AE 13- FUNDAMENTALS OF ACCOUNTING 1

LESSON 1: ACCOUNTING AND ITS ENVIRONMENT

BASIC CONCEPTS
Definition of Accounting
 It is the process of identifying, measuring, and communicating economic information to permit informed
judgments and decisions by the users of information. - American Accounting Association (AAA)
 It is the art of recording, classifying, and summarizing in a significant manner and in terms of money,
transactions and events which are in part at least of a financial character and interpreting the results
thereof. - American Institute of Certified Public Accountants (AICPA)
 Accounting is a 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 decision. - Accounting
Standard Council (ASC)
Nature of Accounting
• Accounting is a process. - It performs the functions of identifying, recording and communicating
economic events with the end goal of providing information to internal and external parties.
• Accounting is an art. - It is an art of recording, classifying, summarizing and finalizing financial data. It
is a combination of techniques and its application requires applied skills and expertise.
• Accounting deals with financial information and transactions. - It deals only with quantifiable financial
transactions. Non-financial transactions are not the focus of accounting process but may be used to
interpret and better estimate some financial data.
• Accounting is a means and not an end. - It is a tool to achieve specific objectives.
• Accounting is an information system. - It is recognized and characterized as a storehouse of information.
It also collects processes and communicates financial information.
Functions of Accounting
• Keeping systematic record of business transactions. - The records should be systematic enough to enable
easy understanding of users.
• Protecting properties of business. - Accounting records serve as evidence that properties of a business do
exist or how much of a particular resource does a company have. The accounting system helps in
preventing employee fraud and misappropriation of company resources.
• Communicating results to various parties in or connected with the business. - Communication of the
results of operations of a company is essential for all concerned parties to enable them to take well-
informed decisions.
• Meeting legal requirements. - It aims to protect the public by providing them the necessary information
to make sound decisions.
Objectives and Purpose of Accounting
• Objective - To provide users with useful information for economic and decision-making study and
judgments.
• Purpose - To help various financial users see the over-all and/or true picture of businesses, organizations
or entities in quantitative, economic and/or financial terms.
Accounting History
• Early civilizations - Accounting history began around 3000BC and it is evidenced by the record-keeping
wealth thru "clay tablets" of Mesopotamia
• The Florentine vs the Venetian approach to reporting
• Florentine Approach is the introduction of double-entry bookkeeping system by Amanito
Manucci, a partner of merchant , in the 14th century.
• Venetian Approach of reporting is where the debits are recorded on the left side of the page
across the credits and introduced by Andrea Bargarigo.
• Luca Pacioli - father of modern accounting; published in 1494 the Venetian method in his book

• Savary and the Napoleonic Commercial Code

• Savary Commercial Code generally uses historical cost as the basis of valuation by Jacques
 Savary.
• Napoleonic Commercial Code gives in notes and example of inventory where it described that
the assets must be carried at their market value on the day inventory and not on the basis of
historical cost by Napoleon Bonaparte.
• The industrial revolution and the share-issuing company (late 18th and early 19th century) - New
accounting practices were introduced like depreciation, allocation of Overhead, inventory accounting,
progression of accounting for business entities, intensified and improved business regulations on
financial reporting and new tax accounting systems and procedures.
• The arrival of income taxation and the conflict with financial accounting - Tax Accounting was born as
a specialized field of accounting with this development where CPAs are infused with taxation works.
• Schmalenbach and the chart of accounts - Eugen Schmalenbach (1873-1955), believed that chart of
accounts are not mere carriers of balances but it contains significant information which can be prepared
regularly and speedily to respond rapidly to the external and internal circumstances influencing the
economic issues of an enterprise.
• The rise of the group of companies and the need for consolidated accounts - The evolution of Business
Combination accounting practices thru merger or consolidation.
• Internalization of markets and reporting - Some businesses are raising capital and trade internationally
with the intention of increasing the liquidity of their organizations.
THE ACCOUNTING PROFESSION
The Classical Notion of Stewardship
It applies to the valuation and the stewardship role.
 Valuation - This gives emphasis on how accounting measures the value of the firm.
When the markets are perfect and complete, the assets and the changes in the book value of owner's
equity can be measured at their market value. While, when the markets are not perfect and complete,
accounting can still be used to approximate the change in the value of the entity.
 Stewardship - Stewardship of the firm affects the value of the firm. Accounting information is used to
assess, monitor and control the activities of the entity.
Specialized Fields and Branches of Accounting
1. Public Accounting - accountants render professional services for a fee
a. External Auditing
Definition - unbiased examination and evaluation of the financial statements of an organization
independently
Report - independent auditor's report (Unqualified, Qualified, Adverse, Disclaimer)
Purpose - give credibility to the financial statements of a company
Frequency - after every audit
Intended Users - external users
Standards - PSA
b. Tax Services - For tax compliance, accountants prepare various tax returns for income taxes,
business taxes and transfer taxes. He may also represent the client in tax assessment and
examinations conducted by BIR.
c. Management Advisory Services - giving advises to clients concerning finance, accounting,
budgeting, accounting systems, organization policies and procedures, product costing, pricing
and distribution, and other business undertakings.
2. Private Accounting - accountants are employed in private businesses and NGOs
a. Financial Accounting
Definition - bookkeeping of financial transactions and events of a business and preparation of
basic financial statements
Report - Financial statements: (1) General Purpose Financial Statements are prepared to
accommodate the information needs of persons who have no capability to request or acquire
information directly from the company and (2) Special Purpose Financial
Statements - utilized by internal parties to guide them in the decision making process for the
 company
Purpose - guide internal and external users in economic decisions
Frequency - periodic
Intended Users - external and internal users
Standards - Philippine Financial Reporting Standards (PFRS) and Philippine Accounting
Standards (PAS)
b. Cost Accounting - concerned with inventory costing and product costing of the processed or
manufactured goods
c. Tax Accounting - involved in tax compliance and tax planning
d. Management Accounting - deals with business and financial planning, strategic planning,
budgeting, analysis, monitoring and controlling the business.
e. Internal Auditing - concerned with safeguarding and protection of organization's assets,
reliability of accounting records, and adherence to established policies and procedures of the
company.
f. Private Accounting - accountants are employed in private businesses and NGOs
3. Government Accounting
Definition - accounting for the receipt and disposition of government fund and property and
interpreting the result thereof; used by all government agencies
Report - periodic financial reports and financial statements
Purpose - show stewardship of public funds by the government
Frequency - periodic
Intended Users - external and internal users
Standards - National Government Accounting System (NGAS) - enhances responsibility
accounting in all agencies and discourages misappropriation and misuse of public funds
4. Accounting Education
a. Focuses in education students and professionals alike about accounting, auditing, taxation, and
advanced accounting and business subjects.
Career Opportunities in Accounting Profession
Career Opportunities in Accounting Position
Fields of Accountancy Positions
Entry-level Middle-level Advanced-level
Public Practice -Audit Staff -Audit Manager -Partner
-Tax Staff -Tax Manager -Senior Partner
-Management Services or -Consulting Manager -Senior Consultant or
Consulting Staff Senior Financial Advisor
Commerce and -Financial Accounting and -Comptroller -Chief Financial Officer
Industry Reporting Staff -Senior Information -Chief Information
-Management Accounting Systems Auditor Officer
Staff -Senior Fraud Examiner -Comptroller
-Tax Accounting Staff -Senior Forensic Auditor
-Internal Audit Staff
-Financial Analyst
-Credit Analyst
-Cost Accountant
Government -Accounting and Budget -State Accountant V -National Treasurer
Clerk -Director III and Director -VP for Finance/CFO
-State Accounting IV (for GOCCs)
Examiner -Government -Commissioner
-State Accountant Accountancy and Audit -Associate Commissioner
-LGU Accountant -Financial Services -Assistant Commissioner
 -Revenue Officer Manager (COA, BIR, BOA)
-Audit Examiner -Audit Services Manager
-Budget Analyst -Senior Auditor
-Financial Services
Specialist
Education / Academe -Junior Accounting -Senior Faculty -VP for Academic
Instructions -Accounting Department Affairs
Chair -VP for Finance
-College Dean -VP for Administration
-College or University
President
Basic Professional Values and Ethics
 Integrity – to be straightforward and honest in all professional and business relationships.
 Objectivity – to not allow bias, conflict of interest or undue influence of others to override professional
or business judgments.
 Professional Competence and Due Care – to maintain professional knowledge and skill at the level
required to ensure that a client or employer receives competent professional services based on current
developments in practice, legislation and techniques and act diligently and in accordance with
applicable technical and professional standards.
 Confidentiality – to respect the confidentiality of information acquired as a result of professional and
business relationships and, therefore, not disclose any such information to third parties without proper
and specific authority, unless there is a legal or professional right or duty to disclose, nor use the
information for the personal advantage of the professional accountant or third parties.
 Professional Behavior – to comply with relevant laws and regulations and avoid any action that
discredits the profession.
Philippine Accountancy Act of 2004
The Republic Act 9298 (RA9298) otherwise known as the "Philippine Accountancy Act of 2004" serves
as the regulating law for the certified public accountants (CPAs) in the Philippines. The act was officially
promulgated on July 28, 2003 by the Congress of the Philippines. Topics and its accompanying details are
included in the CPA Board Examinations as part of the Auditing Theory subject.
Philippine Regulatory Authority
 Professional Regulation Commission (PRC) thru Board of Accountancy (BOA) - responsible for
administration, implementation and enforcement of regulatory policies on the regulation and licensing of
professionals and occupations under its jurisdiction.
 Philippine Institute of Certified Public Accountants (PICPA) - national organization of CPAs and the
accredited professional organization (APO).
 Bureau of Internal Revenue (BIR) - ensures compliance of national and business taxes and license
requirements of business and organizations.
 Securities and Exchange Commission (SEC) - keeps an eye in the operations of partnerships and
corporations
 Bangko Sentral ng Pilipinas (BSP) - regulates the operations of financial institutions, banks and business
import and export activities
 Local Government Units (LGU) - ensure payment of local taxes
Financial Reporting Standards Council (FRSC)
The Financial Reporting Standards Council (FRSC) was established by the Board of Accountancy (BOA
or the Board) in 2006 under the Implementing Rules and Regulations of the Philippine Accountancy of Act of
2004 to assist the Board in carrying out its power and function to promulgate accounting standards in the
Philippines. The FRSC’s main function is to establish generally accepted accounting principles in the
Philippines.
Professional Organizations of CPAs
 Philippine Institute of Certified Accountants (PICPA) is the accredited professional organization (APO)
of CPAs by the Professional Regulation Commission (PRC) and has been awarded twice as PRC most
outstanding APO from among other professional organizations. PICPA was founded in November 1929 by a
group of illustrious pioneers in the accounting profession: Enrique Caguiat, Santiago de la Cruz, Francisco
Dalupan, Jaime Hernandez, Felipe Ollada, Ramon del Rosario, Antonio Sanchez, Jose Torres, Artemio Tulio,
Clemente Uson and Jesus Zulueta. W. W. Larkin, holder of CPA Certificate No. 1, was its first president.
The group set forth the following objectives:
 To promote and maintain high professional and ethical standards among accountants;
 To advance the science of accounting;
 To develop and improve accountancy education;
 To encourage cordial relations among accountants, and
 To protect the Certificate of Certified Public Accountant granted by the Republic of the Philippines.
PICPA also functions as the policy making body of the following accounting organizations which function as its
implementing arms:
 ACPAPP - Association of CPAs in Public Practice
 ACPACI - Association of CPAs in Commerce and Industry
 ACPAE - Association of CPAs in Education
 GACPA - Government Association of CPAs
The professional organizations for Management Accounting fields are as follows:
 PAMA - Philippine Association of Management Accountants
 PIMA - Philippine Institute of Management Accounting
BUSINESS ORGANIZATIONS AND THEIR ACTIVITIES, AND USERS OF ACCOUNTING INFORMATION
Forms of Business Organizations
a. Sole or Single Proprietorship - Business is owned by only one person
Advantage Disadvantage
1. Ease of formation - do not go through 1. Unlimited liability - can go after
rigid registration process and can be personal properties even after extinguishing
formulated even with small amount of all business assets to satisfy claims of
capital creditors
2. Owner has full control of the business 2. Difficulty of raising additional capital -
- can single-handedly decide on matters owner is the only one who can provide
pertaining to the business additional capital
3. Owners can mix personal and business 3. Owner's bias - owner has the final
assets - in case of difficulties, may use word
personal assets to help the business recover
4. Owners have all profits for themselves
5. Simple taxation
b. Partnership - contract whereby two or more persons bind themselves to contribute money, property
(other assets owned by a person), or industry (skills and expertise) to a common fund, with the intention
of dividing profits among themselves and may also be formed for the exercise of a profession
Advantage Disadvantage
1. Easier to create than corporation 1. Unlimited liability
2. Better ability to acquire additional 2. Mutual agency
capital than sole proprietorship 3. Limited life
3. Larger pool of human capital than sole
proprietorship
c. Corporation - artificial being created by the operation of law, having the right of succession and the
powers, attributes and properties expressly authorized by law or incident to its existence
Advantage Disadvantage
1. Ability to acquire additional capital 1. Heavily regulated by the government -
 2. Transferable owner's rights - closely monitored by the government
ownership rights are represented by stocks 2. Double taxation - taxed on corporate
and can be transferred through sale, and individual level
donation or other modes of transfer 3. Not easy to form
3. Limited liability of stockholders 4. More expensive to form than sole
4. Virtually unlimited life - 50 years and proprietorship and partnership
can be extended (no limit in extension)
5. Large pool of human capital
Types of Business According to Activities
1. Service
Definition - generally use their employees to provide services to customers
Input - labor
Output - intangible; service
Advantages - absence of inventory; no production facilities
Disadvantages - inability to standardize services; maintaining human capital
Service revenue - primary source of revenue through performance of services
2. Merchandising
Definition - buy finished or almost finished goods from suppliers and resell the same to customers
Input - goods or merchandise bought from suppliers
Output - tangible; merchandise
Advantages - visible products; less conversion, time and effort
Disadvantage - managing inventory
3. Manufacturing (Manufacturers)
Definition - create their own products
Input - raw materials, labor, overhead
Output - tangible; manufactured products
Advantages - visible products; quality control
Disadvantages - generally need production facilities; high conversion costs; cost of quality control;
managing inventory
Users of Accounting Information

Activities in Business Organizations

 Financing Activities
 Organizations require financial resources to obtain other resources in financial markets
 Are the methods an organization uses to obtain financial resources from financial markets and how it
manages these resources. (e.g., repaying creditors and paying a return to the owners)
 Investing Activities
 Involve the selection and management including disposal and replacement of long-term resources that
will be used to develop, produce and sell goods and services. (e.g. Buying land, equipment, buildings
and other resources that are needed in the operation of the business and selling theses resources when
they are no longer needed.
 Operating Activities
 Involve the use of resources to design, produce, distribute, and market goods and services. (e.g. research
 and development, design and engineering, purchasing, human resources, production, distribution,
marketing and selling and servicing.
LESSON 2: ACCOUNTING STANDARDS
Basic Accounting Concepts and Principles
 Accounting Concepts refer to abstract ideas or assumptions which sets, governs, regulates and
standardizes practices in the accounting world.
 Accounting Principles is the so-called Generally Accepted Accounting Principles or GAAP. These
GAAPs are the doctrines, creeds, dogmas we apply and follow in the accounting practice.
 Framework is the basis of the Financial Reporting Standards (IFRS-PFRS), which addresses the
concepts underlying the information presented in general purpose financial statements.
The Basic Financial Statements and their definition
1. Statement of Financial Position shows the financial condition or position of the organization at any given
time.
2. Income Statement is the results of operating the business during a given time are reflected in the Income
Statement.
3. Statement of Changes in Equity shows movements of owner's capital for a particular period.
4. Cash Flow Statement reflects the financing and investing activities of the business or the sources and
applications of funds during the period.
5. Notes to Financial Statements are supplied to achieve proper understanding of the financial statements.
Objective of Financial Statements
The objective of financial statements is to provide information about the financial position, performance
and changes in financial position of an entity that is useful to a wide range of users in making economic
decisions.
Elements of Financial Statements
Statement of Financial Position elements
Asset, Liabilities and equity
Income Statement elements
Income and Expense
Recognition and Measurement Concepts and Principles
A. Recognition is the process of incorporating in the statement of financial position or income statement an item
that meets the definition of an element and satisfies the criteria for recognition.
1. Realization principle is also known as the Revenue Recognition principle. Revenue must be recognized
the earnings process is virtually complete and collection is reasonably assured.
2. Matching principle states that expenses are recognized in the same period as the related revenues are
recognized. Meaning, expenses recognition is driven by a matching process.
B. Measurement is the process of determining the monetary amounts at which the elements of the financial
statements are to be recognized and carried in the statement of financial position and income statement.
1. Historical cost principle states that the measurement of asset or liability must be based on the amount
given or received in the exchange transaction.
2. Current Cost - Assets are carried at the amount of cash or cash equivalents that would have to be paid if
the same or an equivalent asset was acquired currently. Liabilities are carried at an undiscounted amount of cash
or cash equivalents that would be required to settle the obligation currently.
3. Realizable (settlement) Value - Assets are carried at the amount of cash or cash equivalents that could
currently be obtained by selling the asset in an orderly disposal. Liabilities are carried at their settlement values;
that is, the undiscounted amounts of cash or cash equivalents expected to be paid to satisfy the liabilities in the
normal course of business.
4. Present Value - Assets are carried at the present discounted value of the future net cash inflows that the
item is expected to generate in the normal course of business. Liabilities are carried at their present discounted
value of the future net cash outflows that are expected to be required to settle the liabilities in the normal course
of business.
Criteria for General Acceptance of an Accounting Principle
1. Relevance- to the extent that it results in information that is meaningful and useful to those who need to know
something about a certain organization.

2. Objectivity- to the extent that the resulting information is not influenced by the personal bias or judgments of
those who furnish it. It connotes reliability, and trustworthiness. It also connotes verifiability, which means that
there is some way of finding out whether the information is correct.
3. Feasibility- to the extent that it can be implemented without undue complexity or cost.
Basic Accounting Principles
1. Objectivity Principle- Accounting records and statements are based on the most reliable data available so that
they will be accurate and as useful as possible.
2. Historical Cost- states that acquired assets should be recorded at their actual cost and not at what
management thinks as at the reporting date.
3. Revenue recognition principle
4. Expense recognition principle
5. Full disclosure principle – Information communicated to users reflect a balance between detail and
conciseness, keeping in mind the cost-benefit principle.
6. Materiality Principle
7. Consistency Principle- Like transactions are accounted for in like manner from period to period.
Basic Accounting Assumptions
A. Underlying Assumptions
 Accrual Basis Assumption recognized income when earned and expenses when incurred irrespective of
the timing of cash receipt or payment
 Going Concern Assumption presumes organizations to operate continuously or indefinitely.
B. Inherent or Implicit Assumptions
 Economic Entity or Separate Entity Assumption presumes that economic events and transactions can be
identified with an economic entity.
 Periodicity or Time Period Assumption refers to the equal length of time or relatively short periods of
the economic life of the organization.
 Monetary Unit Assumption states that elements of financial statements must be measured in terms of
Philippine Peso currency.
Qualitative Characteristics
1. Understandability - Users are assumed to have a reasonable knowledge of business and economic
activities and accounting and willingness to study the information with reasonable diligence.
2. Relevance - Information has the quality of relevance when it influences the economic decisions of users
by helping them evaluate past, present and future events confirming, or correcting, their past
evaluations.       
a. Materiality depends on the size of the item or error judged in the particular circumstances of its
omission or misstatements.
b. Predictive Value - Accounting information should be helpful to external decision makers by
increasing their ability to make predictions about the outcome of future events.
c. Feedback Value - Accounting information should be helpful to external decision makers who are
confirming past predictions or making updates, adjustments, or corrections to predictions.
d. Timeliness - Accounting information must be available on time when needed if it is to influence
decisions. Lack of timeliness reduces relevance.  Information is useless if not available when
needed.
3. Reliability - Information has the quality of reliability when it is free from material error and bias and can
be depended upon by users to represent faithfully that which is either purports to represent or could
reasonably be expected to represent.
a. Faithful representation - A statement of financial position should represent faithfully the
transactions and other events that result in assets, liabilities and equity of the entity at the
reporting date which meet the recognition criteria.
 b. Substance over form - If information is to represent faithfully the transactions and other events
that it purports to represent, it is necessary that they are accounted for and presented in
accordance with their substance and economic reality and not merely their legal form.
c. Prudence is the inclusion of a degree of caution in the exercise of the judgments needed in
making estimates required under conditions of uncertainty, such that assets or income are not
overstated and liabilities or expenses are not understated.
d. Completeness - To be reliable, the information in financial statements must be complete within
the bounds of materiality and cost. An omission   can cause information to be false or misleading
and thus unreliable and deficient in terms of its relevance.
e. Neutrality - To be reliable, the information contained in financial statements must be neutral, that
is, free from bias.
4. Comparability - Users must be able to compare the financial statements of an entity through time in
order to identify trends in its financial position and performance. Users must be able to compare the
financial statements of different entities in order to evaluate their relative financial position, performance
and changes in financial position.
a. Consistency - The reported accounting information should conform to procedures and methods
that remain unchanged from one period to another. Comparisons over time are difficult unless
there is consistency in the way accounting principles are applied across fiscal years.
 Constraints on Relevant and Reliable Information
1. Timeliness - Management may need to balance the relative merits of timely reporting and the provision
of reliable information.
2. Balance between benefit and cost - The benefits derived from information should exceed the cost of
providing it.
3. Balance between qualitative characteristics - Generally, the aim of financial statements is to achieve an
appropriate balance among the characteristics in order to meet the objective of financial statements.
4. True and fair view/fair presentation - Financial statements are frequently described as showing a true
and fair view of, or as presenting fairly, the financial position, performance and changes in financial
position of an entity
The Accounting Equation and the Double Entry System (Part 1)
The Accounting Equation
Assets = Liabilities + Equity
Assets - are valuable resources owned by the entity
Characteristics of an asset:
 Controlled by the enterprise- Control is the ability to obtain the economic benefits and to restrict the
access of others.
 Past events- The event must be past before an asset can arise.
 Future economic benefits- these are evidenced by the prospective receipt of cash. This could be cash
itself, an account receivable or any item which may be sold.
Examples of assets:
Cash, Cash equivalents, notes receivable, accounts receivable, inventories, prepaid expenses, property, plant
and equipment, investments, intangible assets and other assets.
Classification of Assets
 Current Assets- assets that are expected to be realized, sold or consumed within the enterprise’s normal
operating cycle.
 Non-Current Assets - All other assets which are not current and are expected to be realized in more than
12 months
Examples of Current assets
1. Cash
 Most basic and familiar of all assets
 Also includes money in the form of bank deposits, cash equivalents and checks
 Most liquid
  Money – everything composed of bills and coins, considered as legal tender or legal tenders of other
nations
 Cash Equivalents – short-term investments which are considered subject to negligible changes in fair
value, and are maturing within three months from the date of purchase
2. Accounts Receivable
 Oral promises to the entity to receive cash at a later date and usually arise from the normal course of
business
 Trade Receivables - arise from the normal course of business
 Non-Trade Receivables – do not arise from the normal course of business (other receivables)
3. Short-Term Investments
 Investments in low-risk, highly liquid assets such as bonds and stocks, which are expected to be
liquidated in less than a year
 Most often, these are entered to make the most income out of its idle cash
4. Notes Receivable
 Written promises to the entity to receive cash at a later date and usually arise from the normal course of
business
 Sometimes called promissory notes
5. Inventories
 Includes raw materials, work-in-process items, finished goods and supplies
 Raw Materials – inputs for producing other materials
 Work-In-Process Items – raw materials entered into production but awaiting completion
 Supplies – do not serve as input for a product but are used in the production
 Finished Goods – end products upon completing production
6. Prepayments
 Paid in advance for goods or services anticipated to be received by the entity in the future
 Would only cease to be as such when they are finally used up
Examples of Non-Current assets
1. Investments
 Most liquid of the non-current assets
 Investments which are not expected to be realized within 1 year
2. Fixed Assets
 Most tangible, longest-serving assets
 Expected to not be converted into cash immediately and regularly placed as a means of production
 Not usually consumable and are only used through utilization
 Depreciation – deterioration with the passage of time, through usage, normal wear-and-tear, and
obsolescence (except land)
3. Intangible Assets
 Lack physical substance and yet are similarly realizable over long periods of time
 Value and assets are harder to measure and evaluate
 Includes patents, copyrights, franchises, goodwill, trademarks and licenses
 Often are represented by written documents or certificates stating their description and ownership status
4. Other Assets
 All remaining assets which do not fall into any of the accounts mentioned
 Catch-all for assets which are usually very much unique or hard to classify
Liabilities - are obligations of the entity to outside parties who have furnished resources
Characteristics of a Liability:
1. Obligations- may be legal or not.
2. Transfer economic benefits- this could be transfer of cash, or other property, the provision of a service or the
refraining from activities which would otherwise be profitable.
3. Past events
4. Complementary nature of assets and liabilities - as should be evident from the above, assets and liabilities are
seen as mirror images of each other.
Examples of Liabilities
Notes payable, accounts payable, accrued liabilities, unearned revenues, mortgage payable, bonds payable, and
other debts of the enterprise.
Classification of Liabilities
1. Current Liabilities - Expected to be settled or paid out within 12 months
Paying Out – not necessarily payment through cash, can also be conversion and/or refinancing
2. Noncurrent Liabilities - Form the residual portion of liabilities
Liabilities that are expected to be settled after more than a year, or have a legal or contractual capacity to defer
payment accordingly
Examples of Current Liabilities
1. Accounts Payable
 Opposite of accounts receivable
 Contemplate only about borrowings involved in the production process
2. Notes Payable
 Written promises of the entity to pay sum certain in a future determinable time
 Can also arise from the regular borrowings
 Opposite of notes receivable
 Pay interest regularly and may be paid in lump sum or instalments
3. Accrued Liabilities
 All other accounts which the company should pay, arising from the normal course of business
 Company has already received benefits from certain events yet still been unable to pay for it
4. Current Portion of Long-Term Debts
 Portion of the remaining debt that is due many years from now
5. Other Payables
 All other due from the entity outside the normal course of the business
 Catch-all classification
Examples of Non-Current Liabilities
1. Bonds Payable
 Degree more formal than notes payable
 Have stated interest rates
 Usually issued by the government, banks and huge corporations seeking huge financing sources
Bond Indenture – agreement of a long-term debt, often in huge sums
Term Bonds – Have principal maturing in a single date
Serial Bonds – Have principal maturing in multiple dates
Equity - Residual interest of the owners in the assets of the business after considering all liabilities
 Owner’s Capital – equity of sole proprietorships and partnerships
 Stockholder’s Equity – equity of corporations
Capital - this account is used to record the original and additional investments of the owner of the business
entity.
Withdrawals - When the owner of the business entity withdraws cash or other assets, such as recorded in the
drawing or withdrawal account rather than directly reducing the owner’s equity account.
Income Summary – It is a temporary account used at the end of the accounting period to close income and
expenses.
Stockholder’s Equity
1. Common Share
 Security which represents ownership in a corporation
Common Shareholders – those who own common stocks
Rights of a Common Shareholder:
 Right to vote in the stockholder’s meetings
 Right to receive dividends
  Pre-emptive right which is the right to be offered first to buy additional shares in the event of future
issuance
Par Value – legal nominal value assigned to stocks
2. Preferred Stock
 Also, a security which represents ownership in a corporation
 Has preference as to corporate dividends and/or liquidation
Preferred Stockholders – those who own preferred stocks
Treasury Shares – shares bought by the corporation itself and have the effect of decreasing total shareholder’s
equity
3. Additional Paid-in Capital
 Also called share premium
 Excess over par value contributed by the company’s shareholders in a stock issue
 Arises from the selling of the stock at higher price than the par value
4. Retained Earnings
 Accumulated net income from operations over several periods
 Measure of how much the company earned since day one of its operations
Increases in Equity
Revenues – amounts received by a business earned as a result of selling something or rendering a service
Operating Revenue – originate from main business operations
Sales Revenue – main source of revenue for businesses that sells products
Service Revenue - main source of revenue for businesses that render services
Non-Operating Revenue – result of some side activities
Interest Revenue –earned as a result of investment in debt securities or receivables from other
entities
Dividend Revenue – earned as a result of dividend declaration of a company where in a business
has invested stocks
Contributions Revenue – earned by not-for-profit organizations usually in the form of donations
by outside parties
Gains – result of non-recurring activities or the increase in value of investments
Capital Contributions – result of transactions with owners and may be in the form of cash or non-cash assets for
the use in the business
Decreases in Equity
Result of expenses, losses and distribution to owners
Expenses – amounts consumed by the business to operate and the result of attempting to generate revenues
Cost of Goods Sold – incurred by the company to make the inventory sell or buy them
Utility Expense – water and electricity
Depreciation Expense – use of building and equipment
Office Supplies Expense – use of office supplies
Insurance Expense – insurance paid for, expiring over time
Salaries Expense – salaries and benefits of employees
Bad Debts Expense – estimate of how much accounts receivable the company will not be able to collect
Interest Expense – incurred as a result of borrowing money
Losses – direct opposite of gains
Distribution to Owners – assets given to owners, usually in cash
Liquidating Dividends – originate from some other equity account
The Expanded Accounting Equation
Assets = Liabilities + Equity + Income - Expenses
INCOME – is increases in economic benefits during the period in the form of increases in assets, or decreases
in liabilities, that result in increases in equity, excluding those relating to investments by the business owner.
EXPENSES – are decreases in economic benefits during the period in the form of decreases in assets, or
increases in liabilities, that result in decreases in equity, excluding those relating to distributions to the business
owner.
The difference between income and expenses represents profit or loss.