
17. Costs of Sales-Food and Beverages
18. Employees’ Benefits
19. Advances to Employees
20. Credit Card Receivable

D) Changes in Accounting Values

At the beginning of the year, Sto. Rosario Dormitory owned by Ms. Pamela Tao has assets of P500,000
and liabilities of P200,000.

Let assume that the following changes took place in accounting values.

Consider the assumptions separately and independent from each other using the above data as the basis.

1. If asset has increased to P600,000 and liability has decreased by P20,000, how much is the Owner’s
Equity before these changes took place?
 2. If Asset has decreased by P90,000 and Liability has increased by P40,000, what is the
amount of the Owner’s Equity at the end of the year?

3. If Asset has increased to P570,000 and Liability has increased by P10,000, what would be
the effect in the Owner’s Equity?

4. If during the year, Liability has increased by 30% and there is a corresponding decrease
in Owner’s Equity by P20,000, how much would this change affect the Asset?

5. If Asset has increased by P150,000 and a corresponding decrease in Owner’s Equity by

10%, how would it affect the liability during the year?

6. If during the year, the claim of the outside creditor has increased by 20% and the
residual interest amounted to P310,000, how much is the owner’s claim in Assets?

7. If Asset has increased by P150,000 and financial obligation has reached to P300,000 ,
how much would be the Owner’s Equity balance at the end of the year?

8. If Asset has increased by 30% and Owner’s Equity has increased by the same percent,
how much is the outstanding financial obligation of the business?

9. If Asset decreased by 10% and Owner’s Equity decreased by 15%, how much would
represent unpaid accounts of the business?

If the financial obligation of the business has increased by 20%, while the residual interest decreased by
P20,000, how much is total ownership