MODULE OVERVIEW

This module provides a reinforcement of basic accounting, within the context of business and business
decisions. Structured according to prepared course syllabus, students are expected to obtain knowledge
of the principles and concepts of accounting as well as their application that will enable them to appreciate
the production of accounting data.

Emphasis is placed on understanding the reasons underlying basic accounting concepts and providing
students with an adequate background on the recording of transactions, their classifications and reporting
function of accounting in a service firm through the preparation of Statement of Financial Position, Income
Statement, Statement of Changes in Equity, and Cash Flow Statement. Exposure through the use of
numerous problems and practice sets (both those found in the module and those to be given by the
instructor as the term progresses) in recording and reporting transactions is a requirement in this course.

In no way is this module deemed to be absolutely adequate and complete for the learning of basic
accounting. Reading of other materials and practice through problems and exercises are greatly
encouraged.

LEARNING OUTCOMES

After this completing this course, the student is expected to:

Define accounting and discuss the importance of accounting as a language of business.

Understand the framework of accounting, its functions, principles, and assumptions; and to name the
financial statements and their elements and understand their relationships

Identify and differentiate business transactions, explain the accounting cycle, and understand and
prepare journal entries

Transfer data from journals to ledgers and prepare basic financial statements; analyze the results of
business transactions

Prepare adjusting entries, closing, entries; prepare the post-closing trial balance; prepare and post
reversing entries
 1 - INTRODUCTION TO ACCOUNTING

CONTENT
1. Definition, purpose, nature, functions, scope, and objectives of accounting
2. Users of accounting information
3. History of accounting
4. Forms of business organization
5. Types of businesses and kinds of business activities
6. Relationship between business and accounting

DEFINITION OF TERMS
Entity refers to any firm or organization (for-profit or non-profit). However, in this module, the term will
mostly be used to refer to any business enterprise.

DEFINITION OF ACCOUNTING
American Accounting Association
Accounting is the process of identifying, measuring, and communicating economic information to permit
informed judgment and decision by users of the information.

American Institute of Certified Public Accountants

Accounting 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.

Financial Reporting Standards Council

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 decisions.

Basic Purpose Accountable event – an economic

To provide quantitative financial information about a business that event which has an effect on
is useful to statement users particularly owners and creditors, in
assets, liabilities and equity
making economic decisions.

Functions of Accounting
1. Identifying accountable events – means the recognition or non-recognition of economic activities

2. Measuring accountable events – is the process of determining the monetary amounts at which
elements of the financial statements are to be recognized.

3. Communicating accountable events – is the process of preparing and distributing accounting

reports to potential users of accounting information

WHY STUDY ACCOUNTING?

“For most people accounting is not remotely important.
Anyone in any sort of white-collar job [] is likely to run into
budgets and be held accountable for things (even if they
are not that much within their control). To a degree
therefore some competence in reading figures and how to
present them matters.” (Thomson, 2019)

Even for non-accountants, accounting knowledge will be a

very important asset. More so since everyone can become
an entrepreneur. Knowledge in accounting will surely be of great help to keep the business in good health
and even help it succeed and grow.

“Financial statements contain important information about your company’s operating results and financial
position. The relationship between certain items of financial data can be used to identify areas where your
firm excels and, more importantly, where there are opportunities for improvement. Using, understanding,
and interpreting these statements will help you make much better business decisions.” (Gettler, 2013)

Even for other employees and managers, accounting gives a better understanding of how their organization
works. They end up with better control and confidence over their budgets and careers.

It makes the point that managers can’t afford not to understand basic accounting.

“Financial management is a crucial aspect of any thriving business. Profit maximization is a real concern
for any organization – and it depends on solid financial decisions. To make good decisions, management
needs good information. And that information comes from the accounting system.

According to an online article by Tax and Accounting Center, Inc., accounting is a must-learn
for owners of Small & Medium Enterprises in the Philippines so that they will not be at the
mercy of retainer paid accountants or bookkeepers. But even if your skill is not enough to
independently produce complete financial statements for compliance, minimum skill and
knowledge will go a long way, from having good company recording and control procedures
to avoiding exploitation and fraud and many more.

Branches of Accounting
1. Public Accounting
a. Auditing – involves examination of financial statements of clients for the purpose of
expressing an opinion as to the fairness with which the financial statements are prepared
b. Tax services – involves the preparation of tax returns and the determination of tax
consequences of certain proposed business endeavors
c. Management advisory services – involves the development and interpretation of
accounting information intended specifically to aid management in running the business
2. Private Accounting
a. General accounting – includes bookkeeping and preparation of financial reports
b. Cost accounting – involves determining and controlling costs
c. Budgeting – involves preparation of financial plan as well as preparation of report
summarizing deviations from plan after the plan has been implemented
d. Internal auditing – involves examination of financial records of the company to detect
fraud and other malpractices and to ensure adherence to established accounting
procedures
e. Government accounting – involves analyzing, classifying, summarizing, and
communicating all transactions involving receipt and disposition of government funds and
property and interpreting the results thereof
f. Accounting education – the CPA serves as a faculty member in accounting in various
colleges and universities
g. International accounting – this is concerned with the transactions of multinational
companies in their dealings in the international trade

Users of Financial Information

A. Primary Users
1. Existing and potential investors – they need to determine whether to hold, buy, or sell
their investments
2. Lenders and Creditors – these are potential and existing creditors. They need information
on the capability of the business to pay loans and interests when they fall due
 B. Other Users
1. Employees – these comprise the labor force of the business firm. They want to know
whether the business has the ability to provide and sustain remuneration, other benefits
and growth. The firm’s stability and profitability can be determined through analysis of the
financial reports.
2. Customers – Customers who have businesses of their own are sometimes dependent on
the company for the smooth operation of their businesses. They need information about
the company’s stability and profitability
3. Government and its agencies – they require information to regulate the activities of the
entity, determine taxation policies, and as a basis for national income and similar statistics
4. Public – the financial statements may assist the public by providing information about the
trends and recent developments in the prosperity of the entity and the range of its activities

Exercise 1.1: Classify the following users as primary or secondary.

ENTITY USER USER TYPE SPECIFIC USER
(Primary/Secondary) CLASSIFICATION
1. Bank Depositor
2. Shampoo Households
Manufacturer
3. Any business BIR
4. Any business Securities and
Exchange
Commission
5. SME Lending company
6. San Miguel Inquiring buyer of
Corporation shares

Double-Entry Bookkeeping
This is based on the fundamental accounting assumption that all business transactions have two-fold
effects – that for every value received, there is a corresponding equal value given up.

HISTORY OF ACCOUNTING
Early Times
Accounting records are made by making markings on whatever surface that was most convenient – stones,
clay tablets, papyrus. The Romans for example kept elaborate records and their systems were standardized
for military payrolls and the accountability of provincial governors. However, they did not develop any
system of commercial bookkeeping since numbers were expressed in terms of letters in the alphabet.

14th to 15th Century

The Italians pursued trade and commerce vigorously and developed extensive record-keeping systems.
They learned numerals and the basics of arithmetic from the Arabs. This paved the way to the development
of the double-entry bookkeeping system. Because of their efforts in finding ways to come up with functional
record-keeping systems, they were regarded as the fathers of modern accounting. Some note-worthy works
of the Italians are:

• The Genoese system (From Genoa, northwest Italy) assumed the concept of business entity
because it was the first to imply that unlike items could be compared in terms of a common
monetary unit. It also implied distinctions between Capital and income that it included both
expenses and equity accounts. The oldest double-entry books were the Massari ledgers of the
Commune of Genoa from 1340.
 • The Florentine System (Florence, Italy) kept records in great detail almost in narrative form. It listed
debits above credits rather than on separate pages. Separate columns for transactions were
needed to record which monetary value was used. It was also in Florence where development of
big companies such as partnerships took place.
• The Venetian System (Venice, Italy) is the key influence on double-entry bookkeeping. The earliest
Venetian records show an accounting system that was highly developed, including the first true
journal used in Renaissance bookkeeping.

The title of father of the double-entry bookkeeping system, however, was given to
an Italian monk named Fra Luca Pacioli. He wrote the first published work on the
topic called “SUMMA DE ARITHMETICA GEOMETRIA PROPORTIONIS ET
PROPORTIONALISTA in 1494. He did not necessarily invent the system but he
formalized the practice and ideas which have been evolving in the years before and
presented the world with the essentials of bookkeeping as it is known today. Other
Portrait of Pacioli; Source: Wikipedia.com
men in other countries also began to explore about the subject.

16th – 18th century

During this period, the center of commerce shifted sequentially from Italy to Spain, to Portugal, and then to
Northern Europe. With the commercial shift was an accompanying shift in accounting development.
• 1673 – France adopted the first official accounting code, which required, among other things, that
balance sheets should be drawn up every two years. It was also during this period that the practice
of treating accounts as independent living entities started along with the standardization of debits
on the left, credits on the right.
• 1700 – The French revolution led to the development of the Savory and the Napoleon communist
code. The serious study of accounting and development of accounting theory also began in this
period and has continued to the present day.

Industrial Revolution
The social and economic changes in Great Britain, Europe, and the United States that began in the second
half of the 18th Century and involved widespread adoption of industrial methods of production. The
specialization of tasks, the concentration of capital, and the centralization of work forces were important
aspects of these changes, which first affected Great Britain. The industrial revolution had catapulted
England into an unrivaled prosperity. Great Britain was the financial center of the civilized world. With
industrial breakthroughs and shifts in business forms from proprietorship to partnership and stock
companies, came also new trends in accounting to answer the needs of the industry. Accounting for
depreciation has started as well as allocation of overhead and inventory accounting. Increased government
regulation of business made new demands on firms, which also generated new accounting systems. Most
notable is the increased taxation of business and individuals which brought with it new tax accounting
systems and procedures.

In rapidly globalizing world, it only makes sense that same economic transactions are accounted for in the
same manner across various jurisdictions. This is reason why the Philippines has adopted the International
Financial Reporting Standards or IFRS. Thus, Philippine Financial Reporting Standards directly correspond
to IFRS.

However, accounting systems still differ among countries

Accounting variations among countries
due to the following:
1. Differences in economic condition (e.g. degree of Factors causing the differences:
industrialization, rate of inflation, level of economic • Economic condition
growth) • Educational system
2. Educational systems • Political system
3. Political systems
• Legal system
4. Legal systems
5. Socio-cultural characteristics • Socio-cultural characteristics
GENERALLY ACCEPTED ACCOUNTING STANDARDS (GAAPs)

GAAPs represent rules, procedures, practice, and standards followed in the preparation and presentation
of FS. These are like “Laws” that must be followed in financial reporting.

In the Philippines, the Financial Reporting Standards Council is the accounting body tasked with the
establishing of generally accepted accounting principles. Approved statements of the body are called
Philippine Financial Reporting Standards.

PURPOSE OF ACCOUNTING STANDARDS

Financial statements, when prepared in accordance with GAAPs, permit comprehensive analysis and
evaluation and therefore become more credible and reliable to statements users. In other words, the
purpose of accounting standards is to identify practices for preparation and presentation of FS to promote
a common understanding between preparers and FS users.

International Accounting Standards Committee

The IASC, an independent private sector body, with the objective of achieving uniformity in the accounting
principles which are used by business and other organizations for financial reporting around the world, was
formed in 1973 through an agreement made by professional accountancy bodies from Australia, Canada,
France, and many other nations. The IASC is headquartered in London, United Kingdom. In 2001, the IASC
was reorganized into IASB.

Objectives of the IASC

1. To formulate and publish accounting standards to be observed in the presentation of financial
statements and to promote their worldwide acceptance and observation.
2. To work generally for the improvement and harmonization of regulations, accounting standards and
procedures relating to the presentations of financial statements.

*Approved statements of the IASB are known as INTERNATIONAL FINANCIAL REPORTING

STANDARDS (IFRS).

Exercise 1.2:
1. Choose a period or point in the history of accounting that interests you. Do a short research and
explain in a few paragraphs what you have learned, relating its significance to present day practice.

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*You may choose to use a separate sheet if space is inadequate, or submit an encoded work but make sure to credit
proper sources. Summarized answers are encouraged.

2. Is it alright for countries to differ in accounting policies, or is it absolutely necessary to have

uniformity in accounting practices?

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LEGAL FORMS OF BUSINESS ORGANIZATIONS
A. Proprietorship – owned by a single person who has complete control over business decisions
Advantages:
Ease of entry and exit Tax savings
Full ownership and control Few government regulations
Disadvantages:
Unlimited liability
Limitations in raising capital
Lack of continuity
B. Partnership – a legal arrangement in which two or more persons agree to contribute capital or
services to the business and divide the profits or losses that may be derived therefrom.
Advantages:
Ease of formation Management base
Additional sources of capital Tax implication
Disadvantages:
Unlimited liability Difficulty of transferring ownership
Lack of continuity Limitations in raising capital
C. Corporation – an artificial being created by operation of law and is a legal entity separate and
distinct from its owners
Advantages:
Limited liability Ease in transferring ownership
Unlimited life Ability to raise capital
Disadvantages:
Time and cost of formation
Regulation
Taxes

Types of Businesses
A. Service – does not deal with tangible products, but provides some sort of service as its major
operation
B. Merchandising – involved in selling the finished goods produced by other businesses
C. Manufacturing – involved in the conversion of raw materials into some tangible, physical product

TYPES OF BUSINESS ACTIVITIES

A. Operating Activities – principal revenue-producing activities of an enterprise and include:
a. Delivering or producing goods for sale
b. Providing services
B. Financing Activities
a. Obtaining resources from and returning resources to owners
b. Obtaining resources through borrowings (short-term or long-term)
c. Repayments of amounts borrowed
C. Investing Activities
a. Acquisition and disposition of property, plant, and equipment (PPE) and other long-term
assets
b. Acquisition and disposition of debt and equity instruments of other enterprises that are
not considered cash equivalents or held for dealing or trading purposes

RELATIONSHIP BETWEEN BUSINESS AND ACCOUNTING

Accounting is the way a business keeps track of its operations. Accountants analyze the business finances
so the owner can make better decisions. This information is organized into reports that show the financial
health of a business. Accounting helps business owners meet their compliance obligations. (Xero Limited,
n.d.)
Going back to the purpose of accounting, it helps business stakeholders make better decisions through
the recording and processing of economic information. Through accounting, managers and owners
monitor the business enterprise’s health and respond to maintain or improve condition and performance.

EXERCISE 1.3:
1. Contrast the definitions of accounting given by FRSC, AICPA, and AAA [Do not write the definitions
here word-for-word]. Which one gives a clearer picture of what accounting is?

2. What is the basic purpose of accounting? How is this purpose attained?

3. What are the functions of accounting? Explain each.

4. Who are the users of financial information and what are their particular needs?

5. What is the importance of generally accepted accounting standards?

6. What are the forms of business organizations?

Exercise 1.4:
1. Identify the form of business organization according to the characteristic presented. If it applies
to more than one form of organization, select all that applies.

Characteristic Legal Form of Business Nature of Characteristic

Organization (advantage or disadvantage)
1. Ease of transferring ownership

2. Lack of continuity

3. Capital base

4. Management base

5. Limited life

6. Regulation

2. In your own words, how will you relate accounting to business?

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 3. Identify the type of business activity by analyzing the following business transactions:

Type of Business
Business Transaction
Activity
1 The owner invested P200,000 cash in the business.
2 Paid the loan due to BANCO DE ORO, P50,000
3 Rendered service to a customer on account, P3,000
4 Paid the FICELCO bill, P4,350
5 Bought a delivery truck on account, P450,000
6 The owner withdrew cash from the business for personal use, P5,000
7 Paid the rent for the month, P10,000
Sold an old computer for P500. The computer has a book value of P2,000 at
8 the time of sale.
9 An account customer paid his account in full, P2,560
The account with a certain supplier was paid by issuing a check for the full
10 amount, P12,000
 2 - THE ACCOUNTING FRAMEWORK

CONTENT
1. Basic accounting assumptions
2. Functions of accounting
3. The basic financial statements
4. Elements of financial statements

ACCOUNTING CONCEPTS AND PRINCIPLES

Objective of FS – to provide information about the financial position, performance, and cash flows of an
entity that is useful to a wide range of users in making economic decisions.

Accounting Assumptions are basic notions or fundamental premises on which the accounting process is
based.
1. Going Concern Assumption means that the entity is viewed as continuing in operation indefinitely
in the absence of evidence to the contrary statements.
2. Accrual Assumption means that income is recognized when earned regardless of when received
and expense is recognized when incurred regardless of when paid.
3. Accounting Entity Assumption states that the enterprise is separate from the owners, managers,
and employees who constitute the firm. Transactions of the firm must not be merged with
transactions of the owners.
4. Time Period Assumption requires that the indefinite life of an enterprise is subdivided into time
periods of accounting periods which are usually of equal length for the purpose of preparing FS.
5. Monetary Unit Assumption has two aspects:
a. Quantifiability – means that elements of the FS should be stated in terms of a unit of
measure which is the peso in the Philippines
b. Stability of Peso – means that the purchasing power of peso is stable or constant and that
its instability is insignificant and therefore may be ignored. The accounting function is to
account for pesos only and not for changes in its purchasing power.

Identifying Function of Accounting

This is the recognition or non-recognition of accountable events. There are four recognition principles:
1. Asset recognition
2. Liability recognition
3. Recognition of income
4. Recognition of expense

RECOGNITION PRINCIPLES – Recognition as defined by the Conceptual Framework is the process of

capturing for inclusion in the statement of financial position or the statement(s) of financial performance an
item that meets the definition of an asset, a liability, equity, income or expenses.

Basically, whether to recognize an element answers the questions, “Should we record it? Should we make
a journal entry? Should it be included in the financial statements?”

Recognition is appropriate if it results in both relevant information about assets, liabilities, equity, income
and expenses and a faithful representation of those items, because the aim is to provide information that is
useful to investors, lenders and other creditors.

• Asset - A present economic resource controlled by the entity as a result of past events. An
economic resource is a right that has the potential to produce economic benefits.
• A present obligation of the entity to transfer an economic resource as a result of past events. An
obligation is a duty or responsibility that the entity has no practical ability to avoid.
• Income - Increases in assets, or decreases in liabilities, that result in increases in equity, other than
those relating to contributions from holders of equity claims.
 • Expenses - Decreases in assets, or increases in liabilities, that result in decreases in equity, other
than those relating to distributions to holders of equity claims.

These terms will be explained further later.

Measuring Function of Accounting

1. Historical Cost – original acquisition cost
2. Current Cost – replacement cost or current purchase price
3. Realizable Value – current selling price
4. Present Value – discounted value of future net cash inflows that the asset is expected to generate
in the normal course of business

Communicating Function of Accounting

Financial statements
1. Statement of financial position
2. Income statement
3. Statement of comprehensive income
4. Statement of changes in equity
5. Statement of cash flows
6. Notes to financial statements

*The statements enumerated above are those required to be presented under Philippine Financial
Reporting Standards. Other reports may still be made by companies for other purposes.
*Numbers 3 & 6 are tackled in higher accounting subjects. The rest are basic financial statements
introduced in basic accounting courses. SOCI is a complete statement that covers items not reported in the
Income Statement, and the Notes to financial statements clarify accounting procedures used by a company,
as well as to divulge information that has occurred during and immediately after the close of the accounting
period.
STATEMENT OF FINANCIAL POSITION
This is a formal statement showing the financial position of an entity as of a particular date. The
balance sheet shows the three elements of financial position, namely:

1. Assets Operating Cycle

These are properties or things of value, tangible or
intangible, controlled by the entity as a result of This is the time from the acquisition of asset to the time
past transactions and events and from which future this asset is realized into cash or cash equivalents in the
economic benefits are expected to flow to the ordinary course of business.
entity. An entity which conducts business on cash basis has a
shorter operating cycle than that of a business which
2. Liabilities extends credit to customers.
These are present obligations of an entity arising
from past transactions or events, the settlement of
Cash
which is expected to result in an outflow of asset
from the entity.

3. Owner’s Equity Cash sale Inventory

This is the residual interest of the owner or owners
in the assets of the business entity. Also known as
Operating Cycle of a cash-basis business
net assets. The other term for owner’s equity is
capital.
Cash
ASSETS
Characteristics:
Collection Inventory
1. Acquired from a past event
2. Value of the assets can be measured reliably
3. Will give future economic benefits to the owner
4. Owner of the assets has complete control over Axxount Credit

them and has the legal capacity to restrict Receivable Sale

others from using these assets

Operating Cycle of a business extending credit

*Note that even if an entity is expecting to receive

any payment or asset (say, someone has promised to give or donate property) if such cannot be
reliably measured, no recognition will be made, although the information may be disclosed in
Notes to Financial Statements.

Classification:
1. Current Assets – include unrestricted cash or cash equivalents and other noncash items
which are expected to be realized, sold, or consumed within the normal operating cycle.
2. Noncurrent Assets – those assets which cannot be classified as current

Examples of Current Assets

1. Cash – literally money, coins and currency that are legal tender or standard medium of
exchange
2. Cash equivalents – highly liquid investments readily available for cash, normally within
3mos.
3. Marketable securities - short term investments that can be realized into cash within a year
4. Accounts receivable – collectibles from customers arising from credit sales in the ordinary
course of business. These are open accounts not covered by promissory notes, otherwise,
they are called Notes receivable.
 5. Merchandise inventory – goods or products acquired to be sold to customers at a profit
6. Prepaid expenses – represent unused portion of an expense that has already been paid
for
Normally, prepaid expenses are determined at the end of the reporting period.
Examples of prepaid expenses:
Prepaid supplies – unused office supplies like pens, coupon bonds, ink, etc.
Unexpired insurance – portion of insurance premium that has not been used yet
Prepaid rent – portion of rent that has not yet expired
7. Interest receivable – represents interest earned on promissory notes issued by customers

Examples of Noncurrent Assets

1. Property, plant and equipment – tangible assets Property, plant, and equipment
held for use in production or supply of goods and
services, for rental to others, or for administrative (PPE), except Land, are shown in the
purposes and are expected to be used during Balance Sheet net of accumulated
more than one period (PAS 16) depreciation.
2. Long-term investments – intended to be held for
more than a year
3. Intangible assets – identifiable nonmonetary asset without physical substance
4. Other noncurrent assets

Examples of PPE
1. Land – the lot the business owns
2. Building – the structure owned and used by the business in its operation
3. Equipment
a. Office equipment like computers, typewriters, fax machines, copiers
b. Delivery equipment like trucks, van, tricycle
c. Transportation equipment like cars, motorcycle used by owner in transacting
business
d. Store equipment like cash register, money counters, detectors
e. Shop equipment like computers and printers in a computer shop; welding and
press machine in a machine shop; or cellphones in a loading station.
4. Furniture and fixtures – appliances, cabinets, show cases, sala sets, audio and video units
5. Tools – like screwdrivers, pliers, etc.

LIABILITIES
Characteristics:
a. Present obligation of the business
b. Arises from a past transaction or event
c. Settlement of the liability requires the transfer of cash and noncash assets or to provide
services at some future date

Classifications of Liabilities
1. Current liabilities – expected to be settled within 12 months after the reporting period or
within the normal operating cycle
2. Noncurrent liabilities – those not classified as current

Examples of Current Liabilities:

1. Accounts payable – obligation or debt to suppliers for purchases of goods or services on
credit in the ordinary course of business not covered by a promissory note
 2. Notes payable – obligation in the ordinary course of business covered by a note
3. SSS premium payable – premium deducted by employer from employees’ salaries to be
remitted to the Social Security System
4. Withholding taxes payable – taxes withheld for employees to be remitted to the BIR
5. Philhealth contributions payable – medical contributions deducted from employees’
salaries to be remitted to PHILHEALTH
6. Accrued expenses – expenses incurred but not yet paid, like rent payable, salaries
payable, utilities payable (bills for water, electricity, telephone, etc.)

Examples of Noncurrent Liabilities:

1. Mortgage payable – loans with real property given as collateral
2. Bank loan payable – those payable beyond 1 year from the balance sheet date
3. Notes payable -those payable beyond 1 year from the balance sheet date

OWNER’S EQUITY
Account titles:
1. (Name of owner), capital – used to record investments of the owner
2. (Name of owner), withdrawals – used to record withdrawals of owner from the business
assets

Forms for the STATEMENT OF FINANCIAL POSITION

1. Report form – the three sections: Assets, Liabilities, and Equity are presented following a
downward sequence
2. Account Form – assets are presented on the left side while Liabilities and Equity on the right
side.

An accountant is having a hard time sleeping and goes to see his doctor. “Doctor, I just
can’t get to sleep at night.” “Have you tried counting sheep?” “That’s the problem – I make a
mistake and then spend three hours trying to find it.”
Sample Statement of Financial Position

Report Form

ARIATE LAW OFFICE

STATEMENT OF FINANCIAL POSITION
January 1, 2020

ASSETS
Current Assets
Cash PHP 30,000
Accounts Receivable 45,000
Prepaid Advertising 5,000
Prepaid Insurance 10,000
Office Supplies 500
Total Current Assets PHP 90,500

Noncurrent Assets
Property, plant and equipment 20,000
Less: Accumulated depreciation 5,000
Total Noncurrent Assets 15,000

TOTAL ASSETS PHP 105,500

LIABILITIES AND OWNER'S EQUITY

Current Liabilities
Accounts Payable PHP 30,000
Accrued Expenses 8,000
Unearned Fees 20,000
Loan Payable 30,000
Total Current Liabilities PHP 88,000

Owner's Equity

Ariate, Capital 17,500

TOTAL LIABILITIES AND OWNER'S EQUITY PHP 105,500

INCOME STATEMENT

Forms for the INCOME STATEMENT

1. Functional presentation - also known as Cost of This statement shows the result of
Sales method, expenses are classified according to
operation.
their function as part of Cost of Sales, selling
activities, administrative activities, and others
activities. If income > expenses = net income
2. Natural Presentation – also known as Nature of If income < expenses = net loss
expense method, expenses are aggregated
according to their nature.

Examples of Income accounts:

1. Service fees or service income – used to record income earned for services rendered to
customers in the ordinary course of business
2. Professional fees – used to record services rendered by a doctor, CPA, lawyer,
architect, engineer, and other professionals in the ordinary course of business
3. Commission income – income earned by agents and brokers
4. Rent revenues or rent income – income earned in renting out assets to other entities
5. Interest income – income earned on money lent. Usually, interest is earned on Notes
Receivable
6. Tuition fees – income account used by academic institutions
7. Gain on sale of PPE – income earned on the sale or disposal of PPE when selling price
is more than its book value
8. Sales or Sales Income or Sales revenue – income account for a merchandising business
representing sale of goods in the ordinary course of business

TYPES OF ACCOUNTS
1. Real accounts – balance sheet accounts, and as differentiated from nominal accounts,
are forwarded to the next accounting period
2. Nominal accounts – income statement accounts and are temporary in nature. At the
end of the accounting period, these accounts are closed to Capital.

Examples of Expense and Loss Accounts:

A. For service business
1. Salaries and wages – remuneration for services of employees
2. Taxes and licenses – used for permits, licenses
3. Doubtful Accounts expense – used for bad accounts receivable. The other term is
bad debts expense, or uncollectible accounts expense
4. Communication expense –connected with the use of telephones, cellphones, faxes,
internet, and other modes of communication
5. Utility expenses – expenses for water and electricity usage
6. Supplies expense – for office supplies, shop supplies, store supplies, etc.
7. Rent expense – rent of space
8. Insurance expense
9. Depreciation expense – for value lost on PPE due to usage, obsolescence, wear and
tear, etc.
10. Interest expense
11. Loss on sale of PPE – difference between selling price and book value, where SP <
BV
B. For merchandising business
 1. Cost of sales – cost of merchandise sold
2. Purchases – cost of merchandise bought
3. Purchase returns and allowances – cost of merchandise returned to suppliers. This
is a deduction from purchases.
4. Freight in – cost of transporting merchandise bought
5. Freight out – cost of transporting merchandise sold
6. Sales commissions expense – given to salesmen for sales made

Sample Income Statement

Ariate Law Firm
Income
Statement
For the Month of
December 2019

Revenue
PHP
Fees Earned
60,000

Expenses
PHP
Salary Expense
15,000
Rent Expense 7,000
Advertising
1,000
Expense
Utilities Expense 3,000
Depreciation Expense 5,000
Supplies Expense 2,000
Interest Expense 5,000
Miscellaneous Expense 2,000
PHP
40,000

PHP
NET INCOME
20,000

STATEMENT OF CASH FLOWS

This is a basic statement summarizing the changes in the cash account – cash receipts and cash
disbursements – of the business during a given period of time. It consists of the following:
1. Cash flows from operating activities – derived primarily from principal revenue producing activities
of the entity.
Examples:
a. cash received from sale of services or merchandise (inflow)
b. cash from collection of receivables (inflow)
c. cash payments to suppliers for goods and services (outflow)
 d. cash payments for selling, administrative and other expenses (outflow)
2. Cash flows from investing activities – derived from the acquisition and disposal of noncurrent assets
a. Cash received from sale of noncurrent assets (inflow)
b. Cash payment for acquisition of noncurrent assets (outflow)
3. Cash flows from financing activities – derived from equity and borrowings of the entity
Cash inflows
a. Cash received from short-term or long-term borrowings
b. Cash received from owner
Cash outflows
c. Payments for short-term or long-term borrowings
d. Cash withdrawals by owner

Sample Statement of Cash Flows

De Los Santos Salon
Statement of Cash Flows
For the Period Ended December 31,
2019

Cash flows from operating activities

PHP
Cash received for services rendered
112,074
Collection of accounts receivable 30,824
Payment of
(11,500)
salaries
Payment for utilities (2,500)
Payment for miscellaneous expenses (28,000)
Payment for supplies (3,500)
Payment for communication expenses (3,500)
Cash provided by operation PHP 93,898

Cash flows from investing activities

Payment for equipment (50,000)
Cash used in investing activities (50,000)

Cash flows from financing activities

Payment of
(25,950)
interest
Cash used in financing activities (25,950)

Net increase in
PHP 17,948
cash

STATEMENT OF CHANGES IN EQUITY

This summarizes the changes in a company’s equity for a period of time. This shows the beginning
balance of the equity and the changes that occurred in a given period of time. These changes
often refer to additional investments, withdrawals, and the operation’s income or loss. The
resulting ending balance is presented in the Statement of Financial Position.

De Los Santos Salon

Statement of Changes in Equity
For the Period Ended December
31, 2019

Ariate, Capital, January 1,

2019 ₱20,000.00
Investment in December
2019 ₱10,000.00
Net income for 2019 20,000.00
TOTAL ₱30,000.00
Less: Withdrawals 27,500.00
Decrease in Owner's Equity 2,500.00

Ariate, Capital, December 31, 2019 ₱17,500.00

EXERCISE:

1. What are the kinds of financial statements? Discuss each briefly.

2. What are the basic accounting elements? Classify each according to financial statement.

3. Explain the relationship of the different financial statements.

 4. Classify the following accounts in column A and column B:

Financial Statement
ITEMS Accounting Element
Classification
Statement of Financial
1 Cash Current asset
Position
2 Rent income
3 Notes receivable
4 Land
5 Withdrawal
6 Mortgage payable
7 Merchandise inventory
8 Prepaid insurance
9 Depreciation expense – building
10 Bad debts
11 Utilities expense
12 Professional revenue
13 Uncollectible accounts
14 Supplies on hand
15 Plant, property, and equipment
 3 - THE ACCOUNTING PROCESS

CONTENT:
1. Definition of business transactions and source documents
2. The accounting equation
3. The accounting cycle
4. Typical account titles used
5. Rules of debit and credit and their applications
6. Journalizing

BUSINESS TRANSACTIONS
This is an accountable event or economic event which has an effect on assets, liabilities and equity of the
business entity.

This means that there are transactions or events which do not affect the elements of financial statements,
and are therefore not recorded. It can be recalled from the recognition principles that elements must at least
be measurable and have probable impact on business resources, obligations, and performance.

Each business transaction is identified, analyzed, measured, summarized and communicated to the data
users, all in accordance with the generally accepted accounting principles. Business transactions may be
1. Internal – only the business is involved in the business transaction
2. External – the parties involved are the business and a third party

Internal
Party involved Example of transactions
The business only The building was destroyed by fire
The business only Yearly Depreciation expense for the company’s
equipment was charged

External
Third party involved Example of transactions
Another business entity The business bought one ream of bond paper
from PASSERSBUY for P150
The owner The owner, Juan dela Cruz, invested additional
cash of P25,000 into the business
The creditor The business borrowed cash from LANDBANK to
finance business expansion, P200,000
The Government The business paid for business permits and
licenses, P2,500
The employees The business paid for salaries worth P12,000
The customers The business rendered service to a customer and
received cash of P3,500
*Note that parties that would be considered internal under a different discipline like the owner and the employees are
considered external parties since the business is treated as a separate being from its stakeholders under the
accounting entity assumption.

SOURCE DOCUMENTS
To meet the quality of objectivity, each transaction must be supported by a document. The document must
be properly compiled and controlled for easy reference. Where a good system of record keeping exists,
financial information becomes more reliable for it can easily be traced back to the source documents.

✓ Original documents are considered better source documents than duplicated or copies
 ✓ Source documents coming from independent outside parties are considered neutral and more
objective evidence of transactions than those documents coming from within the business entity
✓ Documents coming from within the business entity are to be recorded only when approved for
recording by authorized officer or officers of the business

Examples of Source Documents

1. Official receipt (OR)
This supports cash payments if the OR is
issued by other entities or it support cash
receipts when the OR is issued by the
business.

2. Charge Sales Invoice (CSI)

This supports purchases on account when
issued by other entities. When the CSI is
issued by the business, it supports sales on
account.

3. IOUs
This supports advances made by employees.

4. Promissory notes (PN)

This supports receivables from customers, if
the PN is issued by the customer. This
supports liability to a creditor, when the PN is issued by the business.

5. Statement of Account (SOA)

This supports liability to a creditor for purchases of goods or services on account, or to a service
provider like FICELCO and VIWAD.

6. Cash Sales Invoice (CI)

This supports cash purchases when issued by other
entities. When the CI is issued by the business, it supports
cash sales.

7. Delivery Receipt (DR)

This supports delivery of goods to customers.

8. Bank passbook, bank statements, validated deposit slips

and withdrawals
They support information about cash in bank.

9. Payroll sheet
Prepared to support payment of salaries of employees.

10. Registration papers

These support ownership of PPE like transport vehicles,
land, building. They also support payment of permits and
licenses.

The Accounting Process:

1. Identification – those events that is financial in nature that should be recognized and
recorded.
 2. Recording – transactions may be recorded manually, with the use of mechanical
devices, or with the use of computers.
3. Classifying – is the grouping of similar items together in order to make the recording of
many different events and transactions more efficient.
4. Summarizing – is the stating of groups of data in concise form
5. Interpretation – provides explanation and develops relationships that give meaning to the
information.

THE ACCOUNTING EQUATION

The relationship between the three basic accounting elements of the balance sheet – Assets,
Liabilities, and Owner’s Equity – can be expressed in the form of a simple equation known as the
Accounting Equation. All accounting information is recorded within the framework of the
Accounting Equation. This equation is

Assets = Liabilities + Owner’s Equity

P500,000 = P200,000 + P300,000 *assumed figures

Assets – are the resources owned by the business that will provide future benefits
Liabilities – are the rights of creditors that represent the debt of the business
Owner’s equity – are the rights of the owners in the business. This is the amount by which the
business assets exceed
business liabilities. The statement of changes in equity shows another way of computing capital:
Capital = beginning capital + additional investment + net income (–net loss) –
withdrawal
Derived formula
Net income (loss) = total revenues – total expenses and losses
Liabilities = assets – capital If,
Capital = assets – liabilities Total revenues > total expense = net income
Net assets = assets – liabilities Total expenses > total revenues = net loss
Net assets = capital

Who to pay How much to pay When to pay

Creditor Amount borrowed + interest Determinable future time
Owner Remaining assets after On termination of business
payment to the creditor* operation
*remaining assets may be equal, more, or less than the capital invested. If remaining assets are less than capital
invested, investors have incurred a loss. Needless to say, if there are no more assets remaining but there is still an
outstanding balance for liabilities the owners have incurred a loss equal to the amount of liabilities remaining .

The accounting equation must always balance. The peso amount on the left side of the equation
should always equal to the peso amount on the right side. If the assets decrease, liabilities and/or
equity must also decrease. An increase in an asset may also correspond to a decrease in another
asset, or an increase in a liability may also have a corresponding decrease in another liability.

Business transactions – economic events or condition that directly changes an entity’s financial
condition or directly affects its results of operations. An accounting transaction takes place when
a business exchanges a thing or things of value for another. In short, the business

Debit/s Credit/s
Value/s received = Value/s given up
Transactions are always looked upon from the business point of view, which is separate and
distinct from the owner’s point of view. This refers to the principle of Entity Concept. All business
transactions can be stated in terms of changes in the three elements of the accounting equation.

DOUBLE-ENTRY ACCOUNTING – is a record keeping system in which each business

transaction affects at least two accounts.
Account – is the record used to classify and store information about increases and decreases in
an item.
The T-Account – is so called because of its shape. It is used to show the increase or decrease in
an account caused by a transaction. It is a more efficient and convenient tool used by accountants
to analyze the parts of a transaction.

Top Account title

Left side Right side Debit Credit

Rules of debit and credit – debits and credits are used to record the In other words,
increases and decreases in each account affected by a business
transaction. The rules of debit and credit vary according to whether
DEBIT:
an account is classified as an asset, liability, or an owner’s equity
✓Increase in asset
account.
✓Decrease in liability
Rules for asset accounts: ✓Decrease in capital
o Withdrawals
1. An asset account is increased on the debit side o Expenses and losses
2. An asset account is decreased on the credit side
3. The normal balance for an asset is a debit balance. CREDIT:
✓Decrease in asset
Rules for Liability and Owner’s equity
✓Increase in liability
1. The liability and capital accounts are increased on the credit
✓Increase in capital
side. o Investment
2. The liability and capital accounts are decreased on the debit o Income and gains
side.
3. The normal balance for the liability and capital accounts is a
credit balance.
ILLUSTRATIVE PROBLEM
The following are transactions of Wahclass Boarding House for the month of May 2020, its first
month of operation:
DATE Type of
BUSINESS TRANSACTION Parties involved
2020 activity
May
Miss Wah invested the following: The business and the owner Financing
Cash, P150,000; Lot, P265,000 and
1
her house, P450,000 in her new
business venture, a boarding house
Cost of construction of 10 rooms, The business and the Investing
15 additional kitchen and toilets paid in contractor
cash, P108,000
Purchased tables and chairs from The business and the trade Investing
22 CATANDUANES BAZAAR, creditor (CATANDUANES
P12,500. Terms: on account. BAZAAR)
Business permit paid, P1,500 The business and the Operating
23
government
Thirty students applied as bed The business and the Not yet an
spacer. Two students will be customers (the students) accountable
25 accepted per room. Rent is P1,500 event
per student per month inclusive of
electricity and water costs
Twenty students were accepted to The business and the Not yet an
start on June 1. Bed spacers are customers (the students) accountable
28 required to pay rent in advance event
equivalent to one month every 1st
day of the month.
June
The twenty bed spacers paid their The business and the Operating
1
June rent today customers (the students)
Paid CATANDUANES BAZAAR the The business and the trade Operating
1 account in full creditor (CATANDUANES
BAZAAR)
The bill for electricity was paid The business and FICELCO Operating
25
today, P4,200
The bill for water usage was paid The business and VIWAD Operating
26
today, P1,800
Analysis of Business Transactions
2020
May 1 Miss Wah invested the following: Cash, P150,000; Lot, P265,000 and her house, P450,000
in her business venture, a boarding house

Analysis guide:

QUESTIONS ANSWERS
Who are the parties involved in the transaction? The business and the owners
Is this a business transaction? Yes, it is an external business transaction.
Did it affect the accounting elements? If so, which Yes. Two elements were affected:
elements were affected? CAPITAL is affected because of the investment by
the owners.
ASSETS were affected because the investment
was made in the form of cash, house, and lot
which are all assets.
What are the effects to the accounting elements? Total assets were increased because of the
receipt of cash, house, and lot.
Capital was also increased because an
investment is always an increase in capital.
What are the value received and value parted Increase in asset = value received or Debit
with? Increase in capital = value parted with or Credit
How much is the value received and value parted Value received (DEBIT):
with? Cash P150,000
Lot 265,000
House 450,000
Total P865,000

Value parted with (Credit):

Total investment P865,000
What are the accounts to be used to record the Assets
transaction? For cash, use CASH
For lot, use LAND
For house, use BUILDING

Investment
Use Wah, CAPITAL
How should you record the transaction in the T- Enter the value received on the left side of the
account? account, and enter the value parted with on the
right.

Cash Land
2020 2020
May 1 150,000 May 1 265,000

Wah, Capital Building

2020 2020
May 1 865,000 May 1 450,000
 Cost of construction of 10 rooms, additional kitchen and The business and the Investing
15
toilets paid in cash, P108,000 contractor

Cash Building
2020 2020
May 1 150,000 May 15 108,000 May 1 450,000
15 108,000

Purchased tables and chairs from CATANDUANES The business and the Investing
22
BAZAAR, P12,500. Terms: on account. trade creditor

Furniture and Fixtures Accounts Payable

2020 2020
May 22 12,500 May 22 12,500

23 Business permit paid, P1,500 The business and the government Operating

Cash Taxes and Licenses

2020 2020
May 1 150,000 May 15 108,000 May 23 1,500
23 1,500

Thirty students applied as bed spacer. The business and the customers Not yet an
Two students will be accepted per room. (the students) accountable
25
Rent is P1,500 per student per month event
inclusive of electricity and water costs

Analysis:
This is not an accountable event. No accounting element has been affected yet. No value has been
received by the business from the business, nor has any value been parted with.

Twenty students were accepted to start The business and the customers Not yet an
on June 1. Bed spacers are required to (the students) accountable
28
pay rent in advance equivalent to one event
month every 1st day of the month.

Analysis:
This is not an accountable event. No accounting element has been affected yet. No value has been
received by the business from the business, nor has any value been parted with.
June
The twenty bed spacers paid their June The business and the customers Operating
1
rent today (the students)

Cash Rent income

2020 2020 2020
May 1 150,000 May 15 108,000 June 1 30,000
June 1 30,000 23 1,500

Paid CATANDUANES BAZAAR the The business and the trade creditor Operating
1
account in full (CATANDUANES BAZAAR)

Cash Accounts Payable

2020 2020 2020 2020
May 1 150,000 May 15 108,000 June 1 12,500 May 22 12,500
23
June 1 30,000 1,500
June 1
12,500

The bill for electricity was paid today, The business and FICELCO Operating
25
P4,200

Cash Utilities
2020 2020 2020
May 1 150,000 May 15 108,000 June 25 4,200
June 1 30,000 23 1,500
June 1 12,500
25 4,200

The bill for water usage was paid The business and VIWAD Operating
26
today, P1,800

Cash Utilities
2020 2020 2020
May 1 150,000 May 15 108,000 June 25 4,200
June 1 30,000 23 1,500 28 1,800
June 1 12,500
25 4,200
28 1,800
In summary, the general ledger (a group of accounts or T-accounts) will show the following at
the end of June 2020:

WAH BOARDING HOUSE

General Ledger
June 30, 2020

ASSETS: LIABILITIES: CAPITAL:

Cash Accounts Payable Wah, Capital
2020 2020 2020 2020
May 1 150,000 May 15 108,000 June 1 2,500 May 22 12,500 May 1 865,000
June 1 30,000 23 1,500 0
June 1 12,500
25 4,200
28 1,800
180,000 128,000
52,000

Land Rent income

2020 2020
May 1 265,000 June 1 30,000

Furniture and Fixtures Utilities

2020 2020
May 22 12,500 June 25 4,200

Building Taxes and Licenses

2020 2020
May 1 450,000 May 23 1,500
15 108,000
558,000

To facilitate the preparation of financial statements, a “Trial Balance” (this is a working paper,
not a financial statement) is prepared to prove the equality of debits and credits

WAH BOARDING HOUSE

Trial Balance
June 30, 2020

Cash ₱52,000
Land 265,000
Furniture and fixtures 12,500
Building 558,000
Wah, capital ₱865,000
Rent income 30,000
Utilities 6,000
Taxes and licenses 1,500
₱895,000 ₱895,000
TRIAL BALANCE – is a listing of all the asset, liability, capital, revenue, and expense account
balances at one point in time. All debits are summed, as are all credits, to ensure that total
debits equal total credits. Testing for the equality of total debits and credits is one way of finding
out whether you have made any errors in recording transaction amounts.

Purpose of the trial balance:

1. It indicates if the ledger is in balance by showing whether the total accounts with debit
balances equals the total accounts with credit balances.
2. It aids in locating errors.
3. It assists in the preparation of financial statements.

RECORDING BUSINESS TRANSACTIONS

Accounting Cycle – is the complete series of steps used to account for a business’ financial
transactions during a fiscal period. These are the steps:
1. Analysis of business transactions
Examples of source documents:
2. Journalizing
3. Posting to the ledger accounts 1. Invoices (purchases and sales)
4. Preparing the trial balance 2. Receipts
5. Preparing adjusting entries 3. Memorandum
6. Completing the worksheet 4. Deposit slip
7. Preparing the financial statements 5. Check stubs
8. Journalizing and posting closing entries 6. Cash register tapes
9. Preparing the post-closing trial balance 7. Payroll time cards

BUSINESS TRANSACTION FLOW

source journal ledger financial

trial balance
documents entries accounts statements

Source Documents – papers prepared as evidence to support business transactions. The type
of document depends on the nature of the transaction.
The Journal – book of original entry. It is the book where all transactions are initially recorded in
a chronological order of the day to day transactions. The process of recording transactions in a
journal is called journalizing.
The Ledger – is a book of final entry. It is a book or file with the business entire collection of
account records also referred to as general ledger.
The Trial Balance – is a listing of all the accounts in the general ledger and the sum of the debit
and credit amounts of their balances.

CHART OF ACCOUNTS – is a list of all accounts and their account (code) numbers used for
journalizing business transactions.

Order of the accounts – the accounts are normally listed in the order in which they appear in the
financial statements. The balance sheet accounts first, in the order of assets, liabilities and
owner’s equity. The income statement accounts are then listed in the order of revenues and
expenses.
Numbering of accounts – an account number identifies the account. Account numbers may
have two, three, four, or more digits. The number of digits used varies with the needs of the
business. The first digit 1 will represent Assets; 2 will represent Liabilities; 3 will represent Owner’s
Equity; 4 will represent Revenues; and 5 will represent Expenses. The second digit indicates the
location of the account within its class.

Example for CHART OF ACCOUNTS:

Giselle Dela Cruz, a lawyer, decided to open a law firm named Dela Cruz Law Firm. The partial
chart of accounts listed below is used:

Balance Sheet accounts Income Statement accounts

1 – Assets 4 – Revenues
11 – Cash 41 – Fees Earned
12 – Accounts Receivable
18 – Furniture and Equipment
5 – Expenses
51 – Salary Expense
2 – Liabilities
54 – Utilities Expense
21 – Accounts Payable
24 – Loan Payable 55 – Communication Expense
59 – Miscellaneous Expense
3 – Owner’s Equity
31 – Dela Cruz, Capital
32 – Dela Cruz, Drawing

TRIAL BALANCE – a statement not required by the standards, but only facilitates the
preparation of the financial statements.

A trial balance in which debits equals credits is not necessarily error-free. A trial balance may
contain errors but still look correct if:
1. No entry was made for a given transaction.
2. An entry was posted twice.
3. An amount was journalized or posted to the wrong account.
4. An incorrect amount was recorded for a given transaction.

Transposition Error – occurs when digits are incorrectly arranged. Example: P864 is written or
posted as P684 or P468.

Slide Error – occurs when the decimal point is put in the wrong place. Example: P684 is written
as P68.40 or P6.84.

Procedures to Correct Errors in Journalizing and Posting:

1. Draw a straight horizontal line through the error and insert the correct title or amount if
the entry is incorrect or the posting is incorrect.
2. Make a correcting entry and post it to correct wrong entry already posted.

Correcting Entry – an entry made to correct an error in a journal entry discovered after posting.

What do you call a trial balance that doesn’t balance? A late night.