FINANCIAL ACCOUNTING

AND REPORT IN TOURISM

TRM 202
ATTY. ARMANDO D. DALISAY JR, CPA, REB, REA, LPT
LESSON 1.1 – INTRODUCTION OF ACCOUNTING
MODULE 1 – INTRODUCTION TO ACCOUNTING

• Accounting is one of the key functions for almost any business. It may be handled by a
bookkeeper or an accountant at a small firm, or by sizable finance departments with dozens of
employees at larger companies. A bookkeeper can handle basic accounting needs, but a Certified
Public Accountant (CPA) should be utilized for larger or more advanced accounting tasks.

• The reports generated by various streams of accounting, such as cost accounting and managerial
accounting, are invaluable in helping management make informed business decisions.
Regardless of the size of a business, accounting is a necessary function for decision making, cost
planning, and measurement of economic performance measurement.

• It is therefore important to know and understand the definition of accounting and its branches, its
history, principles and standards.
LEARNING OUTCOMES:

• Learning Objectives:
1. The learner should be able to know the history of accounting, its origin and the people who first use the system and how
the system evolved into its present condition.
2. The Learners should be able to define Accounting and understand every word used in its definition and relate these
words with the ultimate purpose or purposes of accounting information system and to identify the primary uses of the
financial information.
3. The learner should understand the basic principles in accounting to be able to understand how the system works and
how the information should be recorded and presented in the financial reports.
4. The learner should be able to understand the different types of business and the different forms of business organization
and should be able to identify each and distinguish it from the others.
5. The learner should be able to understand the basic accounting equation and all the elements in it as well as the account
titles that would be used in recording the transactions.
WHAT IS ACCOUNTING?

• Accounting is the process of recording financial transactions pertaining to a business. The accounting
process includes analyzing, recording, summarizing, financial transactions or events over an
accounting period, and reporting these transactions in the form of financial statements (Income
Statement, Balance Sheet, Capital Statement and Statement of Cash Flows) to government’s
regulatory, and tax collecting agencies.
• In simple explanation, Accounting is how the business records, organizes, and understands its
financial information. Accounting can be thought of as a big machine where raw financial information
are put into, such as records of all business transactions, taxes, estimates and allowance, etc., that
then spits out an easy to understand reports or statements about the financial state of the business.
These financial statements tell its reader whether the business is making a profit or not, where the
cash came from and where it was put, what the current amount of the assets and liabilities of the
business and how much remained as capital of the business owner or owners.
WHAT IS ACCOUNTING?

• Technical definitions of accounting have been published by different accounting bodies. The American
Institute of Certified Public Accountants (AICPA) defines accounting as: "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 financial character, and interpreting the results thereof."

• The American Accounting Association on the other hand defines accounting as “the process of
identifying, measuring and communicating economic information to permit informed judgment and
decision by users of the information”.

• According to the Accounting 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 economic decisions, in making reasoned choices among alternative courses of
action.”
BRANCHES OF ACCOUNTING

1. Financial Accounting- Financial accounting involves recording and categorizing transactions for business.
This data is generally historical, meaning it’s from the past. It also involves generating financial statements
based on these transactions. All financial statements, such a balance sheet and income statement, must
be prepared according to the generally accepting accounting principles (GAAP). Financial accounting is
performed to conform to external regulations and requirements.
2. Cost Accounting - Cost accounting is considered a type of managerial accounting. Cost accounting is
most commonly used in the manufacturing industry, an industry that has a lot of resources and costs to
manage. It is a type of accounting used internally to assess a company’s operations. Cost accounting
concerns itself with recording and analyzing manufacturing costs. It looks at a company’s fixed
(unchanging and constant costs, like rent) and variable costs (changing costs, like shipping charges) and
how they affect a business and how these costs can be better managed, according to Accounting Tools.
BRANCHES OF ACCOUNTING

3. Auditing - There are two types of auditing: external and internal auditing. In external auditing, an independent
third party reviews a company’s financial statements to make sure they are presented correctly and comply with
GAAP and IFRS. Internal auditing involves evaluating how a business divides up accounting duties, who is
authorized to do what accounting task and what procedures and policies are in place. Internal auditing helps a
business to zero in fraud, mismanagement and waste or identify and control any potential weaknesses in its
policies or procedures.
4. Managerial Accounting -Also known as management accounting, this type of accounting provides data about a
company’s operations to managers. The focus of managerial accounting is to provide data that managers need to
make decisions about a business’s operations, not comply strictly with GAAP. Managerial accounting includes
budgeting and forecasting, cost analysis, financial analysis, reviewing past business decisions and more. Cost
accounting is a type of managerial accounting.
BRANCHES OF ACCOUNTING

3. Accounting Information Systems - Known as AIS for short, accounting information systems concerns itself
with everything to do with accounting systems and processes and their construction, installation, application
and observation. This can include accounting software management and the management of bookkeeping
and accounting employees.

4. Tax Accounting- Tax accounting involves planning for tax diminution, payment scheme and the
preparation of tax returns. This branch of accounting helps businesses to comply with regulations of the
Philippine Taxing Authorities, more particularly the Local Government Units for the Mayor’s Permits, BIR for
the Internal Taxes and Bureau of Customs for taxes on importation and exportation. Tax accounting also
helps businesses figure out their income tax and other taxes and how to legally reduce their amount of tax
owing. Tax accounting also analyzes tax-related business decisions and any other issues related to taxes.
BRANCHES OF ACCOUNTING

4. Forensic Accounting -This specialized accounting service is trending in accounting and is becoming
increasingly popular. Forensic accounting focuses on legal affairs such as inquiry into fraud, legal cases and
dispute and claims resolution. Forensic accountants need to reconstruct financial data when the records are
incomplete. This could be to decode fraudulent data or convert a cash accounting system to accrual
accounting. Forensic accountants are usually consultants who work on a project basis.

5. Fiduciary Accounting - This branch of accounting centers around the management of property for another
person or business. The fiduciary accountant manages any account and activities related to the
administration and guardianship of property. Fiduciary accounting covers estate accounting, trust accounting
and receivership (the appointing of a custodian of a business’s assets during events such as bankruptcy).
PURPOSES AND USES OF ACCOUNTING INFORMATION

• The purpose of accounting is to accumulate and report on financial information about the
performance, financial position, and cash flows of a business. Accounting provides people
interested in the business or company with various pieces of information regarding business
operations, this information is then used to reach decisions about how to manage the
business, or invest in it, or lend money to it.
USES OF ACCOUNTING INFORMATION

• The purpose of accounting is to accumulate and report on financial information about the
performance, financial position, and cash flows of a business. Accounting provides people
interested in the business or company with various pieces of information regarding business
operations, this information is then used to reach decisions about how to manage the
business, or invest in it, or lend money to it.
USES OF ACCOUNTING INFORMATION

1. A common use of accounting information is measuring the performance of various business

operations. While financial statements are the classic accounting information tool used to
assess business operations, business owners may conduct a more thorough analysis of this
information when reviewing business operations. Financial ratios use the accounting information
reported on financial statements and break it down into leading indicators. These indicators can
be compared to other companies in the business environment or an industry standard. This
helps business owners understand how well their companies operate compared to other
established businesses.
USES OF ACCOUNTING INFORMATION

2. Business owners often use accounting information to create budgets for their companies.
Historical financial accounting information provides business owners with a detailed analysis of
how their companies have spent money on certain business functions. Business owners often
take this accounting information and develop future budgets to ensure they have a financial road
map for their businesses. These budgets can also be adjusted based on current accounting
information to ensure a business owner does not restrict spending on critical economic
resources.
USES OF ACCOUNTING INFORMATION

3. Accounting information is commonly used to make business decisions. For financial

management, an income statement and accounting of expenses provides an important overview
of the business. Decisions may include expanding current operations, using different economic
resources, purchasing new equipment or facilities, estimating future sales or reviewing new
business opportunities.
4. Accounting information usually provides business owners information about the cost of
various resources or business operations. These costs can be compared to the potential income
of new opportunities during the financial analysis process. This process helps business owners
understand how current business operations will be affected when expanding or growing their
businesses. Opportunities with low income potential and high costs are often rejected by
business owners.
USES OF ACCOUNTING INFORMATION

5. External business stakeholders often use accounting information to make investment

decisions. Banks, lenders, venture capitalists or private investors often review a company's
accounting information to review its financial health and operational profitability. This provides
information about whether or not a small business is a wise investment decision. Many small
businesses need external financing to start up or grow. The inability to provide outside lenders
or investors with accounting information can severely limit financing opportunities for a small
business.
ACCOUNTING PRINCIPLES

• The phrase "generally accepted accounting principles" (or "GAAP") consists of three important sets of
rules: (1) the basic accounting principles and guidelines, (2) the detailed rules and standards issued by
FASB and its predecessor the Accounting Principles Board (APB), and (3) the generally accepted
industry practices.

• If a company distributes its financial statements to the public, it is required to follow generally accepted
accounting principles in the preparation of those statements. Further, if a company's stock is publicly
traded, Philippine law requires the company's financial statements be audited by independent public
accountants. Both the company's management and the independent accountants must certify that the
financial statements and the related notes to the financial statements have been prepared in accordance
with GAAP.

• Since GAAP is founded on the basic accounting principles and guidelines, we can better understand
GAAP if we understand those accounting principles.
ACCOUNTING PRINCIPLES

The following is a list of the ten main accounting principles and guidelines with a highly condensed
explanation of each.

1. Economic Entity Assumption

The accountant keeps all of the business transactions of a sole proprietorship separate from the business
owner's personal transactions. For legal purposes, a sole proprietorship and its owner are considered to be
one entity, but for accounting purposes they are considered to be two separate entities.

2. Monetary Unit Assumption

In the Philippines economic activity is measured in Philippine pesos, and only transactions that can be
expressed in Philippine pesos are recorded.

Because of this basic accounting principle, it is assumed that the peso's purchasing power has not changed
over time. As a result, accountants ignore the effect of inflation on recorded amounts. For example, pesos
from a 1960 transaction are combined (or shown) with pesos from a 2019 transaction.
ACCOUNTING PRINCIPLES

3. Time Period Assumption

• This accounting principle assumes that it is possible to report the complex and ongoing activities of a
business in relatively short, distinct time intervals such as the five months ended May 31, 2019, or the 5
weeks ended May 1, 2019. The shorter the time interval, the more likely the need for the accountant to
estimate amounts relevant to that period. For example, the property tax bill is received on December 15
of each year. On the income statement for the year ended December 31, 2018, the amount is known; but
for the income statement for the three months ended March 31, 2019, the amount was not known and an
estimate had to be used.

• It is imperative that the time interval (or period of time) be shown in the heading of each income
statement, statement of owner’s/stockholders' equity, and statement of cash flows. Labeling one of these
financial statements with "December 31" is not good enough–the reader needs to know if the statement
covers the one week ended December 31, 2019 the month ended December 31, 2019 the three months
ended December 31, 2019 or the year ended December 31, 2019
ACCOUNTING PRINCIPLES

4. Cost Principle

• From an accountant's point of view, the term "cost" refers to the amount spent (cash or the cash
equivalent) when an item was originally obtained, whether that purchase happened last year or thirty
years ago. For this reason, the amounts shown on financial statements are referred to as historical cost
amounts.

• Because of this accounting principle asset amounts are not adjusted upward for inflation. In fact, as a
general rule, asset amounts are not adjusted to reflect any type of increase in value. Hence, an asset
amount does not reflect the amount of money a company would receive if it were to sell the asset at
today's market value. (An exception is certain investments in stocks and bonds that are actively traded on
a stock exchange.) If you want to know the current value of a company's long-term assets, you will not
get this information from a company's financial statements–you need to look elsewhere, perhaps to a
third-party appraiser.
ACCOUNTING PRINCIPLES

5. Full Disclosure Principle

• If certain information is important to an investor or lender using the financial statements, that information
should be disclosed within the statement or in the notes to the statement. It is because of this basic
accounting principle that numerous pages of "footnotes" are often attached to financial statements.

• For example, the company is named in a lawsuit that demands a significant amount of money. When the
financial statements are prepared it is not clear whether the company will be able to defend itself or
whether it might lose the case. As a result of these conditions and because of the full disclosure principle
the lawsuit will be described in the notes to the financial statements.

• In compliance with this full disclosure principle, a business usually lists its significant accounting policies
as the first note to its financial statements.
ACCOUNTING PRINCIPLES

6. Going Concern Principle

• This accounting principle assumes that a business will continue to exist long enough to carry
out its objectives and commitments and will not liquidate in the foreseeable future. If the
business' financial situation is such that the accountant believes that it will not be able to
continue on, the accountant is required to disclose this assessment.

• The going concern principle allows the business to defer some of its prepaid expenses until
future accounting periods.
ACCOUNTING PRINCIPLES

7. Matching Principle

• This accounting principle requires companies to use the accrual basis of accounting. The
matching principle requires that expenses be matched with revenues. For example, sales
commissions expense should be reported in the period when the sales were made (and not
reported in the period when the commissions were paid). Wages to employees are reported
as an expense in the week when the employees worked and not in the week when the
employees are paid. If a company agrees to give its employees 1% of its 2019 revenues as a
bonus on January 15, 2020, the company should report the bonus as an expense in 2019 and
the amount unpaid at December 31, 2019 as a liability. The expense is recorded as the sales
or revenue are recorded.
ACCOUNTING PRINCIPLES

8. Revenue Recognition Principle

• Under the accrual basis of accounting (as opposed to the cash basis of accounting), revenues
are recognized as soon as a product has been sold or a service has been performed,
regardless of when the money is actually received. Under this basic accounting principle, a
company could earn and report P1,000,000 of revenue in its first month of operation but
receive P0 in actual cash in that month.

• For example, if ABC Company completes its service at an agreed price of P50,000, ABC
should recognize P50,000 of revenue as soon as its work is done—it does not matter whether
the client pays the P50,000 immediately or in 30 days. Do not confuse revenue with a cash
receipt.
ACCOUNTING PRINCIPLES

9. Materiality

• Because of this basic accounting principle or guideline, an accountant might be allowed to violate another
accounting principle if an amount is insignificant. Professional judgement is needed to decide whether an
amount is insignificant or immaterial.

• An example of an obviously immaterial item is the purchase of a 7,500 printer by a highly profitable multi-
million-peso company. Because the printer will be used for five years, the matching principle directs the
accountant to expense the cost over the five-year period. The materiality guideline allows this company to
violate the matching principle and to expense the entire cost of 7,500 in the year it is purchased. The
justification is that no one would consider it misleading if 7,500 is expensed in the first year instead of
1,500 being expensed in each of the five years that it is used.

• Because of materiality, financial statements usually show amounts rounded to the nearest hundred, to the
nearest thousand, or to the nearest million pesos depending on the size of the company.
ACCOUNTING PRINCIPLES

• Conservatism

• If a situation arises where there are two acceptable alternatives for reporting an item,
conservatism directs the accountant to choose the alternative that will result in less net
income and/or less asset amount. Conservatism helps the accountant to "break a tie." It does
not direct accountants to be conservative. Accountants are expected to be unbiased and
objective.
ACCOUNTING PRINCIPLES

• The basic accounting principle of conservatism leads accountants to anticipate or disclose losses, but it does not allow
a similar action for gains. For example, potential losses from lawsuits will be reported on the financial statements or in
the notes, but potential gains will not be reported. Also, an accountant may write inventory down to an amount that is
lower than the original cost, but will not write inventory up to an amount higher than the original cost. Accounting
Standards in the World and in the Philippines

• Financial statements have incredible importance for both internal and external stakeholders. They basically are a report
card for the company; hence, it is important that they are regulated and do not report misleading information.

• Accounting standards are exceedingly useful because they attempt to standardize and regulate accounting definitions,
assumptions, and methods. Because of generally accepted accounting standards we are able to assume that there is
consistency from year to year in the methods used to prepare a company's financial statements. And although
variations may exist, we can make reasonably confident conclusions when comparing one company to another, or
comparing one company's financial statistics to the statistics for its industry. Over the years the accounting standards
have become more complex because financial transactions have become more complex.
ACCOUNTING PRINCIPLES

• The basic accounting principle of conservatism leads accountants to anticipate or disclose losses, but it does not allow
a similar action for gains. For example, potential losses from lawsuits will be reported on the financial statements or in
the notes, but potential gains will not be reported. Also, an accountant may write inventory down to an amount that is
lower than the original cost, but will not write inventory up to an amount higher than the original cost. Accounting
Standards in the World and in the Philippines

• Financial statements have incredible importance for both internal and external stakeholders. They basically are a report
card for the company; hence, it is important that they are regulated and do not report misleading information.

• Accounting standards are exceedingly useful because they attempt to standardize and regulate accounting definitions,
assumptions, and methods. Because of generally accepted accounting standards we are able to assume that there is
consistency from year to year in the methods used to prepare a company's financial statements. And although
variations may exist, we can make reasonably confident conclusions when comparing one company to another, or
comparing one company's financial statistics to the statistics for its industry. Over the years the accounting standards
have become more complex because financial transactions have become more complex.
IFRS
• The International Financial Reporting Standards (IFRS) Foundation is a not-for-profit international organization
responsible for developing a single set of high-quality, global accounting standards, known as IFRS Standards. IFRS
Standards are set by the IFRS Foundation’s standard-setting body, the IASB.

• • The Monitoring Board is a group of capital market authorities and provides formal link between the Trustees and public
authorities in order to enhance the public accountability of the IFRS Foundation.

• • The International Accounting Standards Board (IASB) is the independent standard- setting body of IFRS Foundation
responsible for the development and publication of IFRS and for approving Interpretations of IFRS as developed by the
IFRS Interpretations Committee.
• The Trustees of the IFRS Foundation are responsible for the governance and oversight of the IASB, including the due
process for the development of the accounting standards. • The IFRS Advisory Council provides advice and counsel to
the Trustees and the Board, whilst the Board also consults extensively with a range of other standing advisory bodies
and consultative groups.

• • The Accounting Standards Advisory Forum (ASAF) provides an advisory forum in which members can constructively
contribute towards the achievement of the IASB’s goal of developing globally accepted high-quality accounting
standards.
• The IFRS Interpretations Committee is the interpretative body of the International Accounting Standards Board, which
reviews implementation issues.
FORMS OF BUSINESS ORGANIZATION

• A business entity is a group of people organized for some profitable or charitable purpose.
The source of capital of the business determines the form of business organization. Business
entities include organizations such as corporations, partnerships, charities, trusts, and other
forms of organization. Business entities, just like individual persons, are subject to taxation
and must file a tax return.

• In Philippines the most common forms of businesses are sole proprietorships, partnerships
and corporation.
FORMS OF BUSINESS ORGANIZATION

1. Sole Proprietorship - Sole Proprietorship is a business entity owned by an individual who has full
control/authority of its business and owns all the assets, personally owes answers to all liabilities or
suffers all losses but enjoys all the profits to the exclusion of others. A sole proprietorship must apply for a
business name and be registered with the Department of Trade and Industry (DTI) - National Capital
Region (NCR). In the provinces, application may be filed with the DTI regional/provincial offices.

2. Partnership - Under the Civil Code of the Philippines, a partnership is treated as juridical person, having a
separate legal personality from that of its members. Partnerships may either be general partnerships,
where the partners have unlimited liability for the debts and obligation of the partnership, or limited
partnerships, where one or more general partners have unlimited liability and the limited partners have
liability only up to the amount of their capital contributions. It consists of two or more partners. A
partnership with more than Peso 3,000 capital must register with the Securities and Exchange
Commission (SEC).
FORMS OF BUSINESS ORGANIZATION

3 . Corporation - Corporation is composed of juridical persons established under the Corporation Code and regulated by
the SEC with a personality separate and distinct from that of its stockholders. The liability of the shareholders of a
corporation is limited to the amount of their share capital. It consists of at least five to 15 incorporators, each of whom must
hold at least one share and must be registered with the SEC. Minimum paid up capital is Peso 5,000. A corporation can
either be stock or non-stock company regardless of nationality. Such company, if 60% Filipino - 40% foreign-owned is
considered a Filipino corporation; if more than 40% foreign-owned, it is considered a domestic foreign-owned corporation.

a. Stock Corporation- Stock Corporation is a corporation with capital stock divided into shares and authorized to distribute to the holders of
such share’s dividends or allotments of the surplus profits on the basis of the shares held.

b. One Person Corporation- A One-Person Corporation (OPC) is a corporation with a single stockholder, who can only be a natural person
(who must be of legal age), trust or estate. As an incorporator, the “trust” does not refer to a trust entity but rather pertains to the subject being
managed by a trustee.

c. Non-Stock Corporation- Non-Stock Corporation is a corporation organized principally for public purposes such as charitable, educational,
cultural, or similar purposes and does not issue shares of stock to its members.
TYPES OF BUSINESS ACTIVITY

• A business entity is an organization that uses economic resources to provide goods or services to customers in
exchange for money or other goods and services.

• There are three major types of businesses:

1. Service Business - A service type of business provides intangible products (products with no physical form). Service
type firms offer professional skills, expertise, advice, and other similar products. Examples of service businesses are:
salons, repair shops, schools, banks, accounting firms, and law firms.

2. Merchandising Business - This type of business buys products at wholesale price and sells the same at retail price.
They are known as "buy and sell" businesses. They make profit by selling the products at prices higher than their
purchase costs. A merchandising business sells a product without changing its form. Examples are: grocery stores,
convenience stores, distributors, and other resellers.

3. Manufacturing Business - Unlike a merchandising business, a manufacturing business buys products with the intention
of using them as materials in making a new product. Thus, there is a transformation of the products purchased. A
manufacturing business combines raw materials, labor, and overhead costs in its production process. The manufactured
goods will then be sold to customers.
REPORTS OR FINANCIAL STATEMENTS GENERATED FROM THE ACCOUNTING SYSTEM

• Financial statements are written reports prepared by business’ management to present its
financial affairs in a given period (monthly, quarterly, six monthly or yearly). These statements
include Balance Sheet, Income Statement, Cash Flows and Statement of Owner/s’ Equity (for
sole proprietorship and partnership) or Shareholders’ Equity (in case of corporation). Balance
Sheet.

• A balance sheet is a financial statement that reports a company's assets, liabilities and
shareholders' equity at a specific point in time, and provides a basis for computing rates of
return and evaluating its capital structure. It is a financial statement that provides a snapshot
of what a company owns and owes, as well as the amount invested by owner/s’ or
shareholders. The equation that you need to remember when you prepare a balance sheet is
this –

• Assets = Liabilities + Shareholders Equity.

REPORTS OR FINANCIAL STATEMENTS GENERATED FROM THE ACCOUNTING SYSTEM

• Assets. The International Financial Reporting Standards (IFRS) framework defines an asset
as follows: “An asset is a resource controlled by the enterprise as a result of past events and
from which future economic benefits are expected to flow to the enterprise.”
Properties of an Asset
There are three key properties of an asset:
1. Ownership: Assets represent ownership that can be eventually turned into cash and
2. cash equivalents
3. Economic Value: Assets have economic value and can be exchanged or sold
4. Resource: Assets are resources that can be used to generate future economic benefits
IMPORTANCE OF ASSET CLASSIFICATION

• Classifying assets is important to a business. For example, understanding which assets

• are current assets and which are fixed assets is important in understanding the net working
capital of a company. In the scenario of a company in a high-risk industry, understanding
which assets are tangible and intangible helps to assess its solvency and risk. Determining
which assets are operating assets and which assets are non-operating assets is important to
understanding the contribution of revenue from each asset, as well as in determining what
percentage of a company’s revenues comes from its core business activities.
ASSETS ARE GENERALLY CLASSIFIED IN THREE WAYS:

1. Convertibility: Classifying assets based on how easy it is to convert them into cash.

2. Physical Existence: Classifying assets based on their physical existence (in other words,
tangible vs. intangible assets).

3. Usage: Classifying assets based on their business operation usage/purpose.

ASSETS ARE GENERALLY CLASSIFIED IN THREE WAYS:

1. Classification of asset as to Convertibility - If assets are classified based on their convertibility into cash,
assets are classified as either current assets or fixed assets. An alternative expression of this concept is
short-term vs. long-term assets.

• Current Assets - Current assets are assets that can be easily converted into cash and cash equivalents
(typically within a year). Current assets are also termed liquid assets and examples of such are:

• o Cash
o Cash equivalents
o Short-term deposits

o Stock
o Marketable securities

o Office supplies
CLASSIFICATION OF ASSET AS TO CONVERTIBILITY

b. Non-Current Assets or Fixed Assets - Non-current assets are assets that cannot be easily and
readily converted into cash and cash equivalents. Non-current assets are also termed fixed
assets, long-term assets, or hard assets. Examples of non-current or fixed assets include:

• o Land
o Building
o Machinery o Equipment o Patents
o Trademarks
CLASSIFICATION OF ASSET AS TO PHYSICAL EXISTENCE

2. Classification of asset as to Physical Existence - If assets are classified based on their

physical existence, assets are classified as either tangible assets or intangible assets.
a. Tangible Assets - Tangible assets are assets that have a physical existence (we can touch,
feel, and see them). Examples of tangible assets include:

• o Land
o Building
o Machinery
o Equipment
o Cash
o Office supplies
o Stock
o Marketable securities
CLASSIFICATION OF ASSET AS TO PHYSICAL EXISTENCE

b. Intangible Assets - Intangible assets are assets that do not have a physical existence.
Examples of intangible assets include:
o Goodwill
o Patents
o Brand
o Copyrights
o Trademarks o Trade secrets o Permits
o Corporate intellectual property
CLASSIFICATION OF ASSETS AS TO USAGE

3. Classification of assets as to Usage - If assets are classified based on their usage or purpose, assets are
classified as either operating assets or non-operating assets.

a. Operating Assets - Operating assets are assets that are required in the daily operation of a business.

In other words, operating assets are used to generate revenue from a company’s core business

activities. Examples of operating assets include:

o Cash
o Stock
o Building
o Machinery

o Equipment

o Patents
o Copyrights

o Goodwill
CLASSIFICATION OF ASSETS AS TO USAGE

b. Non-Operating Assets - Non-operating assets are assets that are not required for daily
business operations but can still generate revenue. Examples of non-operating assets include:

• o Short-term investments
o Marketable securities
o Vacant land
o Interest income from a fixed or time deposit
LIABILITIES

• Defined by the International Financial Reporting Standards (IFRS) Framework: “A liability is a present
obligation of the enterprise arising from past events, the settlement of which is expected to result in
an outflow from the enterprise of resources embodying economic benefits.

• Classification of Liabilities
These are the three main classifications of liabilities:
1. Current liabilities (short-term liabilities) are liabilities that are due and payable within one year.
2. Non-current liabilities (long-term liabilities) are liabilities that are due after a year or more.
3. Contingent liabilities are liabilities that may or may not arise, depending on a certain event.
LIABILITIES

Current Liabilities also known as short-term liabilities, are debts or obligations that need to be paid
within a year. Current liabilities should be closely watched by management to make sure that the
company possesses enough liquidity from current assets to guarantee that the debts or obligations can
be met.
Examples of current liabilities:
• Accounts payable

• Interest payable

• Income taxes payable

• Bills payable

• Bank account overdrafts

• Accrued expenses

• Short-term loans
LIABILITIES

1. Current liabilities are used as a key component in several short-term liquidity measures. Below are
examples of metrics that management teams and investors look at when performing financial analysis of
a company.

• Examples of key ratios that use current liabilities are:

•  The current ratio: Current assets divided by current liabilities

•  The quick ratio: Current assets, minus inventory, divided by current liabilities

• The cash ratio: Cash and cash equivalents divided by current liabilities
LIABILITIES

2. Non-current liabilities, also known as long-term liabilities, are debts or obligations that are due in over
a year’s time. Long-term liabilities are an important part of a company’s long-term financing. Companies
take on long-term debt to acquire immediate capital to fund the purchase of capital assets or invest in
new capital projects.
Long-term liabilities are crucial in determining a company’s long-term solvency. If companies are unable
to repay their long-term liabilities as they become due, then the company will face a solvency crisis.
List of non-current liabilities:
o Bonds payable
o Long-term notes payable
o Deferred tax liabilities
o Mortgage payable
o Capital leases
LIABILITIES

• Contingent Liabilities are liabilities that may occur, depending on the outcome of a future event.
Therefore, contingent liabilities are potential liabilities. For example, when a company is facing a
lawsuit of P100,000, the company will incur a liability if the lawsuit proves successful. However, if the
lawsuit is not successful, then no liability would arise.

• In accounting standards, a contingent liability is only recorded if the liability is probable (defined as
more than 50% likely to happen) and the amount of the resulting liability can be reasonably
estimated.
Examples of contingent liabilities:

• Lawsuits
Product warranties
CAPITAL

Capital also known as net assets or equity; capital refers to what is left to the owners after all liabilities are settled.
Simply stated, capital is equal to total assets minus total liabilities. Capital is affected by the following:

1. Initial and additional contributions of owner/s (investments),

2. Withdrawals made by owner/s (dividends for corporations),

3. Income, and

4. Expenses.

Owner contributions and income increase capital. Withdrawals and expenses decrease it. The terms used to refer to a
company's capital portion varies according to the form of ownership. In a sole proprietorship business, the capital is
called Owner's Equity or Owner's Capital; in partnerships, it is called Partners' Equity or Partners' Capital; and in
corporations, Stockholders' Equity.

In addition to the three elements mentioned above, Assets, Liabilities and Capital, there are two items that are also
considered as key elements in accounting equation. They are income and expenses; these items are ultimately
included as part of capital.
CAPITAL

• Income refers to an increase in economic benefit during the accounting period in the form of an
increase in asset or a decrease in liability that results in increase in equity, other than contribution
from owners. Income encompasses revenues and gains.

• Revenues refer to the amounts earned from the company’s ordinary course of business such as
professional fees or service revenue for service companies and sales for merchandising and
manufacturing concerns.

• Gains come from other activities, such as gain on sale of equipment, gain on sale of short-term
investments, and other gains.

• Income is measured every period and is ultimately included in the capital account. Examples of
income accounts are: Service Revenue, Professional Fees, Rent Income, Commission Income, Interest
Income, Royalty Income, and Sales.
CAPITAL

• Expenses are decreases in economic benefit during the accounting period in the form of a decrease in
asset or an increase in liability that result in decrease in equity, other than distribution to owners.
Expenses include ordinary expenses such as Cost of Sales, Advertising Expense, Rent Expense, Salaries
Expense, Income Tax, Repairs Expense, etc.; and losses such as Loss from Fire, Typhoon Loss, and Loss
from Theft. Like income, expenses are also measured every period and then closed as part of capital.
Net income refers to all income minus all expenses.
INCOME STATEMENT

• The income statement is the next financial statement everyone should look at. It looks quite different
than the balance sheet. In the income statement, it’s about the revenue and the expenses.
It starts with the gross sales or revenue. Then we deduct any sales return or sales discount from the
gross sales to get the net sales. From net sales, we deduct the costs of goods sold, and we get the
gross profit. From gross profit, we deduct the operating expenses like the expenses required for daily
administrative and selling expenses. By deducting the operating expenses, we get the operating
income.

• From the operating income we add, if there is any, interest and other non-operating income received
during the period and deduct the interest charges paid and other non-operating losses sustained
during the period, by this we get the EBT, meaning Earnings Before Taxes. From EBT, we deduct the
income taxes for the period, and we get the Net Income or Net Profit, meaning profit after tax.
CASH FLOW STATEMENT

Cash Flow Statement is the third most important statement every investor should look at. There are
three separate segments of a cash flow statement. These are cash flow from the operating activities,
cash flow from investing activities, and cash flow from finance activities.
1. Cash Flow from Operations is the cash generated from the core operations of the business.
2. Cash Flow from Investing Activities relates to the cash inflows and outflows related to
investment in the company like buying of property, plant, and equipment or other investments.
3. Cash Flow from Financing Activities relates to the cash inflows or outflows related to debt or equity of
the company. It includes raising of equity or capital, debt, loan repayments, buyback of
shares, and similar financing activities.
CASH FLOW STATEMENT - EXAMPLE
STATEMENT OF OWNER/PARTNERS’ EQUITY (FOR SOLE PROPRIETORSHIP AND
PARTNERSHIP) OR STATEMENT OF CHANGES IN SHAREHOLDERS’ EQUITY (FOR
CORPORATION)

• Statement of Owner/Partners’ Equity or Statement of Changes in Shareholders’ Equity is a

financial statement that provides a summary of changes in the owner/partners’ or
shareholders’ equity in a given period.
ILLUSTRATION OF INCOME STATEMENT FOR THE DIFFERENT FORMS OF BUSINESS
ORGANIZATION:

• Sole Proprietorship’s Income Statement

ILLUSTRATION OF INCOME STATEMENT FOR THE DIFFERENT FORMS OF BUSINESS
ORGANIZATION:

• Partnership’s Income Statement

ELEMENTS OF STATEMENT OF CHANGES IN OWNER/PARTNERS’ EQUITY/CAPITAL

• Capital or investment- A capital or investment is a sum of cash acquired by a business to

pursue its objectives, such as continuing or growing operations. It also can refer to permanent
fixed assets such as property, plant, & equipment which ownership has been transferred to
the business.
Net income - For a business, net income equals is the amount remaining after subtracting all
costs and expenses from revenue. If the costs and expenses exceed revenue, it is called net
loss and this is subtracted from the capital or investment.
Drawings or withdrawals- represent an amount of cash or non-cash items removed by the
owner or partners from the business for personal use or expenditure.
CORPORATION INCOME STATEMENT
ELEMENTS OF STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY

• Common Stock is the first and most important component of shareholders’ equity. Common
stockholders are the owners of the company, however there are corporations which issue
preference shares which holders are also owners of the company but with limited rights.
Additional Paid in Capital means when the company receives a premium on the shares.
Premium results when the shares of stock are issued above par value.
Retained earnings or losses are accumulated from the previous period. In simple terms,
retained earnings are the amount the company keeps after paying the dividend from net
income.
Treasury shares are the sum total of all the common shares that have been purchased back
by the company.
Dividend is the distribution of some of a company's earnings to a class of its shareholders, as
determined by the company's board of directors.
END