lOMoARcPSD|11706204 Fundamentals of Accounting, Business Management 1 Fundamentals Of Accounting, Part I (Far Eastern University) StuDocu is not sponsored or endorsed by any college or university Downloaded by Resty Quito (restyquito2290@gmail.com) lOMoARcPSD|11706204 Unit 1 Introduction to Accounting ACCOUNTING defined. “Accounting is the process of IDENTIFYING, RECORDING, and COMMUNICATING economic events of an organization to interested users.” Explain the three highlighted words in the definition of accounting: IDENTIFYING – this involves selecting economic events that are relevant to a particular business transaction. The economic events of an organization are referred to as transactions. Examples of economic events or transactions - In a bakery business: • sales of bread and other bakery products • purchases of flour that will be used for baking • purchases of trucks needed to deliver the products RECORDING – this involves keeping a chronological diary of events that are measured in pesos. The diary referred to in the definition are the journals and ledgers which will be discussed in future chapters. COMMUNICATING – occurs through the preparation and distribution of financial and other accounting reports. Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 1 | 201 lOMoARcPSD|11706204 1. The nature of accounting According to Accounting Theory “Accounting is a systematic recording of financial transactions and the presentation of the related information to appropriate persons.” Based on this definition we can derive the following basic features of accounting: • Accounting is a service activity. Accounting provides assistance to decision makers by providing them financial reports that will guide them in coming up with sound decisions. • Accounting is a process: A process refers to the method of performing any specific job step by step according to the objectives or targets. Accounting is identified as a process, as it performs the specific task of collecting, processing and communicating financial information. In doing so, it follows some definite steps like the collection, recording, classification, summarization, finalization, and reporting of financial data. • Accounting is both an art and a discipline. Accounting is the art of recording, classifying, summarizing and finalizing financial data. The word ‘art’ refers to the way something is performed. It is behavioral knowledge involving a certain creativity and skill to help us attain some specific objectives. Accounting is a systematic method consisting of definite techniques and its proper application requires skill and expertise. So by nature, accounting is an art. And because it follows certain standards and professional ethics, it is also a discipline. • Accounting deals with financial information and transactions: Accounting records financial transactions and data, classifies these and finalizes their results given for a specified period of time, as needed by their users. At every stage, from start to finish, accounting deals with financial information and financial information only. It does not deal with non-monetary or non-financial aspects of such information. • Accounting is an information system: Accounting is recognized and characterized as a storehouse of information. As a service function, it collects processes and communicates financial information of any entity. This discipline of knowledge has evolved to meet the need for financial information as required by various interested groups. Function of accounting in business. Accounting is the means by which business information is communicated to business owners and stakeholders. The role of accounting in business is to provide information for managers and owners to use in operating the Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 2 | 201 lOMoARcPSD|11706204 business. In addition, accounting information allows business owners to assess the efficiency and effectiveness of their business operations. Prepared accounting reports can be compared with industry standards or to a leading competitor to determine how the business is doing. Business owners may also use historical financial accounting statements to create trends for analyzing and forecasting future sales. Accounting is considered as the language of business. Accounting helps the users of these financial reports to see the true picture of the business in financial terms. In order for a business to survive, it is important that a business owner or manager be well-informed. The function of accounting in business. Mr. Juan is a retired government employee who is good at baking. One day he decides to put up a bakery shop in your barangay. He renovates a portion of his house to serve as the area for the production of bread. He purchases baking equipment and raw materials to produce five different types of bread. Mr. Juan also hires Jose to help him with the baking and, at the same time, to be in-charge of sales. Mr. Juan pays Jose on a weekly basis. Every day, Mr. Juan’s wife deposits the daily cash sales in their bank account at XY Savings Bank. With the help of accounting, what possible decisions or questions of Mr. Juan can accounting provide an answer to? • Is my business earning? (profitability) • How much daily or monthly sales do I need in order to recover my fixed cost? (break-even) • Do I need to hire additional workers to help me with my production? • Can I afford to set up a new store in another place? Where do I get the funds? • Can I afford to pay a bank loan? Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 3 | 201 lOMoARcPSD|11706204 The history of accounting Accounting is as old as civilization itself. It has evolved in response to various social and economic needs of men. Accounting started as a simple recording of repetitive exchanges. The history of accounting is often seen as indistinguishable from the history of finance and business. The evolution of accounting: • The Cradle of Civilization Around 3600 B.C., record-keeping was already common from Mesopotamia, China and India to Central and South America. The oldest evidence of this practice was the “clay tablet” of Mesopotamia which dealt with commercial transactions at the time such as listing of accounts receivable and accounts payable. • 14th Century - Double-Entry Bookkeeping The most important event in accounting history is generally considered to be the dissemination of double entry bookkeeping by Luca Pacioli (‘The Father of Accounting’) in 14th century Italy. Pacioli was much revered in his day, and was a friend and contemporary of Leonardo da Vinci. The Italians of the 14th to 16th centuries are widely acknowledged as the fathers of modern accounting and were the first to commonly use Arabic numerals, rather than Roman, for tracking business accounts. Luca Pacioli wrote Summa de Arithmetica, the first book published that contained a detailed chapter on double-entry bookkeeping. • French Revolution (1700s) The thorough study of accounting and development of accounting theory began during this period. Social upheavals affecting government, finances, laws, customs and business had greatly influenced the development of accounting. • The Industrial Revolution (1760-1830) Mass production and the great importance of fixed assets were given attention during this period. • 19th Century – The Beginnings of Modern Accounting in Europe and America The modern, formal accounting profession emerged in Scotland in 1854 when Queen Victoria granted a Royal Charter to the Institute of Accountants in Glasgow, creating the profession of the Chartered Accountant (CA). Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 4 | 201 lOMoARcPSD|11706204 In the late 1800s, chartered accountants from Scotland and Britain came to the U.S. to audit British investments. Some of these accountants stayed in the U.S., setting up accounting practices and becoming the origins of several U.S. accounting firms. The first national U.S. accounting society was set up in 1887. The American Association of Public Accountants was the forerunner to the current American Institute of Certified Public Accountants (AICPA). In this period rapid changes in accounting practice and reports were made. Accounting standards to be observed by accounting professionals were promulgated. Notable practices such as mergers, acquisitions and growth of multinational corporations were developed. A merger is when one company takes over all the operations of another business entity resulting in the dissolution of another business. Businesses expanded by acquiring other companies. These types of transactions have challenged accounting professionals to develop new standards that will address accounting issues related to these business combinations. • The Present - The Development of Modern Accounting Standards and Commerce The accounting profession in the 20th century developed around state requirements for financial statement audits. Beyond the industry's self-regulation, the government also sets accounting standards, through laws and agencies such as the Securities and Exchange Commission (SEC). As economies worldwide continued to globalize, accounting regulatory bodies required accounting practitioners to observe International Accounting Standards. This is to assure transparency and reliability, and to obtain greater confidence on accounting information used by global investors. Nowadays, investors seek investment opportunities all over the world. To remain competitive, businesses everywhere feel the need to operate globally. The trend now for accounting professionals is to observe one single set of global accounting standards in order to have greater transparency and comparability of financial data across borders. Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 5 | 201 lOMoARcPSD|11706204 Test Answer the following questions. 1. Is accounting important to you? Does it affect your daily activities? How? ________________________________________________________________ ________________________________________________________________ ________________________________________________________________ 2. Define accounting ________________________________________________________________ ________________________________________________________________ ________________________________________________________________ 3. Give examples of decisions or questions that can be supported by accounting information. ________________________________________________________________ ________________________________________________________________ ________________________________________________________________ Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 6 | 201 lOMoARcPSD|11706204 Unit 2 Branches of Accounting Branches of Accounting According to Investopedia, “Accounting is divided into several branches to better serve the needs of different users with varying information needs. These branches sometimes overlap and they are often closely intertwined.” Financial Accounting Financial accounting is the broadest branch and is focused on the needs of external users. Financial accounting is primarily concerned with the recognition, measurement and communication of economic activities. This information is communicated in a complete set of financial statements. It is assumed under this branch that the users have one common information need. Financial accounting conforms with accounting standards developed by standard-setting bodies. In the Philippines, there is a Council created to set these standards. Examples of these financial reports include: • the balance sheet (statement of financial condition) • income statement (the profit and loss statement, or P&L) • statement of cash flows Financial accounting is primarily concerned with processing historical data. Although financial accounting generally meets the needs of external users, internal users of accounting information also use this information for their decision-making needs. Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 7 | 201 lOMoARcPSD|11706204 Management (or Managerial) Accounting Management accounting emphasizes the preparation and analysis of accounting information within the organization. The objective of managerial accounting is to provide timely and relevant information for those internal users of accounting information, such as the managers and employees in their decision-making needs. Oftentimes, these are sensitive information and is not distributed to those outside the business - for example, prices, plans to open up branches, customer list, etc. Managerial accounting involves financial analysis, budgeting and forecasting, cost analysis, evaluation of business decisions, and similar areas. Government Accounting Government accounting is the process of recording, analyzing, classifying, summarizing, communicating and interpreting financial information about the government in aggregate and in detail reflecting transactions and other economic events involving the receipt, spending, transfer, usability and disposition of assets and liabilities. This branch of accounting deals with how the funds of the government are recorded and reported. Government accounting deals with these transactions, the recording of inflow and outflow of funds of the government. Auditing There are two types of auditing: external and internal auditing. External auditing refers to the examination of financial statements by an independent CPA (Certified Public Accountant) with the purpose of expressing an opinion as to fairness of presentation and compliance with the generally accepted accounting principles (GAAP). The audit does not cover 100% of the accounting records but the CPA reviews a selected sample of these records and issues an audit report. Internal auditing deals with determining the operational efficiency of the company regarding the protection of the company’s assets, accuracy and reliability of the accounting data, and adherence to certain management policies. It focuses on evaluating the adequacy of a company's internal control structure by testing segregation of duties, policies and procedures, degrees of authorization, and other controls implemented by management. Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 8 | 201 lOMoARcPSD|11706204 Tax Accounting. Tax accounting helps clients follow rules set by tax authorities. It includes tax planning and preparation of tax returns. It also involves determination of income tax and other taxes, tax advisory services such as ways to minimize taxes legally, evaluation of the consequences of tax decisions, and other tax-related matters. Cost Accounting. Sometimes considered as a subset of management accounting, cost accounting refers to the recording, presentation, and analysis of manufacturing costs. Cost accounting is very useful in manufacturing businesses since they have the most complicated costing process. Cost accountants also analyze actual and standard costs to help managers determine future courses of action regarding the company's operations. Cost accounting will also help the owner set the selling price of his products. For example, if the cost accounting records shows that the total cost to produce one can of sardines is PHP50, then the owner can set the selling price at PHP60. Accounting Education. This branch of accounting deals with developing future accountants by creating relevant accounting curriculum. Accounting professionals can become faculty members of educational institutions. Accounting educators contribute to the development of the profession through their effective teaching, publications of their research and influencing students to pursue careers in accounting. Accounting teachers share their knowledge on accounting so that students are informed of the importance of accounting and its use in our daily lives. Accounting Research. Accounting research focuses on the search for new knowledge on the effects of economic events on the process of summarizing, analyzing, verifying, and reporting standardized financial information, and on the effects of reported information on economic events. Researchers typically choose a subject area and a methodology on which to focus their efforts. The subject matter of accounting research may include information systems, auditing and assurance, corporate governance, financials, managerial, and tax. Accounting research plays an essential part in creating new knowledge. Academic accounting research "addresses all aspects of the accounting profession" using a scientific method. Practicing accountants also conduct accounting research that focuses on solving problems for a client or group of clients. The Accounting research helps standard-setting bodies around the world to develop new standards that will address recent issues or trend in global business. Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 9 | 201 lOMoARcPSD|11706204 Test 1. Match: Match Column A with Column B. Column A a. Preparation of general-purpose financial statements b. Evaluation of the performance of a sales department c. Develop standards to address a new business set up d. Review tax compliance of the business e. Evaluate whether a branch of the business complies with the collection and deposit policy of the company f. Review whether the financial statements are presented fairly and in compliance with accounting standards g. Report on the spending of government funds h. Report on the total cost of materials and labor used in the production i. Conducting lectures on accounting topics Column B Accounting Education Auditing (External) Auditing (Internal) Accounting Research Cost Accounting Financial Government Accounting Managerial Tax Accounting 2. Match: Match column A with column B, Column A a. What are the sources of income of the government? b. Where do these taxes go? Column B Roads, Hospitals, education and others Taxes paid by Filipinos 3. Essay writing: What branch of accounting do you want to focus on and why? Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 10 | 201 for lOMoARcPSD|11706204 Unit 3 Users of Accounting Information Why accounting is considered as the language of business. Possible answer: Accounting information helps users to make better financial decisions. What business you would want to enter into. Possible answers: • buying and selling of cars • boutique • gasoline station • bakery From the businesses enumerated, choose one business and use this as your example. “If you are the owner, what do you want to know about the business? What possible decisions can accounting support?” Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 11 | 201 lOMoARcPSD|11706204 Users of Accounting “Who uses accounting data or information?” Users of Accounting Information The accounting process provides financial data for a broad range of individuals whose objectives in studying the data vary widely. Three primary users of accounting information were previously identified, Internal users, External users, and Government/ IRS. Each group uses accounting information differently, and requires the information to be presented differently. Accounting information consists of sets of financial statements which is useful for internal users (primary users) of an organization as well as external users (secondary users). There are two broad categories of users of financial information: internal and external users. INTERNAL USERS Internal users of accounting information are those individuals inside a company who plan, organize, and run the business. These users are directly involved in managing and operating the business. These include marketing managers, production supervisors, finance directors, company officers and owners Engage the learners in a question-and-answer type lecture. Accounting supplies managers and owners with significant financial data that is useful for decision making. This type of accounting in generally referred to as managerial accounting. Some of the ways internal users employ accounting information include the following: Assessing how management has discharged its responsibility for protecting and managing the company’s resources Shaping decisions about when to borrow or invest company resources Shaping decisions about expansion or downsizing What information will that user need that can be answered by accounting?” Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 12 | 201 lOMoARcPSD|11706204 Internal users (Primary Users) of accounting information include the following: Management Information need: income/earnings for the period, sales, available cash, production cost Decisions supported: analyze the organization's performance and position and take appropriate measures to improve the company results. sufficiency of cash to pay dividends to stockholders; pricing decisions. Organization’s management requires accounting information for analyzing the performance and actual position of the business. Accounting information helps the management to arrive at an evaluated decision. It helps with cost determination, investment decisions, helps to identify warning signals in case of a downfall etc. Employees Employees are interested to know the accounting details of their organization so that they are aware of overall profitability of the company which has a direct impact on their remuneration and job security. Information need: profit for the period, salaries paid to employees Decisions supported: job security, consider staying in the employ of the company or look for other employment opportunities. Owners Information need: profit or income for the period, resources or assets of the business, liabilities of the business Decisions supported: considerations regarding additional investment, expanding the business, borrowing funds to support any expansion plans. Accounting information is presented to internal users usually in the form of management accounts, budgets, forecasts and financial statements. This information will support whatever decision of the internal users. The external users of accounting information Owners are more concerned about the returns they get out of their investment in the organization and this purpose is fulfilled through the accounting information. Not only do they want their capital safe they are also interested in knowing the profit earned or loss incurred by the business time to time. Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 13 | 201 lOMoARcPSD|11706204 EXTERNAL USERS External users are individuals and organizations outside a company who want financial information about the company. These users are not directly involved in managing and operating the business. The two most common types of external users are potential investors and creditors. Potential Investors use accounting information to make decisions to buy shares of a company . Creditors (such as suppliers and bankers) use accounting information to evaluate the risks of granting credit or lending money. Also included as external users are government regulatory agencies such as Securities and Exchange Commission (SEC), Bureau of Internal Revenue (BIR), Department of Labor and Employment (DOLE), Social Security System (SSS), and Local Government Units (LGUs). Typically called financial accounting, the record of a business’ financial history for use by external entities is used for many purposes. The external users of accounting information fall into six groups; each has different interests in the company and wants answers to unique questions. The groups and some of their possible questions are: External users (Secondary Users) of accounting information include the following: Creditors: for determining the credit worthiness of an organization. Terms of credit are set by creditors according to the assessment of their customers' financial health. Creditors include suppliers as well as lenders of finance such as banks. Tax Authorities (BIR): for determining the credibility of the tax returns filed on behalf of a company. Investors: for analyzing the feasibility of investing in a company. Investors want to make sure they can earn a reasonable return on their investment before they commit any financial resources to a company. Similar to owners, external investors are concerned about their ROI (Return on Investment) from the organization. Since investors do not have a direct control over the business operations they use accounting information to find out how their money is being spent by the managers. It helps them in decision-making such as whether to increase, decrease or hold their investments. Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 14 | 201 lOMoARcPSD|11706204 Customers: for assessing the financial position of its suppliers which is necessary for them to maintain a stable source of supply in the long term. They are a complex group which includes producers at every level of processing, wholesalers, retailers, and end users. Good financial health shows that customers at each level are comfortable with continuous inflow of stock from the business. Customers use the accounting information for assessing the financial position of its suppliers which is essential for maintaining a stable source of supply in future. Regulatory Authorities (SEC, DOLE): for ensuring that a company's disclosure of accounting information is in accordance with the rules and regulations set in order to protect the interests of the stakeholders who rely on such information in forming their decisions. Regulatory and Tax Authorities – Regulatory Authorities including the govt. agencies ensure that the accounting information is prepared based on the accounting principles, standards and rules & regulations governing the organization. The primary objective is to protect the interest of the stakeholders of the organization. Correct tax evaluation is also done by the authorities after analyzing the financial statements. Banks & NBFCs – They are a crucial part of any business environment since they advance both short & long-term loans to a business. Accounting information helps them in determining the creditworthiness of the organization. Based on the financial health of an organization, the future terms and conditions of credit are assessed by the Banks and NBFCs. Suppliers – Other businesses which supply goods to an organization on credit would also want to assess the repaying capacity of that organization before providing any form of credit. Accounting information plays a crucial role in this case. Public – General public would want to know the financial health of a business to get a fair idea of the firm’s niche & overall economy of the nation. It can help to analyze employment trends, the general financial stability of a country etc. Questions: 1. Give examples of external users. Possible answers on examples of External Users: a. potential investors – b. banks c. suppliers d. BIR e. DOLE Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 15 | 201 lOMoARcPSD|11706204 2. What kind of information do users need that can be answered by accounting?”. Possible answers on information provided by Accounting: a. Income or profit of the business b. resources or assets of the business c. liabilities or amount owed by the business to its suppliers d. taxes paid by the business e. salaries and other benefits paid to employees 3. What decisions of external users that are supported by accounting information: Possible answers a. Potential Investors – Is it profitable for me to invest in this business? b. Banks – If extend a loan to this company, will it be able to pay this loan? Does this company have sufficient resources to pay its loan? c. Suppliers – Do I extend credit to this company? For how long? d. BIR – Is the owner paying the correct taxes? e. DOLE – Are the employees paid according to what the law states? Do they get the benefits required? SUMMARY OF THE DIFFERENCES BETWEEN INTERNAL AND EXTERNAL USERS Internal users of accounting information are those who are involved in planning, organizing and running the business. They need more detailed information on a timely basis in order to support their decisions. Examples of these internal users are managers, employees and owners. The external users of accounting information are those individuals or organizations outside a company who are interested in its financial information. Examples of these external users are potential investors, suppliers and government agencies. 1. Is the Local Government Unit (LGU) interested in your accounting reports? Possible Answer: Yes. The LGU will check whether you are paying your local taxes. As required, businesses must have a business permit before they are allowed to operate in the city or municipality. This is renewed every year, with appropriate taxes paid. The local government may review your accounting records to check whether you are declaring or paying the correct taxes. 2. Are the officers of the Local Government Unit internal or external users? Why? Possible Answer: External. They are not directly involved in the operation or management of the business. Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 16 | 201 lOMoARcPSD|11706204 Test Answer the following questions 1. Give at least 3 internal users of accounting information. ________________________________________________________________ ________________________________________________________________ ________________________________________________________________ 2. Give at least 3 external users of accounting information. ________________________________________________________________ ________________________________________________________________ ________________________________________________________________ 3. Differentiate internal users from external users of accounting information. ________________________________________________________________ ________________________________________________________________ ________________________________________________________________ 4. Multiple choice. Write the word of the correct answer. a. What statement(s) do external and internal users of accounting information rely on? Income Statement Statement of Retained Earnings Balance Sheet Statement of Cash Flows All answers are correct. b. Which of the following is an example of external users of accounting information? Directors Managers Owners Employees Analysts c. Djokovic is the Chief Information Officer for InfoTech Inc. Murray is the Chief Lending Officer at the Bank where InfoTech has a large bank loan. Which statement is true for both Djokovic and Murray, in connection with InfoTech? Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 17 | 201 lOMoARcPSD|11706204 External User Information User Internal User Supplier Investor d. The process of providing financial information to external decision makers is referred to as: Public accounting. Government accounting. Financial accounting. Managerial accounting. e. The primary objective of financial reporting is to provide information: About a firm's financing and investing activities. About a firm's economic resources and obligations. About a firm's product lines. Useful in predicting cash flows. f. Which of the following is not true? managerial accounting information is prepared for internal users managerial accounting information is not required by various laws there are specific standards of acceptability for managerial accounting the structure of managerial accounting practice is relatively flexible 5. Write TRUE if the statement is true and write FALSE if the statement is false. a. Shareholders are the owners of a corporation and have little or no risk to their personal assets. b. External users of the accounting information include banks, shareholders, creditors, suppliers, and customers. c. Internal users of accounting information include banks, shareholders, and customers. d. Good ethics is good business. e. Ethics and ethical behaviour are important. Ethics are beliefs that separate right from wrong. f. Managerial accounting provides information to the organization's decision makers. Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 18 | 201 lOMoARcPSD|11706204 Unit 4 Forms of Business Organizations Forms of Business Organizations: A. Concept of sole/single proprietorship. “Suppose you want to open your own sari-sari store that will need PHP10,000 to start and you used your PHP10,000 savings to start the said business. You are the sole owner of the said sari-sari store. This type of business is called sole/single proprietorship.” Sole/single proprietorship. • A form of business is owned by one person; the simplest, and the most common form of business organization • It is not separate from the owner. The business and the owner are inseparable The advantages of sole/single proprietorship. • The owner keeps all the profits. • The owner makes all the decisions. • It is easy to form and operate. The disadvantages of sole/single proprietorship. • The life of the business is limited to the life of the owner. Once the owner dies, the business will cease to operate under the name of the proprietor. • The amount of capital is limited only by the wealth of the proprietor. B. Concept of partnership: “What if the needed amount to start your dream sari-sari store is PHP50,000 and you only have PHP25,000 cash savings. You ask Juan, your friend if he is willing to invest his PHP25,000 and become part owner of the sari-sari store. Assuming he agrees, what form of business organization was created?” Partnerships • A form of business owned by two or more persons. The details of the arrangement between the partners are outlined in a written document called articles of partnership. Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 19 | 201 lOMoARcPSD|11706204 • Profits are divided among partners based on their agreed sharing. • The owner is called a partner. The advantages of a partnership • Higher capital because two or more persons will contribute to the common fund. • It is easy to operate like a sole/single proprietorship The disadvantages of a partnership • The profits are divided among the partners. • A partner can be held liable for the acts of the other partners. • In a lawsuit, the personal properties of the partners can be held beyond their contributions and may be used to answer for any liability of the partnership. C. The concept of a corporation: “Assuming your dream is to open a grocery store and not just a sari-sari store but you will need PHP1,000,000 to start the said business. You have only PHP25,000, your friend Juan has PHP25,000, and your mother is willing to invest her PHP50,000, but still these are not enough to start your dream grocery store. Where will you get the money to raise the PHP1 million? You may consider setting up a corporation?” Corporations • • • • • • • • • • A corporation is a business organized as a separate legal entity (artificial person) under the corporation law with ownership divided into transferable shares of stocks Corporation Code of the Philippines creates a corporation. The corporation begins its existence from the date the Articles of Incorporation is approved by the Securities and Exchange Commission (SEC). The SEC (Securities and Exchange Commission) is the government agency primarily tasked to regulate private corporations in the Philippines. The owners are called stockholders or shareholders. The word ‘Corporation/Incorporation/Corp./Inc.’ appears in the name of the entity. The voting rights of a shareholder is generally based on the percentage of ownership. The management of the business is delegated by the shareholders to the Board of Directors The ownership is divided into shares and the value of one share may be denominated at a smaller amount, for example at PHP10 per share. The proof of ownership is evidenced by a stock certificate. Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 20 | 201 lOMoARcPSD|11706204 The advantages of a corporation • Can easily raise additional funds by selling shares of stocks to the public. • Shareholders are not personally liable for the debts of the corporation. The extent of their liability is limited to their equity (ownership) in the corporation. The disadvantages of a corporation • It is relatively complicated to set up. • Subject to several legal restrictions as listed in the Corporation Code of the Philippines D. The nature of cooperatives: “Assuming all the mothers in your barangay decided to open a sari-sari store where all the members can buy in cash or in credit. Some mothers were also taught how to sew dresses and bags as part of the project of the group. These bags are then sold to a certain company. Aside from that, the organization provides seminars to the members on various topics involving mothers and their roles. At the end of the year, the profits are distributed among the members based on their capital contribution. The amount of their purchases in the sari-sari store during the year is also computed and they receive something out of the profit/surplus based on their purchases. This form of business organization is called a cooperative. a. Cooperatives • • • • • A cooperative is a duly registered association of persons with a common bond of interest, voluntarily joining together to achieve their social, economic and cultural needs. The owners are called members who contribute equitably to the capital of the cooperative. The members are expected to patronize their products and services. The word ‘cooperative’ appears in the name of the entity. This form of business organization is regulated by the Cooperative Development Authority (CDA). Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 21 | 201 lOMoARcPSD|11706204 Role of CDA as a government agency regulating the cooperatives. WHAT IS COOPERATIVE? A cooperative is an autonomous and duly registered association of persons, with a common bond of interest, who have voluntarily joined together to achieve their social, economic and cultural needs and aspirations by making equitable contributions to the capital required, patronizing their products and services and accepting a fair share of risks and benefits of the undertaking in accordance with the universally accepted cooperative principles. What are the objectives and goals of a cooperatives? The primary objective of every cooperative is to help improve the quality of life of its members. Towards this end, the cooperative shall aim to: (a) Provide goods and services to its members to enable them to attain increased income, savings, investments, productivity, and purchasing power, and promote among themselves equitable distribution of net surplus through maximum utilization of economies of scale, cost-sharing and risk-sharing; (b) Provide optimum social and economic benefits to its members; (c) Teach them efficient ways of doing things in a cooperative manner; (d) Propagate cooperative practices and new ideas in business and management; (e) Allow the lower income and less privileged groups to increase their ownership in the wealth of the nation; and (f) Cooperate with the government, other cooperatives and people-oriented organizations to further the attainment of any of the foregoing objectives. WHAT ARE THE TYPES OF COOPERATIVES? Cooperatives may fall under any of the following types: (a) Credit Cooperative : is one that promotes and undertakes savings and lending services among its members. It generates a common pool of funds in order to provide financial assistance and other related financial services to its members for productive and provident purposes; (b) Consumer Cooperative : is one the primary purpose of which is to procure and distribute commodities to members and non-members; Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 22 | 201 lOMoARcPSD|11706204 (c) Producers Cooperative : is one that undertakes joint production whether agricultural or industrial. It is formed and operated by its members to undertake the production and processing of raw materials or goods produced by its members into finished or processed products for sale by the cooperative to its members and nonmembers. Any end product or its derivative arising from the raw materials produced by its members, sold in the name of and for the account of the cooperative, shall be deemed a product of the cooperative and its members; (d) Marketing Cooperative : is one which engages in the supply of production inputs to members and markets their products; (e) Service Cooperative : is one which engages in medical and dental care, hospitalization, transportation, insurance, housing, labor, electric light and power, communication, professional and other services; (f) Multi-Purpose Cooperative : combines two (2) or more of the business activities of these different types of cooperatives; (g) Advocacy Cooperative : is a primary cooperative which promotes and advocates cooperativism among its members and the public through sociallyoriented projects, education and training, research and communication, and other similar activities to reach out to its intended beneficiaries; (h) Agrarian Reform Cooperative : is one organized by marginal farmers majority of which are agrarian reform beneficiaries for the purpose of developing an appropriate system of land tenure, land development, land consolidation or land management in areas covered by agrarian reform; (i) Cooperative Bank : is one organized for the primary purpose of providing a wide range of financial services to cooperatives and their members; (J) Dairy Cooperative : is one whose members are engaged in the production of fresh milk which may be processed and/or marketed as dairy products; (k) Education Cooperative : is one organized for the primary purpose of owning and operating licensed educational institutions, notwithstanding the provisions of Republic Act No.9155, otherwise known as the Governance of Basic Education Act of 2001; (l) Electric Cooperative : is one organized for the primary purpose of undertaking power generation, utilizing renewable sources, including hybrid systems, acquisition and operation of sub transmission or distribution to its household members; (m) Financial Service Cooperative : is one organized for the primary purpose of engaging in savings and credit services and other financial services; Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 23 | 201 lOMoARcPSD|11706204 (n) Fishermen Cooperative : is one organized by marginalized fishermen in localities whose products are marketed either as fresh or processed products; (o) Health Services Cooperative : is one organized for the primary purpose of providing medical, dental, and other health services; (p) Housing Cooperative : is one organized to assist or provide access to housing for the benefit of its regular members who actively participate in the savings program for housing. It is co-owned and controlled by its members; (q) Insurance Cooperative : is one engaged in the business of insuring life and property of cooperatives and their members; (r) Transport Cooperative : is one which includes land and sea transportation, limited to small vessels, as defined or classified under the Philippine maritime laws, organized under the provisions of RA 9520; (s) Water Service Cooperative : is one organized to own, operate and manage waters systems for the provision and distribution of potable water for its members and their households; (t) Workers Cooperative : is one organized by workers, including the selfemployed, who are at the same time the members and owners of the enterprise. Its principal purpose is to provide employment and business opportunities to its members and manage it in accordance with cooperative principles; and (u) Other types of Cooperatives : as may be determined by the Authority. WHAT ARE THE CATEGORIES OF COOPERATIVES? Cooperative shall be categorized according to membership and territorial consideration. In terms of membership, cooperatives shall be categorized into: Primary-the members of which are natural persons. Secondary-the members of which are primaries. Tertiary-the members of which are secondary cooperatives. Thus, those with cooperative memberships are considered federations or unions as the case may be. In terms of territory, cooperatives shall be categorized according to areas of operation which may or may not coincide with the political subdivisions of the country. Those organized by minors shall be considered a laboratory cooperative and must be affiliated with a registered cooperative. It is governed by special guidelines promulgated by the CDA. Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 24 | 201 lOMoARcPSD|11706204 WHO CAN BE MEMBERS OF A COOPERATIVE? A cooperative has two kinds of members: regular members and associate members. A regular member is one who has complied with all the membership requirements and entitled to all the rights and privileges of membership as stated in the Cooperative Code and the cooperative by laws. An associate member has no right to vote and be voted upon and is entitled only to such rights and privileges provided by the cooperative's by laws. WHAT ARE THE PRIVILEGES OF A COOPERATIVE? Cooperative registered under R.A. 9520 can enjoy the following privileges: (1) Cooperatives shall enjoy the privilege of depositing their sealed cash boxes or containers, documents or any valuable papers in the safes of the municipal or city treasurers and other government offices free of charge, and the custodian of such articles shall issue a receipt acknowledging the articles received duly witnessed by another person; (2) Cooperatives organized among government employees, notwithstanding any law or regulation to the contrary, shall enjoy the free use of any available space in their agency, whether owned or rented by the Government; (3) Cooperatives rendering special types of services and facilities such as cold storage, ice plant, electricity, transportation, and similar services and facilities shall secure a franchise therefor, and such cooperatives shall open their membership to all persons qualified in their areas of operation; (4) In areas where appropriate cooperatives exist the preferential right to supply government institutions and agencies rice, corn and other grains, fish and other marine products meat, eggs, milk, vegetables, tobacco and other agricultural commodities produced by their members shall be granted to the cooperatives concerned; (5) Preferential treatment in the allocation of fertilizers and in rice distribution shall be granted to cooperatives by the appropriate government agencies; (6) Preferential and equitable treatment in the allocation or control of bottomries of commercial shipping vessels in connection with the shipment of goods and products of cooperatives; (7) Cooperatives and their federations, such as market vendor cooperatives, shall Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 25 | 201 lOMoARcPSD|11706204 have preferential rights in management of public markets and/or lease of public market facilities, stall or spaces; (8) Credit cooperatives and/or federations shall be entitled to loans, credit lines, rediscounting of their loan notes, and other eligible papers with the Development Bank of the Philippines, the Philippine National Bank, the Land Bank of the Philippines and other financial institutions except the Central Bank of the Philippines; (9) Cooperatives transacting business with the Government of the Philippines or any of its political subdivisions or any of its agencies or instrumentalities, including government-owned and controlled corporations shall be exempt from prequalification bidding requirements; and (10) Cooperatives shall enjoy the privilege of being represented by the provincial or city fiscal or the Office of the Solicitor General, free of charge, except when the adverse party is the Republic of the Philippines. (11) Cooperatives shall enjoy the privilege of being represented by the provincial or city fiscal or the Office of the Solicitor General, free of charge, except when the adverse party is the Republic of the Philippines; (12) shall have the preferential right in the management of the canteen and other services related to the operation of the educational institution where they are employed: Cooperatives organized by faculty members and employees of educational institutions Provided, That such services are operated within the premises of the said educational institution; and (13) The appropriate housing agencies and government financial institutions shall create a special window for financing housing projects undertaken by cooperatives, with interest rates and terms equal to, or better than those given for socialized housing projects. This financing shall be in the form of blanket loans to qualified cooperatives, without need for individual processing. HOW TO ORGANIZE A COOPERATIVE? Organizing a cooperative can be complex and simple. It requires an understanding of the basic needs of the prospective cooperative members. It demands patience from the organizer who must make the cooperative's long-term goals and objectives, and its visions a real part of the members' lives. But it can be too easy because the Cooperative Code of the Philippines (RA 6938) has devised very clear-cut steps for the cooperative organizer and members. The following are the basic information that the prospective members should understand before organizing a cooperative. Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 26 | 201 lOMoARcPSD|11706204 There are nine (9) steps suggested in setting up a cooperative. FIRST. Get organized. You must have at least 15 members to do that. At once determine the common problems you would want solved and the basic needs you would want provided for through a cooperative. You may want to include increasing your production, marketing your produce, credit assistance, power generation, banking or insurance and other similar needs. Determining your problems and needs will also help you classify the kind of cooperative you will be organizing. Even before a cooperative is set up, a dedicated core group people who will do all the organizational and paper works is a must. From this core group, working communities may be formed to set things moving. These committees may include membership, finance, executive, secretariat to name a few. SECOND. Reserved your proposed cooperative name. Secure and fill up Cooperative Name Reservation Request Form (CNRRF). This must be submitted to CDA Central Office or any of its Extension Office. A reservation fee shall apply. Please click Name Reservation button. THIRD. Prepare a general statement called an economic survey. Economic Survey is a general statement describing, among others, the structure and purposes of the proposed cooperative. The structure and actual staffing pattern shall include a bookkeeper. This should indicate the area of operation, the size of membership and other pertinent data in a format provided by the Authority. FOURTH. Prepare the cooperative's by-laws. The by-laws contain the rules and regulations governing the operation of the cooperative. FIFTH. Prepare the articles of cooperation. Mandatory contents of the articles of cooperation are the following: (a) the name of the cooperative, which must include the word "cooperative"; (b) the purpose or purposes and scope of business for which the cooperative is to be registered; (c) the term of existence of cooperative; (d) the area of operation and the postal address of its principal office; (e) the names, nationality and the postal addresses of the registrants; (f) the common bond of membership; (g) The list of names of the directors who shall manage the cooperative; and (h) The amount of its share capital, the names and residences of its contributors, Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 27 | 201 lOMoARcPSD|11706204 and a statement of whether the cooperative is primary, secondary or tertiary. The articles of cooperation shall be signed by each of the organizers and acknowledged by them if natural persons, and by the chairpersons or secretaries, if juridical persons, before a notary public. . SIXTH. Secure bond of accountable officer(s). A surety bond should be secured from a duly registered insurance or bonding company. Every director, officer and employee handling funds, securities or property on behalf of the cooperative shall be covered by this. The board of directors shall determine the adequacy of such bonds. SEVENTH. Execute Treasurers Affidavit. A sworn statement of the treasurer elected by the subscribers showing that at least twenty-five per centum (25%) of the authorized share capital has been subscribed, and at least twenty-five per centum (25%) of the total subscription has been paid should be executed and to be attached to the articles of cooperation. The paid-up share capital shall not be less than Fifteen thousand pesos (P15,000.00).. EIGHTH. Complete the Pre-Membership Education Seminar (PMES). A prospective member of a primary cooperative must have completed a PreMembership Education Seminar (PMES). You may contact the Regional or Extension Office which has jurisdiction over your proposed cooperative for technical assistance. NINTH. Register your cooperative with the Cooperative Development Authority (CDA).. Submit the following required documents in four (4) copies: Four (4) copies each of the Economic Survey, Articles of Cooperation and By-Laws duly notarized; 1. Economic Survey; 2. Articles of Cooperation and By-Laws; 3. Surety bond of acountable officers; 4. Treasurer's Affidavit; 5. Approved Cooperative Name Reservation Slip; 6. Certificate of PMES; WHERE DO WE REGISTER COOPERATIVE, AND HOW MUCH SHOULD BE PAID FOR THE REGISTRATION OF COOPERATIVE? The Cooperative Development Authority (CDA) is the sole government agency mandated to register all types of cooperatives. Its main office is located at 827 Aurora Blvd., Immaculate Conception, Quezon City. For registration of primary cooperatives, this power has been delegated to the Regional or Extension Offices. Prospective cooperatives must submit their application to the CDA Extension Office where the principal office of the cooperative is located. Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 28 | 201 lOMoARcPSD|11706204 b. The advantages of a cooperative • Enjoys certain tax exemption privilege • Promotes the concept of sharing resources c. The disadvantages of a Cooperative • Limited distribution of surplus • Requires continuous education programs for members. • The members have active and direct participation in the business of the cooperative. Distinctions: Item 1.Numbers of possible owners 2. Management (who manages the business) 3. Termination of the business Sole Proprietorship 1 Partnership Corporations Cooperatives 2 or more At least 5 15 or more Owner (but he may hire somebody) Partners (or they may hire managers) Death of the owner Death of any partner or withdrawal of a partner Board of Directors Board of and operating directors and management operating management As stated in the As stated in the Articles of Article of incorporation, not Cooperation, not to exceed 50 to exceed 50 years years SEC CDA 4. Government agency In limited capacity, assigned primarily to DTI regulate 5. Transfer of ownership Sell the business (it’s a new entity under a new owner) 6. Liability of owners Unlimited: other properties not used in the business may be held liable for the obligation of the business In limited capacity, DTI Sell the business or interest of a partner (consent of other partners is necessary) Generally unlimited; the other properties of the partners may be held liable for the obligations of the partnership Sell stocks Cannot transfer nor sell his membership Limited to the Limited to the stock investment capital of the shareholder contribution of the member Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 29 | 201 lOMoARcPSD|11706204 Test Answer the following questions. 1. Summarize all the forms of business organizations. ________________________________________________________________ ________________________________________________________________ ________________________________________________________________ 2. Give a brief description of each form and the advantage of creating such forms. ________________________________________________________________ ________________________________________________________________ __________________________________________________________ 3. Discuss: “Your PHP10 daily allowance may be used to buy shares of stocks, thus making you an owner of a Corporation.” ________________________________________________________________ ________________________________________________________________ ______________________________________________________________ 4. Enumerate all the forms of business organizations by nature of ownership. ________________________________________________________________ ________________________________________________________________ ________________________________________________________________ 5. Differentiate a corporation from a partnership according to number of owners and their liabilities. ________________________________________________________________ ________________________________________________________________ ________________________________________________________________ 6. Differentiate a corporation from cooperative. ________________________________________________________________ ________________________________________________________________ ________________________________________________________________ 7. Give two examples of corporations in the Philippines. ________________________________________________________________ ________________________________________________________________ ________________________________________________________________ 8. Give two examples of cooperatives in the Philippines. ________________________________________________________________ ________________________________________________________________ ________________________________________________________________ Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 30 | 201 lOMoARcPSD|11706204 9. Fill-out the blank matrix. Item Sole Partnership Corporations Cooperatives Proprietorship 1.Numbers of possible owners 2. Management (who manages the business) 3. Termination of the business 4. Government agency assigned primarily to regulate 5. Transfer of ownership 6. Liability of owners 10. Multiple choice. Write the word of the correct answer. a. A person who takes a risk to produce goods and services in search of profit entrepreneur magistrate profiteer baliff b. What kind of business is BEST described by these statements? I am the only owner of my business. I take all the risks of doing business. I keep all the profits. proprietorship corporation partnership cooperative c. An entrepreneur enforces government regulations takes the risk to earn profit sets the interest rates at banks manages financial investments Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 31 | 201 lOMoARcPSD|11706204 d. In a corporation, owners share profit, but liability is limited to investment distribution theft production e. A form of business organization that is authorized to act as a legal entity regardless of the number of owners. corporation proprietorship partnership distributor f. What is a disadvantage of partnerships? ease of formation owners share responsibilities limited liability possibility of personality conflict g. What is the advantage of corporations? minimal government regulation limited liability short life span has one owner h. The Dow Jones industrial average swept past 12,000 for the first time. Investors are increasingly optimistic about corporate earnings and the economy. This achievement MOST likely involved which type of business organization? proprietorship partnership corporation conglomerate i. In which type of organization does one person take all the risks? corporation partnership monopoly proprietorship j. Floral Shops, Bookstores, Farms are examples of what type business Sole Proprietorship Corporation Franchise Multinational Corporation Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 32 | 201 lOMoARcPSD|11706204 k. Easy to start, Owner is his/her own boss, Owner keeps all the profits These are advantages of what type of business Franchise Corporation Parntership Sole Proprietorship l. Which ownership type has unlimited liability (owner has full responsibility for company's debt and can lose entire investment as well as personal assets). Partnership Franchise Corporation Sole Proprietorship m. What type of business consists of two or more people? Sole Proprietorship Partnership Corporation Franchise n. Which are the disadvantages of a partnership? Partnership must be reorganized if one partner quits Partners share unlimited liability Partners may not get along All of these are correct o. Law firms, medical practices, and auto body repair shops are examples of what type of ownership sole proprietorship partnership franchise corporation p. What type of business structure is owned by many people? corporation partnership sole proprietorship q. Corporations do NOT continue when stockholders sell stock. True False Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 33 | 201 lOMoARcPSD|11706204 r. Nike, IBM, and Google are examples of partnership franchise corporation partnership s. Business owned by one person partnership franchise sole proprietorship corporation t. Which is NOT a basic type of business ownership? proprietorship partnership corporation retail u. Who plays an important role in all three business organizations? Governors Presidents Entrepreneurs Magistrates v. A form of business organization with one owner who takes all the risks and all the profit is called partnership proprietorship corporation governorship w. A form of business organization with two or more owners who share the risks and the profits proprietorship corporation wholesale partnership x. Owned by many people - stockholders, but treated by the law as one person Sole Proprietorship Franchise Partnership Corporation Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 34 | 201 lOMoARcPSD|11706204 Multiple choice. Write the word of the correct answer. (Cooperative Business) 1. An autonomous association of persons united voluntarily to meet their common economic, social, and cultural needs and aspirations through a jointlyowned and democratically-controlled enterprise Government Cooperative Union 2. Check the three basic interests of business. Ownership Manager Control Supervise Beneficiary 3. Cooperatives are owned, managed, and patronized by _______. Members Manager Proprietor 4. Cooperatives serve best when they answer the needs of the_______. Members Manager Proprietor 5. Check the COOP PRINCIPLES & PRACTICES Open and Voluntary Membership Democratic Member Control For Lending and Credit 6. In Cooperatives, membership is forced. (TRUE / FALSE) 7. In cooperatives, the members are the owners of the business. (TRUE / FALSE 8. Check the cooperative values. Self-help Self-responsibility Democracy Autocratic Business-minded Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 35 | 201 lOMoARcPSD|11706204 9. One of the purposes of Cooperative is to encourage _________. Thrift and savings Borrow when there's no money Lending all the way 10. A type of coop that caters lending services. Credit Coop Consumers Coop Producers Coop Multi-purpose coop 11. A type of coop that is formed by farmers to save money selling of crop and other products of farmers Credit Coop Consumers Coop Producers Coop Multi-purpose coop 12. What is the primary capital of cooperatives? Member's share capital Savings Donations 13. What are the two types of membership? Regular Permanent Associate Part time 14. Death can be a reason to terminate a member in the coop. (TRUE / FALSE) 15. A member can continue to be a member even he does not patronize the Coop services. (TRUE / FALSE) 16. A member can be terminated if he is mentally ill. (TRUE / FALSE) 17. What are the duties of a Coop member? Attend general assembly Patronize products and services Always apply for a credit Withdraw the capital share Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 36 | 201 lOMoARcPSD|11706204 18. What is the highest governing body of the Cooperative? General Assembly BOD Officers 19. Who will preside the General Assembly? Officers Chairman Committees 20. How many times the General Assembly must meet in a year? Only once a year Twice a year One, but BOD might call a special meeting 21. The Board of Directors has the power to create new policies that can be implemented directly without the General Assembly's approval. (TRUE / FALSE) 22. The BOD's number should be 0dd. (TRUE / FALSE) 23. What committee that is responsible for the approval of the loans? Audit committee Credit committee Supevisory committee 24. What committee that is responsible for the checking and analysis of the financial reports? Credit committee Audit committee Supervisory committee 25. Check the choices that holds true about the education committee. Responsible for auditing Calls the meeting Recruits new members Gives training and lecture about the coop 26. The elected vice-chairman will automatically be designated as chairman of what committee? Audit Education Credit Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 37 | 201 lOMoARcPSD|11706204 27. The secretary is responsible for recording and keeping the minutes of meeting. (TRUE / FALSE) 28. Who is responsible for the promulgation of the election of officers? Credit committee Election committee BOD 29. A capital share is of what type of account? Asset Income Liaility Equity 30. Accounts receivable is under the _______ account. Assets Income Liabilities 31. Which of the following is an Asset account? Cash in Hand Checking Account Supplies Building Equipment 32. What is government agency that regulates Cooperatives? Cooperative Development Authority Phil. Federation of Credit Cooperatives Cooperative Authority of the Phils 33. A cooperative is formed because of ______. Mutual benefit Credit Business 34. Check in the following choices the advantages of Cooperatives. Owned by one person Controlled by members It follows the laws of corporation Members are benefeciaries Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 38 | 201 lOMoARcPSD|11706204 35. Which of the following is an advantage of Cooperative form of business? Extensive record keeping Harmony of members Managed by one group 36. The nature and character of cooperatives Service-oriented Self-sufficient Providing goods and services at reasonable cost. Cooperatives are not for profit and not for charity but for service. Cooperatives are for lending 37. A type of coop that caters different services such as lending, savings, marketing, etc. Credit Coop Consumers Coop Producers Coop Multi-purpose coop 38. A type of Coop that focuses on retail business such as grocery, general merchandise, etc. Multi-purpose coop Producers Coop Consumers Coop Credit Coop 39. What is the excess amount of revenues that will be shared by the members? Profit Dividends Share 40. What are the rights of a Coop Member? The right to inspect accounts The right to vote The right to run for a position The right not to avail of the services 41. Salaries and wages of employees is under the _________ account. Expenses Income Liabilities None of the above Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 39 | 201 lOMoARcPSD|11706204 42. The Coop wants to purchase a Photocopy Machine. What is the effect of this purchase in the accounting equation? Debit Assets, Credit Cash Debit Cash, Credit Assets Debit Expenses, Credit Cash 43. Which will you account if a fixed asset depreciates? Expenses Income Accounts Payable None of the above 44. Service fees, interest rates and penalties are accounted on what type of account? Expenses Income Liabilities Equity 45. What will be the effect on the accounting equation when an electricity bill is due at the end of the month? Debit Electricity, Credit Accounts Payable Debit Electricity, Credit Cash Debit Cash, Credit Accounts Payable None of the above Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 40 | 201 lOMoARcPSD|11706204 Unit 5 Types of Business According to Activities Three (3) types of business organizations: • Service Business. This type of business offers professional skills, advice and consultations. Examples: barber shops and beauty parlors, repair shops, banks, accounting and law firms • Merchandising Business. This type of business buys at wholesale and later sells the products at retail. They make a profit by selling the merchandise or products at prices that are higher than their purchase costs. This type of business is also known as "buy and sell". Examples are: book stores, sari-sari stores, hardware stores • Manufacturing Business. This type of business buys raw materials and uses them in making a new product, therefore combining raw materials, labour and expenses into a product for sale later on. Examples are: shoe manufacturing businesses, car manufacturing plants Additional information: There are businesses that may be classified under more than one type of business. A bakery, for example, combines raw materials in making loaves of bread (manufacturing), sells hot pan de sal (merchandising), and caters customers’ orders in small coffee table servings of ensaymada and hot coffee (service). What are 'Business Activities' Business activities include any activity engaged in the primary purpose of making a profit. This is a general term that encompasses all the economic activities carried out by a company during the course of business. Business activities, including operating, investing and financing activities, are ongoing and focused on creating value for shareholders. Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 41 | 201 lOMoARcPSD|11706204 BREAKING DOWN 'Business Activities' There are three main types of business activities: operational, investing and financing. The cash flows used and created by each of these activities is listed in the annual report within the financial statement referred to as the cash flow statement. The cash flow statement is meant to be a reconciliation of net income with cash flow. Each line item on the income statement and balance sheet is identified according to business activity. Noncash items deducted from net income are added back to net income and noncash items added to net income are deducted from cash flows. The end result is a report that gives the investor a summary of both cash and noncash business activities within the company. Operating Business Activities The first section of the cash flow statement is cash flow from operating activities. These activities include many items from the income statement and current portion of the balance sheet. The cash flow statement adds back and deducts certain noncash items such as depreciation, amortization, accounts receivable and accounts payable. These line items impact the net income statement but do not result in a movement of cash in or out of the company. If cash flows from business activities resulting from operations are negative, it means the company must be financing operating activities with investing activities or financing activities. Investing Business Activities The second section in the statement of cash flows is investing activities. These are business activities that are capitalized over more than one year. The purchase of long-term assets is recorded as a use of cash in this section. Likewise, the sale of real estate is shown as a source of cash. The line item "capital expenditures" is considered an investing activity and can be found in this section of the cash flow statement. Financing Business Activities The final section of the cash flow statement is the financing activities section. This section provides an overview of all business activities related to financing. These include initial public offerings, secondary offerings and debt financing. The section also shows the amount of cash being paid out for dividends, share repurchases and interest. Any business activity related to financing and fundraising efforts is included in this section of the cash flow statement. FORMS OF BUSINESS ORGANIZATIONS Accountants frequently refer to a business organization as an accounting entity or a business entity. A business entity is any business organization, such as a Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 42 | 201 lOMoARcPSD|11706204 hardware store or grocery store, that exists as an economic unit. For accounting purposes, each business organization or entity has an existence separate from its owner(s), creditors, employees, customers, and other businesses. This separate existence of the business organization is known as the business entity concept. Thus, in the accounting records of the business entity, the activities of each business should be kept separate from the activities of other businesses and from the personal financial activities of the owner(s). As you will see shortly, the business entity concept applies to the four main forms of businesses—single proprietorships, partnerships, and corporations. Thus, for accounting purposes, all four business forms are separate from other business entities and from their owner(s). A single proprietorship is an unincorporated business owned by an individual and often managed by that same person. Single proprietors include physicians, lawyers, electricians, and other people in business for themselves. Many small service businesses and retail establishments are also single proprietorships. No legal formalities are necessary to organize such businesses, and usually business operations can begin with only a limited investment. The most attractive feature of a proprietorship is that there is no “double taxation”. Both proprietorships and partnerships do not pay taxes on profits at the business level. The only taxes paid are at the personal level—this occurs when proprietors and partners pay taxes on their share of their company’s income. On the other hand, a business owner is personally liable for all debts of his or her company. This is called unlimited liability. If you’re a sole proprietorship and the debts of your business exceed its assets, creditors can seize your personal assets to cover the proprietorship’s outstanding business debt. A partnership is an unincorporated business owned by two or more persons associated as partners. Often the same persons who own the business also manage the business. Many small retail establishments and professional practices, such as dentists, physicians, attorneys, and many CPA firms, are partnerships. Unlimited liability is even riskier in the case of a partnership. Each partner is personally liable not only for his or her own actions but also for the actions of all the partners. If, through mismanagement by one of your partners, the partnership is forced into bankruptcy, the creditors can go after you for all outstanding debts of the partnership. Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 43 | 201 lOMoARcPSD|11706204 A corporation is a business incorporated under the laws of a state and owned by a few stockholders or thousands of stockholders. Almost all large businesses and many small businesses are incorporated. The corporation is unique in that it is a separate legal business entity. The owners of the corporation are stockholders, or shareholders. Stockholders do not directly manage the corporation. They elect a board of directors to represent their interests. Accounting is necessary for all forms of business organizations, and each company must follow generally accepted accounting principles (GAAP). TYPES OF ACTIVITIES PERFORMED BY BUSINESS ORGANIZATIONS The forms of business entities discussed in the previous section are classified according to the type of ownership of the business entity. Business entities can also be grouped by the type of business activities they perform—service companies, merchandising companies, and manufacturing companies. Any of these activities can be performed by companies using any of the three forms of business organizations. •Service companies perform services for a fee. This group includes accounting firms, law firms, and dry cleaning establishments. •Merchandising companies purchase goods that are ready for sale and then sell them to customers. Merchandising companies include auto dealerships, clothing stores, and supermarkets. •Manufacturing companies buy materials, convert them into products, and then sell the products to other companies or to the final consumers. Manufacturing companies include steel mills, auto manufacturers, and clothing manufacturers. Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 44 | 201 lOMoARcPSD|11706204 All of these companies produce financial statements as the final end product of their accounting process. These financial statements provide relevant financial information both to those inside the company—management—and to those outside the company—creditors, stockholders, and other interested parties. The next section introduces four common financial statements—the income statement, the statement of retained earnings, the balance sheet, and the statement of cash flows. IMPORTANT POINTS TO REMEMBER Business entity is any business organization, such as super market, or accounting firm, that exists as an economic unit. Business entity principle states that a business must be keep accounting records separate from its owners or other businesses. Ownership in business entities can be a sole proprietorship, partnership, or corporation. From the accounting perspective and its purpose these types of business are considered separate entities from their owners. The corporation is only one considered as a separate legal entity. A business can be a service company, merchandising company, or a manufacturing company. NEW TERMS Asset Things of value owned by the business. Examples include cash, machines, and buildings. To their owners, assets possess service potential or utility that can be measured and expressed in money terms. Business Entity is any business organization that exists as an economic unit. Liabilities Debts owed by a business—or creditors’ equity. Examples: notes payable, accounts payable. Stockholders’ equity The owners’ interest in a corporation. Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 45 | 201 lOMoARcPSD|11706204 Sole Proprietorships are business entities owned by one single person. Partnerships are business entities owned by at least two people. Corporations are business entities owned by one person or many people called shareholders. Service company is a business entity that provides services to the public and does not sell a product. Merchandising companies are business entities selling a product and possibly a service to the public. A merchandising company purchases the products to be sold from outside vendors. Manufacturing companies are business entities selling a product to the public that is made by the company using raw materials, direct labor and overhead Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 46 | 201 lOMoARcPSD|11706204 Test Multiple Choice. Write the word of the correct answer. 1. What happens in the second stage of production? Manufactures goods using raw materials Extracts and uses the natural resources of the earth Business controls all of the market of a product Provides services to consumers and the other sectors of industry 2. Business size can be measured in a number of ways. Except one: By value of output and sales By capital employed By number of employees By number of competitors 3. Which one may not be interested in comparing the size of businesses? Governments Workers Banks Mayors 4. What is the difference between a takeover and a merger? Takeover is when the owners of two businesses agree to join their firms together to make one business; merger is a business buys out the owns of another business which then becomes part of the 'predator' business Takeover is a business buys out the owns of another business which then becomes part of the 'predator' business; merger is when the owners of two businesses agree to join their firms together to make one business Takeover is when employees who are taking action stand outside their workplace to prevent or protest at the delivery of goods, arrival and departure of other employees, etc.; merger is when employees refuse to work Takeover is when employees refuse to work; merger is when employees who are taking action stand outside their workplace to prevent or protest at the delivery of goods, arrival and departure of other employees, etc. 5. What is one of the reasons why businesses stay small? The number of workers The type of industry the business operates in The profit the business makes The value of output and sales Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 47 | 201 lOMoARcPSD|11706204 6. The primary stage of production is concerned with: Growing crops and extracting the earth’s natural resources Providing services to consumers and industry converting natural resources into finished goods transporting goods to the final consumer. 7. The tertiary sector of industry tends to be the most important sector in high income (most developed) countries because: Agricultural output is more important than services As consumers have little money to spend they use most of their income to buy manufactured goods Most workers are employed in manufacturing products in these countries As consumers, incomes are high they spend more on services such as hotels and leisure. 8. A free market economy is one in which: All resources are owned by the state (government) There are only secondary industries all resources are privately owned Some resources are owned by the state and some are privately owned. 9. Which of the following is a claimed advantage of a free market economy? Government control makes sure that all incomes are equal. As there is no competition, money will not be wasted on advertising Everyone will always have work if they want it. Businesses are free to compete with each other and prices will be kept low. 10. In a mixed economy, which of the following groups of industries are most likely to be controlled/owned by the government? Hotels and restaurants Health and public transport Building and taxi services food shops and farming 11. Which of the following is the best definition of privatisation? When private limited companies convert into public limited companies When a partnership converts into a private limited company When a state owned industry is sold into the private sector When a private sector business is purchased by the government Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 48 | 201 lOMoARcPSD|11706204 12. Which one of the following is a claimed disadvantage of privatisation? Jobs might be lost as the private owners will try to cut costs and increase profits. The government will raise large sums of money which could help to reduce taxes. There will be less competition than when the industry was a nationalised monopoly. Politicians will now influence business decisions. 13. Which of the following is NOT a recognised way of measuring the size of a business? Number of employees Value of sales Value of capital employed Number of computers used 14 There are four laundry companies in one town. They wash and iron sheets and tablecloths for hotels and restaurants. The following table shows data about these firms in 2015: Laundry A Laundry B Laundry C Laundry D Profits made P 2,000 4,000 1,000 6,000 Capital employed P 75,000 100,000 60,000 90,000 Value of sales turnover P 100,000 125,000 130,000 120,000 Number of employees 50 35 40 45 a. Using capital employed as a measure, which appears to be the largest firm? b. Using the number of employees as a measure, which appears to be the largest firm? c. Using the value of sales turnover as a measure, which appears to be the largest firm? 15 Which of the following is the most likely reason for owners wishing to expand their businesses? To keep control of the business To make higher profits To encourage competition To avoid publicity Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 49 | 201 lOMoARcPSD|11706204 16. Which of the following is an example of horizontal integration between two businesses? An oil company and an insurance company merge. A shoe shop buys out the factory making shoes. A steel firm takes over a coal mine that supplies coal. Coca-Cola takes over a small soft drink business. 17. One of the reasons for vertical integration between two businesses could be to: Diversify into a completely different industry Reduce competitors supplying the same product Control the supply of raw materials needed for production Obtain higher market share 18. In some industries there are many successful small firms. One of the reasons for this could be that: The consumers demand specialist products or services There are great opportunities for economies of scale The industry is owned by the state the market is very large. 19. Match Column A with Column B. Column A a. 1. Provides customers to b. 2. Sells goods to customers c. 3. Raw materials are available d. 4. Goods to be sold are purchased from a supplier e. 5. Goods to be sold are produced by the company itself f. 6. Supplies are used, no goods to be sold g. 7. Bakery h. 8. Barber shop i. 9. Cellphone store j. 10. Abenson appliances services Column B either merchandising or manufacturing manufacturing merchandising service Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 50 | 201 lOMoARcPSD|11706204 Unit 6 Accounting Concepts and Principles Accounting Principles Introduction to Accounting Principles There are general rules and concepts that govern the field of accounting. These general rules–referred to as basic accounting principles and guidelines–form the groundwork on which more detailed, complicated, and legalistic accounting rules are based. For example, the Financial Accounting Standards Board (FASB) uses the basic accounting principles and guidelines as a basis for their own detailed and comprehensive set of accounting rules and standards. 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, federal 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 Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 51 | 201 lOMoARcPSD|11706204 financial statements and the related notes to the financial statements have been prepared in accordance with GAAP. GAAP is exceedingly useful because it attempts to standardize and regulate accounting definitions, assumptions, and methods. Because of generally accepted accounting principles 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 generally accepted accounting principles have become more complex because financial transactions have become more complex. Basic Accounting Principles and Guidelines Since GAAP is founded on the basic accounting principles and guidelines, we can better understand GAAP if we understand those accounting principles. The following is a list of the ten main accounting principles and guidelines together with a highly condensed explanation of each. Business entity principle – a business enterprise is separate and distinct from its owner or investor. Examples : o If the owner has a barber shop, the cash of the barber shop should be reported separately from personal cash. o The owner had a business meeting with a prospective client. The expenses that come with that meeting should be part of the company’s expenses. If the owner paid for gas for his personal use, it should not be included as part of the company’s expenses. 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 Economic activity is measured in U.S. dollars, and only transactions that can be expressed in U.S. dollars are recorded. Because of this basic accounting principle, it is assumed that the dollar's purchasing power has not changed over time. As a result, accountants ignore the Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 52 | 201 lOMoARcPSD|11706204 effect of inflation on recorded amounts. For example, dollars from a 1960 transaction are combined (or shown) with dollars from a 2017 transaction. Monetary unit principle – amounts are stated into a single monetary unit Example : o Jollibee should report financial statements in pesos even if they have a store in the United States. o IHOP should report financial statements in dollars even if they have a branch here in the Philippines 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, 2017, or the 5 weeks ended May 1, 2017. 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, 2016, the amount is known; but for the income statement for the three months ended March 31, 2017, 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 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, 2017 the month ended December 31, 2017 the three months ended December 31, 2017 or the year ended December 31, 2017. Time period principle – financial statements are to be divided into specific time intervals. Example: o Philippine companies are required to report financial statements annually. o the salary expenses from January to December 2015 should only be reported in 2015. 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. Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 53 | 201 lOMoARcPSD|11706204 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. Cost principle – accounts should be recorded initially at cost. Example : o When Jollibee buys a cash register, it should record the cash register at its price when they bought it. o When a company purchases a laptop, it should be recorded at the price it was purchased. 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. As an example, let's say a 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 lawsuit. 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. A company usually lists its significant accounting policies as the first note to its financial statements. Disclosure principle – all relevant and material information should be reported. Example: The company should report all relevant information. 6. Going Concern Principle This accounting principle assumes that a company will continue to exist long enough to carry out its objectives and commitments and will not liquidate in the foreseeable future. If the company's financial situation is such that the accountant Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 54 | 201 lOMoARcPSD|11706204 believes the company will not be able to continue on, the accountant is required to disclose this assessment. The going concern principle allows the company to defer some of its prepaid expenses until future accounting periods. Going concern principle – business is expected to continue indefinitely. Example: When preparing financial statements, you should assume that the entity will continue indefinitely. 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 2017 revenues as a bonus on January 15, 2018, the company should report the bonus as an expense in 2017 and the amount unpaid at December 31, 2017 as a liability. (The expense is occurring as the sales are occurring.) Because we cannot measure the future economic benefit of things such as advertisements (and thereby we cannot match the ad expense with related future revenues), the accountant charges the ad amount to expense in the period that the ad is run. Matching principle – cost should be matched with the revenue generated. Example: When you provide tutorial services to a customer and there is a transportation cost incurred related to the tutorial services, it should be recorded as an expense for that period. 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 P20,000 of revenue in its first month of operation but receive P0 in actual cash in that month. Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 55 | 201 lOMoARcPSD|11706204 For example, if ABC Consulting completes its service at an agreed price of P1,000, ABC should recognize P1,000 of revenue as soon as its work is done—it does not matter whether the client pays the P1,000 immediately or in 30 days. Do not confuse revenue with a cash receipt. 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 P150 printer by a highly profitable multi-million-dollar 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 P150 in the year it is purchased. The justification is that no one would consider it misleading if P150 is expensed in the first year instead of P30 being expensed in each of the five years that it is used. Because of materiality, financial statements usually show amounts rounded to the nearest dollar, to the nearest thousand, or to the nearest million dollars depending on the size of the company. Materiality principle – in case of assets that are immaterial to make a difference in the financial statements, the company should instead record it as an expense. Example: A school purchased an eraser with an estimated useful life of three years. Since an eraser is immaterial relative to assets, it should be recorded as an expense. 10. 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. 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. Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 56 | 201 lOMoARcPSD|11706204 Conservatism principle – also known as prudence. In case of doubt, assets and income should not be overstated while liabilities and expenses should not be understated. Example: In case of doubt, expenses should be recorded at a higher amount. Revenue should be recorded at a lower amount. 11. Objectivity principle – financial statements must be presented with supporting evidence. Example: o When the customer paid Jollibee for their order, Jollibee should have a copy of the receipt to represent as evidence. When a company incurred a transportation expense, a voucher should be prepared as evidence. 12. Accrual Accounting Principle – revenue should be recognized when earned regardless of collection and expenses should be recognized when incurred regardless of payment. On the other hand, the cash basis principle in which revenue is recorded when collected and expenses should be recorded when paid. Cash basis is not the generally accepted principle today. Example: When a barber finishes performing his services, he should record it as revenue. When the barber shop receives an electricity bill, it should record it as an expense even if it is unpaid. Other Characteristics of Accounting Information When financial reports are generated by professional accountants, we have certain expectations of the information they present to us: We expect the accounting information to be reliable, verifiable, and objective. We expect consistency in the accounting information. We expect comparability in the accounting information. 1. Reliable, Verifiable, and Objective In addition to the basic accounting principles and guidelines listed in Part 1, accounting information should be reliable, verifiable, and objective. For example, showing land at its original cost of P10,000 (when it was purchased 50 years ago) is considered to be more reliable, verifiable, and objective than showing it at its Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 57 | 201 lOMoARcPSD|11706204 current market value of P250,000. Eight different accountants will wholly agree that the original cost of the land was P10,000—they can read the offer and acceptance for P10,000, see a transfer tax based on P10,000, and review documents that confirm the cost was P10,000. If you ask the same eight accountants to give you the land's current value, you will likely receive eight different estimates. Because the current value amount is less reliable, less verifiable, and less objective than the original cost, the original cost is used. The accounting profession has been willing to move away from the cost principle if there are reliable, verifiable, and objective amounts involved. For example, if a company has an investment in stock that is actively traded on a stock exchange, the company may be required to show the current value of the stock instead of its original cost. 2. Consistency Accountants are expected to be consistent when applying accounting principles, procedures, and practices. For example, if a company has a history of using the FIFO cost flow assumption, readers of the company's most current financial statements have every reason to expect that the company is continuing to use the FIFO cost flow assumption. If the company changes this practice and begins using the LIFO cost flow assumption, that change must be clearly disclosed. 3. Comparability Investors, lenders, and other users of financial statements expect that financial statements of one company can be compared to the financial statements of another company in the same industry. Generally accepted accounting principles may provide for comparability between the financial statements of different companies. For example, the FASB requires that expenses related to research and development (R&D) be expensed when incurred. Prior to its rule, some companies expensed R&D when incurred while other companies deferred R&D to the balance sheet and expensed them at a later date. How Principles and Guidelines Affect Financial Statements The basic accounting principles and guidelines directly affect the way financial statements are prepared and interpreted. Let's look below at how accounting principles and guidelines influence the (1) balance sheet, (2) income statement, and (3) the notes to the financial statements. 1. Balance Sheet Let's see how the basic accounting principles and guidelines affect the balance sheet of Mary's Design Service, a sole proprietorship owned by Mary Smith. (To Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 58 | 201 lOMoARcPSD|11706204 learn more about the balance sheet go to Explanation of Balance Sheet and Quiz for Balance Sheet.) A balance sheet is a snapshot of a company's assets, liabilities, and owner's equity at one point in time. (In this case, that point in time is after all of the transactions through September 30, 2017 have been recorded.) Because of the economic entity assumption, only the assets, liabilities, and owner's equity specifically identified with Mary's Design Service are shown—the personal assets of the owner, Mary Smith, are not included on the company's balance sheet. ASSETS Cash Accounts Receivable Supplies Prepaid Insurance Land Total Assets Mary’s Design Service Balance Sheet September 30, 2017 LIABILITIES 300 Notes Payable 1,000 Accounts Payable 160 Wages Payable 90 Unearned revenues 10,000 Total Liabilities OWNER’S EQUITY M. Smith, Capital 11,550 Total Liabilities and Owner’s Equity 11,550 The assets listed on the balance sheet have a cost that can be measured and each amount shown is the original cost of each asset. For example, let's assume that a tract of land was purchased in 1956 for P10,000. Mary's Design Service still owns the land, and the land is now appraised at P250,000. The cost principle requires that the land be shown in the asset account Land at its original cost of P10,000 rather than at the recently appraised amount of P250,000. If Mary's Design Service were to purchase a second piece of land, the monetary unit assumption dictates that the purchase price of the land bought today would simply be added to the purchase price of the land bought in 1956, and the sum of the two purchase prices would be reported as the total cost of land. The Supplies account shows the cost of supplies (if material in amount) that were obtained by Mary's Design Service but have not yet been used. As the supplies are consumed, their cost will be moved to the Supplies Expense account on the income statement. This complies with the matching principle which requires expenses to be matched either with revenues or with the time period when they are used. The cost of the unused supplies remains on the balance sheet in the asset account Supplies. The Prepaid Insurance account represents the cost of insurance that has not yet expired. As the insurance expires, the expired cost is moved to Insurance Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 59 | 201 lOMoARcPSD|11706204 Expense on the income statement as required by the matching principle. The cost of the insurance that has not yet expired remains on Mary's Design Service's balance sheet (is "deferred" to the balance sheet) in the asset account Prepaid Insurance. Deferring insurance expense to the balance sheet is possible because of another basic accounting principle, the going concern assumption. The cost principle and monetary unit assumption prevent some very valuable assets from ever appearing on a company's balance sheet. For example, companies that sell consumer products with high profile brand names, trade names, trademarks, and logos are not reported on their balance sheets because they were not purchased. For example, Coca-Cola's logo and Nike's logo are probably the most valuable assets of such companies, yet they are not listed as assets on the company balance sheet. Similarly, a company might have an excellent reputation and a very skilled management team, but because these were not purchased for a specific cost and we cannot objectively measure them in dollars, they are not reported as assets on the balance sheet. If a company actually purchases the trademark of another company for a significant cost, the amount paid for the trademark will be reported as an asset on the balance sheet of the company that bought the trademark. 2. Income Statement Let's see how the basic accounting principles and guidelines might affect the income statement of Mary's Design Service. An income statement covers a period of time (or time interval), such as a year, quarter, month, or four weeks. It is imperative to indicate the period of time in the heading of the income statement such as "For the Nine Months Ended September 30, 2017". (This means for the period of January 1 through September 30, 2017.) If prepared under the accrual basis of accounting, an income statement will show how profitable a company was during the stated time interval. Mary’s Design Service Income Statement For the Months Ending September 30, 2017 Revenue and gains Revenues Gain on sale of land Total revenues and gains Expenses and losses Expenses Loss on sale of computer Total expenses and losses Net Income Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) Php 10,000 5,000 15,000 Php 8,000 350 8,350 Php 6,650 P a g e 60 | 201 lOMoARcPSD|11706204 Revenues are the fees that were earned during the period of time shown in the heading. Recognizing revenues when they are earned instead of when the cash is actually received follows the revenue recognition principle and the matching principle. (The matching principle is what steers accountants toward using the accrual basis of accounting rather than the cash basis. Small business owners should discuss these two methods with their tax advisors.) Gains are a net amount related to transactions that are not considered part of the company's main operations. For example, Mary's Design Service is in the business of designing, not in the land development business. If the company should sell some land for P30,000 (land that is shown in the company's accounting records at P25,000) Mary's Design Service will report a Gain on Sale of Land of P5,000. The P30,000 selling price will not be reported as part of the company's revenues. Expenses are costs used up by the company in performing its main operations. The matching principle requires that expenses be reported on the income statement when the related sales are made or when the costs are used up (rather than in the period when they are paid). Losses are a net amount related to transactions that are not considered part of the company's main operating activities. For example, let's say a retail clothing company owns an old computer that is carried on its accounting records at P650. If the company sells that computer for P300, the company receives an asset (cash of P300) but it must also remove P650 of asset amounts from its accounting records. The result is a Loss on Sale of Computer of P350. The P300 selling price will not be included in the company's sales or revenues. 3. The Notes To Financial Statements Another basic accounting principle, the full disclosure principle, requires that a company's financial statements include disclosure notes. These notes include information that helps readers of the financial statements make investment and credit decisions. The notes to the financial statements are considered to be an integral part of the financial statements. Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 61 | 201 lOMoARcPSD|11706204 Test Multiple choice: Write the word/s of the correct answer: 1. The accounting guideline that requires financial statement information to be supported by independent, unbiased evidence other than someone's belief or opinion is the: Business entity principle Monetary unit principle Going-concern principle Cost principle Objectivity principle 2. The principle that requires every business to be accounted for separately and distinctly from its owner or owners is known as the: Objectivity principle Business entity principle Going-concern principle Revenue recognition principle Cost principle 3. The rule that requires financial statements to reflect the assumption that the business will continue operating instead of being closed or sold, unless evidence shows that it will not continue, is the: Going-concern principle Business entity principle Objectivity principle Cost Principle Monetary unit principle 4. To include the personal assets and transactions of a business's owner in the records and reports of the business would be in conflict with the: Objectivity principle Realization principle Business entity principle Going-concern principle Revenue recognition principle 5. The objectivity principle: means that information is supported by independent, unbiased evidence means that information can be based on what the preparer thinks is true means that financial statements should contain information that is optimistic means that a business may not re-organize revenue until cash is received Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 62 | 201 lOMoARcPSD|11706204 6. Marian Mosely is the owner of Mosely Accounting Services. Which accounting principle requires Marian to keep her personal financial information separate from the financial information of Mosely Accounting Services? Monetary unit principle Going-concern principle Cost principle Business entity principle 7. Which of the following accounting principles would require that all goods and services purchased be recorded at cost? Going-concern principle Continuing-concern principle Cost principle Business entity principle 8. The personal assets of the owner of a company will not appear on the company's balance sheet because of which principle/guideline? Cost Economic Entity Monetary Unit 9. Which principle/guideline requires a company's balance sheet to report its land at the amount the company paid to acquire the land, even if the land could be sold today at a significantly higher amount? Cost Economic Entity Monetary Unit 10. Which principle/guideline allows a company to ignore the change in the purchasing power of the dollar over time? Cost Economic Entity Monetary Unit 11. Which principle/guideline requires the company's financial statements to have footnotes containing information that is important to users of the financial statements? Conservatism Economic Entity Full Disclosure Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 63 | 201 lOMoARcPSD|11706204 12. Which principle/guideline justifies a company violating an accounting principle because the amounts are immaterial? Conservatism Full Disclosure Materiality 13. Which principle/guideline is associated with the assumption that the company will continue on long enough to carry out its objectives and commitments? Economic Entity Going Concern Time Period 14. A very large corporation's financial statements have the dollar amounts rounded to the nearest P1,000. Which accounting principle/guideline justifies not reporting the amounts to the penny? Full Disclosure Materiality Monetary Unit 15. Accountants might recognize losses but not gains in certain situations. For example, the company might write-down the cost of inventory, but will not writeup the cost of inventory. Which principle/guideline is associated with this action? Conservatism Materiality Monetary Unit 16. Which principle/guideline directs a company to show all the expenses related to its revenues of a specified period even if the expenses were not paid in that period? Cost Matching Monetary Unit 17. When the accountant has to choose between two acceptable alternatives, the accountant should select the alternative that will report less profit, less asset amount, or a greater liability amount. This is based upon which principle/guideline? Conservatism Cost Materiality Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 64 | 201 lOMoARcPSD|11706204 18. Public utilities' balance sheets list the plant assets before the current assets. This is acceptable under which accounting principle/guideline? Conservatism Cost Industry Practices 19. A large company purchases a P250 digital camera and expenses it immediately instead of recording it as an asset and depreciating it over its useful life. This practice may be acceptable because of which principle/guideline? Cost Matching Materiality 20. A corporation pays its annual property tax bill of approximately P12,000 in one payment each December 28. During the year, the corporation's monthly income statements report Property Tax Expense of P1,000. This is an example of which accounting principle/guideline? Conservatism Matching Monetary Unit 21. A company sold merchandise of P8,000 to a customer in December. The company's sales terms require the customer to pay the company in 30 days. The company's income statement reported the sale in December. This is proper under which accounting principle/guideline? Full Disclosure Monetary Unit Revenue Recognition 22. Accrual accounting is based on this principle/guideline. Cost Full Disclosure Matching 16.The creative chief executive of a corporation who is personally responsible for numerous inventions and innovations is not reported as an asset on the corporation's balance sheet. The accounting principle/guideline that prevents the corporation for reporting this person as an asset is Conservatism Cost Going Concerns Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 65 | 201 lOMoARcPSD|11706204 17.An asset with a cost of P120,000 is depreciated over its useful life of 10 years rather than expensing the entire amount when it is purchased. This complies with which principle/guideline? Cost Full Disclosure Matching 18.Near the end of the current year, a company required a customer to pay P200,000 as a deposit for work that is to begin in the following year. At the end of the current year the company reported the P200,000 as a liability on its balance sheet. Which accounting principle/guideline prevented the company from reporting the P200,000 on its income statement for the current year? Going Concern Materiality Revenue Recognition 19.A retailer wishes to report its merchandise inventory on its balance sheet at its retail value. This would violate which accounting principle/guideline? Cost Full Disclosure Monetary Unit 20.A company borrowed P100,000 in December and will make its only payment for interest when the note comes due six months later. The total interest for the six months will be P3,600. On the December income statement the accountant reported Interest Expense of P600. This action was the result of which accounting principle/guideline? Cost Matching Revenue Recognition B. IDENTIFICATION. Write the word of the cored answer. Accounting principles. Indicate which principles are violated. (Business entity / Monetary unit / Time period / Business entity / Materiality / Objectivity) 1. The owner-manager bought a computer for personal use. The invoice was given to the accountant who recorded it as an asset of the business. 2. The statement of financial position of a company included an equipment purchased from Japan for 350,000 yen. It was reported at that amount in the statement of financial position while all the other assets were reported in Philippine pesos. 3. No financial statements were prepared by Michael Go for his business. He explained that he will prepare the statements when he closes the business, which he predicts to take place after 20 years. Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 66 | 201 lOMoARcPSD|11706204 4. Aside from owning a shoe store, Albert operates a canteen. The assets of the canteen are reported in the statement of financial position of the shoe store. 5. Purchased a hammer at a cost of PHP500. This was recorded as an asset and expense to decrease its value by PHP50 per year for 10 years. 6. A food company ordered a machine needed in the assembly line of its production department. Upon order, the machine was immediately listed as one of its assets. C. Matching. Match the following words with their definition: Column A a. All relevant information should be included in the financial reports b. In case of doubt, assets and income should not be overstated. c. Assume that the company will continue indefinitely. d. All transactions should be supported by unbiased evidence. e. Expenses should be recorded in the period when the revenue is generated. f. Minimal costs incurred should be recorded as an expense. g. A Philippine company should report financial statements in pesos. h. A barber who performs services for a client should record revenue. i. Statement of Financial position should be recorded as of December 31, 2015. j. Column B Going concern principle Objectivity principle Matching principle Materiality principle Time period principle Cost principle Disclosure principle Monetary unit principle Accrual accounting principle A company that purchases furniture should record it at its acquisition price. Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) Conservatism principle P a g e 67 | 201 lOMoARcPSD|11706204 Unit 7 The Accounting Equation The Accounting Equation Introduction to the Accounting Equation From the large, multi-national corporation down to the corner beauty salon, every business transaction will have an effect on a company's financial position. The financial position of a company is measured by the following items: Assets (what it owns) Liabilities (what it owes to others) Owner's Equity (the difference between assets and liabilities) The accounting equation (or basic accounting equation) offers us a simple way to understand how these three amounts relate to each other. The accounting equation for a sole proprietorship is: ASSETS = LIABILITIES +OWNER’S EQUITY Assets are a company's resources—things the company owns. Examples of assets include cash, accounts receivable, inventory, prepaid insurance, investments, land, buildings, equipment, and goodwill. From the accounting equation, we see that the amount of assets must equal the combined amount of liabilities plus owner's (or stockholders') equity. Liabilities are a company's obligations—amounts the company owes. Examples of liabilities include notes or loans payable, accounts payable, salaries and wages payable, interest payable, and income taxes payable (if the company is a regular corporation). Liabilities can be viewed in two ways: (1) as claims by creditors against the company's assets, and (2) a source—along with owner or stockholder equity—of the company's assets. Owner's equity or stockholders' equity is the amount left over after liabilities are deducted from assets: Assets - Liabilities = Owner's (or Stockholders') Equity. Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 68 | 201 lOMoARcPSD|11706204 Owner's or stockholders' equity also reports the amounts invested into the company by the owners plus the cumulative net income of the company that has not been withdrawn or distributed to the owners. If a company keeps accurate records, the accounting equation will always be "in balance," meaning the left side should always equal the right side. The balance is maintained because every business transaction affects at least two of a company's accounts. For example, when a company borrows money from a bank, the company's assets will increase and its liabilities will increase by the same amount. When a company purchases inventory for cash, one asset will increase and one asset will decrease. Because there are two or more accounts affected by every transaction, the accounting system is referred to as double-entry accounting. A company keeps track of all of its transactions by recording them in accounts in the company's general ledger. Each account in the general ledger is designated as to its type: asset, liability, owner's equity, revenue, expense, gain, or loss account. We created a visual tutorial to demonstrate how a variety of transactions will affect the accounting equation and the financial statements. Balance Sheet and Income Statement The balance sheet is also known as the statement of financial position and it reflects the accounting equation. The balance sheet reports a company's assets, liabilities, and owner's (or stockholders') equity at a specific point in time. Like the accounting equation, it shows that a company's total amount of assets equals the total amount of liabilities plus owner's (or stockholders') equity. The income statement is the financial statement that reports a company's revenues and expenses and the resulting net income. While the balance sheet is concerned with one point in time, the income statement covers a time interval or period of time. The income statement will explain part of the change in the owner's or stockholders' equity during the time interval between two balance sheets. When a company records a business transaction, it is not entered into an accounting equation, per se. Rather, transactions are recorded into specific accounts contained in the company's general ledger. Each account is designated as an asset, liability, owner's equity, revenue, expense, gain, or loss account. The general ledger accounts are then used to prepare the balance sheets and income statements throughout the accounting periods. Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 69 | 201 lOMoARcPSD|11706204 In the examples that follow, we will use the following accounts: Cash Accounts Receivable Equipment Notes Payable Accounts Payable J. Ott, Capital J. Ott, Drawing Service Revenues Advertising Expense Temp Service Expense Sole Proprietorship Transaction #1. Let's assume that J. Ott forms a sole proprietorship called Accounting Software Co. (ASC). On December 1, 2017, J. Ott invests personal funds of P10,000 to start ASC. The effect of this transaction on ASC's accounting equation is: Assets P10,000 = = Liabilities No Effect + + Owner’s Equity P10,000 As you can see, ASC's assets increase by P10,000 and so does ASC's owner's equity. As a result, the accounting equation will be in balance. You can interpret the amounts in the accounting equation to mean that ASC has assets of P10,000 and the source of those assets was the owner, J. Ott. Alternatively, you can view the accounting equation to mean that ASC has assets of P10,000 and there are no claims by creditors (liabilities) against the assets. As a result, the owner has a claim for the remainder or residual of P10,000. This transaction is recorded in the asset account Cash and the owner's equity account J. Ott, Capital. The general journal entry to record the transactions in these accounts is: Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 70 | 201 lOMoARcPSD|11706204 Date Account Name 1-Dec, ‘17 Cash J. Ott, Capital Debit Credit 10,000 10,000 After the journal entry is recorded in the accounts, a balance sheet can be prepared to show ASC's financial position at the end of December 1, 2017: Accounting Software Co. Balance Sheet December 1, 2017 LIABILITIES 10,000 Liabilities Owner’s Equity J. Ott, Capital 10,000 Total Liabilities Owner’s Equity ASSETS Cash Total Assets & 10,000 10,000 The purpose of an income statement is to report revenues and expenses. Since ASC has not yet earned any revenues nor incurred any expenses, there are no transactions to be reported on an income statement. Sole Proprietorship Transaction #2. On December 2, 2017 J. Ott withdraws P100 of cash from the business for his personal use. The effect of this transaction on ASC's accounting equation is: Assets - P100 = = Liabilities No Effect + + Owner’s Equity - P100 The accounting equation remains in balance since ASC's assets have been reduced by P100 and so has the owner's equity. This transaction is recorded in the asset account Cash and the owner's equity account J. Ott, Drawing. The general journal entry to record the transactions in these accounts is: Date Account Name 2-Dec, ‘17 J. Ott, Capital Cash Debit Credit 100 Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) 100 P a g e 71 | 201 lOMoARcPSD|11706204 Since the transactions of December 1 and 2 were each in balance, the sum of both transactions should also be in balance: Transaction Assets 1 2 Total = Liabilities Owner’s Equity + 10,000 = No Effect + 10,000 -100 = No Effect + -100 9,900 = 0 9,900 The totals indicate that ASC has assets of P9,900 and the source of those assets is the owner of the company. You can also conclude that the company has assets or resources of P9,900 and the only claim against those resources is the owner's claim. The December 2 balance sheet will communicate the company's financial position as of midnight on December 2: ASSETS Cash Total Assets Accounting Software Co. Balance Sheet December 1, 2017 LIABILITIES 9,900 Liabilities Owner’s Equity J. Ott, Capital 9,900 Total Liabilities Owner’s Equity Beginning owner’s equity + owner’s investment + Net Income Subtotal -Owner’s draws Ending owner’s equity, Dec 2 & 9,900 9,900 0 +10,000 0 10,000 -100 9,900 Withdrawals of company assets by the owner for the owner's personal use are known as "draws." Since draws are not expenses, the transaction is not reported on the company's income statement. Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 72 | 201 lOMoARcPSD|11706204 Sole Proprietorship Transaction #3. On December 3, 2017 Accounting Software Co. spends P5,000 of cash to purchase computer equipment for use in the business. The effect of this transaction on the accounting equation is: Assets = Liabilities + Owner’s Equity No Effect + No Effect 5,000 = -5,000 = The accounting equation reflects that one asset increases and another asset decreases. Since the amount of the increase is the same as the amount of the decrease, the accounting equation remains in balance. This transaction is recorded in the asset accounts Equipment and Cash. Equipment increases by P5,000, and Cash decreases by P5,000. The general journal entry to record the transactions in these accounts is: Date Account Name Debit 3-Dec, ‘17 Equipment Cash Credit 5,000 5,000 The combined effect of the first three transactions is shown here: Transaction Assets 1 2 3 Total = Liabilities Owner’s Equity + 10,000 = No Effect + 10,000 -100 = No Effect + -100 +5,000 No Effect No Effect -5,000 9,900 = 0 9,900 The totals tell us that the company has assets of P9,900 and the source of those assets is the owner of the company. It also tells us that the company has assets of P9,900 and the only claim against those assets is the owner's claim. Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 73 | 201 lOMoARcPSD|11706204 The balance sheet dated December 3, 2017 will reflect the financial position as of midnight on December 3: Accounting Software Co. Balance Sheet December 1, 2017 LIABILITIES 9,900 Liabilities Owner’s Equity J. Ott, Capital 9,900 Total Liabilities Owner’s Equity ASSETS Cash Total Assets 9,900 9,900 & Beginning owner’s equity + owner’s investment + Net Income Subtotal -Owner’s draws Ending owner’s equity, Dec 2 0 +10,000 0 10,000 -100 9,900 The purchase of equipment is not an immediate expense. It will become part of depreciation expense only after it is placed into service. We will assume that as of December 3 the equipment has not been placed into service, therefore, no expense will appear on an income statement for the period of December 1 through December 3. Sole Proprietorship Transaction #4. On December 4, 2017 ASC obtains P7,000 by borrowing money from its bank. The effect of this transaction on the accounting equation is: Assets = Liabilities + Owner’s Equity 7,000 = 7,000 + No Effect As you can see, ASC's assets increase and ASC's liabilities increase by P7,000. This transaction is recorded in the asset account Cash and the liability account Notes Payable as shown in this accounting entry: Date Account Name Debit 4-Dec, ‘17 Cash Credit 7,000 Notes Payable Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) 7,000 P a g e 74 | 201 lOMoARcPSD|11706204 The combined effect on the accounting equation from the first four transactions is available here: Transaction Assets 1 2 3 4 Total = Liabilities Owner’s Equity + 10,000 = No Effect + 10,000 -100 = No Effect + -100 +5,000 No Effect No Effect -5,000 +7,000 7,000+ No Effect 9,900 = 0 9,900 The totals indicate that the transactions through December 4 result in assets of P16,900. There are two sources for those assets—the creditors provided P7,000 of assets, and the owner of the company provided P9,900. You can also interpret the accounting equation to say that the company has assets of P16,900 and the lenders have a claim of P7,000 and the owner has a claim for the remainder. The balance sheet dated December 4 will report ASC's financial position as of that date: ASSETS Cash Equipment Total Assets Accounting Software Co. Balance Sheet December 1, 2017 LIABILITIES 11,900 Notes Payable 5,000 Owner’s Equity J. Ott, Capital 16,900 Total Liabilities Owner’s Equity Beginning owner’s equity + owner’s investment + Net Income Subtotal -Owner’s draws Ending owner’s equity, Dec 2 7,000 & 9,900 16,900 0 +10,000 0 10,000 -100 9,900 The proceeds of the bank loan are not considered to be revenue since ASC did not earn the money by providing services, investing, etc. As a result, there is no income statement effect from this transaction. Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 75 | 201 lOMoARcPSD|11706204 Sole Proprietorship Transaction #5. On December 5, 2017 Accounting Software Co. pays P600 for ads that were run in recent days. The effect of this advertising transaction on the accounting equation is: Assets = Liabilities + Owner’s Equity 6,000 = No Effect + 600 Since ASC is paying P600, its assets decrease. The second effect is a P600 decrease in owner's equity, because the transaction involves an expense. (An expense is a cost that is used up or its future economic value cannot be measured.) Although owner's equity is decreased by an expense, the transaction is not recorded directly into the owner's capital account at this time. Instead, the amount is initially recorded in the expense account Advertising Expense and in the asset account Cash. The general journal entry to record the transaction is: Date Account Name Debit 5-Dec, ‘17 Advertising Expense Cash Credit 600 600 The combined effect of the first five transactions is available here: Transaction Assets 1 2 3 4 5 Total = Liabilities Owner’s Equity + 10,000 = No Effect + 10,000 -100 = No Effect + -100 +5,000 No Effect No Effect -5,000 +7,000 7,000+ No Effect -600 No Effect -600 16,300 = 7,000 9,300 The totals now indicate that Accounting Software Co. has assets of P16,300. The creditors provided P7,000 and the owner of the company provided P9,300. Viewed another way, the company has assets of P16,300 with the creditors having a claim of P7,000 and the owner having a residual claim of P9,300. Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 76 | 201 lOMoARcPSD|11706204 The balance sheet as of the end of December 5, 2017 is: ASSETS Cash Equipment Total Assets Accounting Software Co. Balance Sheet December 1, 2017 LIABILITIES 11,900 Notes Payable 5,000 Owner’s Equity J. Ott, Capital 16,900 Total Liabilities Owner’s Equity Beginning owner’s equity + owner’s investment + Net Income Subtotal -Owner’s draws Ending owner’s equity, Dec 2 7,000 9,900 16,900 & 0 +10,000 _(600) 9,400 -100 9,300 **The income statement (which reports the company's revenues, expenses, gains, and losses during a specified time interval) is a link between balance sheets. It provides the results of operations—an important part of the change in owner's equity. Since this transaction involves an expense, it will involve ASC's income statement. The company's income statement for the first five days of December is: Accounting Software Co. Income Statement For the Five Days Ended December 5, 2017 Revenues Service Revenues Expenses Advertising Expense Net Income 0 ______600 _____(600) Sole Proprietorship Transaction #6. On December 6, 2017 ASC performs consulting services for its clients. The clients are billed for the agreed upon amount of P900. The amounts are due in 30 days. The effect on the accounting equation is: Assets = Liabilities + Owner’s Equity 900 = No Effect + 900 Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 77 | 201 lOMoARcPSD|11706204 Since ASC has performed the services, it has earned revenues and it has the right to receive P900 from the clients. This right (known as an account receivable) causes assets to increase. The earning of revenues causes owner's equity to increase. Although revenues cause owner's equity to increase, the revenue transaction is not recorded into the owner's capital account at this time. Rather, the amount earned is recorded in the revenue account Service Revenues. This will allow the company to report the revenues on its income statement at any time. (After the year ends, the amount in the revenue account will be transferred to the owner's capital account.) The general journal entry to record the transaction is: Date Account Name Debit 6-Dec, ‘17 Accounts Receivable Service Revenues Credit 900 900 The combined effect of the first five transactions is available here: Transaction Assets 1 2 3 4 5 6 Totals = Liabilities Owner’s Equity + 10,000 = No Effect + 10,000 -100 = No Effect + -100 +5,000 No Effect No Effect -5,000 +7,000 7,000+ No Effect -600 No Effect -600 +900 No Effect +900 17,200 = 7,000 10,200 The totals tell us that at the end of December 6, the company has assets of P17,200. It also shows the sources of the assets: creditors providing P7,000 and the owner of the company providing P10,200. The totals also reveal that the company has assets of P17,200 and the creditors have a claim of P7,000 and the owner has a claim for the remaining P10,200. Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 78 | 201 lOMoARcPSD|11706204 Below is the balance sheet as of midnight on December 6: Accounting Software Co. Balance Sheet December 1, 2017 ASSETS LIABILITIES Cash 11,900 Notes Payable Accounts Receivable 900 Equipment 5,000 Owner’s Equity J. Ott, Capital Total Assets 17,200 Total Liabilities Owner’s Equity Beginning owner’s equity + owner’s investment + Net Income Subtotal -Owner’s draws Ending owner’s equity, Dec 2 7,000 & 10,200 17,200 0 +10,000 300 10,300 100 10,200 **The income statement (which reports the company's revenues, expenses, gains, and losses during a specified time interval) is a link between balance sheets. It provides the results of operations—an important part of the change in owner's equity. The Income Statement for Accounting Software Co. for the period of December 1 through December 6 is: Accounting Software Co. Income Statement For the Five Days Ended December 6, 2017 Revenues Service Revenues Expenses Advertising Expense Net Income Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) 900 ______600 ______300 P a g e 79 | 201 lOMoARcPSD|11706204 Sole Proprietorship Transaction #7. On December 7, 2017 ASC uses a temporary help service for 6 hours at a cost of P20 per hour. ASC will pay the invoice when it is due in 10 days. The effect on its accounting equation is: Assets = Liabilities + Owner’s Equity No Effect = 120 + -120 ASC's liabilities increase by P120 and the expense causes owner's equity to decrease by P120. The liability will be recorded in Accounts Payable and the expense will be reported in Temp Service Expense. The journal entry for recording the use of the temp service is: Date Account Name Debit 7-Dec, ‘17 Temp Service Expense Accounts Payable Credit 120 120 The combined effect of the first five transactions is available here: Transaction Assets 1 2 3 4 5 6 7 Totals = Liabilities Owner’s Equity + 10,000 = No Effect + 10,000 -100 = No Effect + -100 +5,000 No Effect No Effect -5,000 +7,000 7,000+ No Effect -600 No Effect -600 +900 No Effect +900 No Effect +120 -120 17,200 = 7,120 10,080 The totals show us that the company has assets of P17,200 and the sources are the creditors with P7,120 and the owner of the company with P10,080. The accounting equation totals also tell us that the company has assets of P17,200 with the creditors having a claim of P7,120. This means that the owner's residual claim is P10,080. Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 80 | 201 lOMoARcPSD|11706204 The financial position of ASC as of midnight on December 7, 2017 is: Accounting Software Co. Balance Sheet December 1, 2017 ASSETS LIABILITIES Cash 11,900 Accounts Payable Accounts Receivable 900 Notes Payable Equipment 5,000 Owner’s Equity J. Ott, Capital Total Assets 17,200 Total Liabilities Owner’s Equity Beginning owner’s equity + owner’s investment + Net Income Subtotal -Owner’s draws Ending owner’s equity, Dec 2 120 7,000 & 10,080 17,200 0 +10,000 ____180 +10,180 -___100 +10,080 **The income statement (which reports the company's revenues, expenses, gains, and losses for a specified time interval) is a link between balance sheets. It provides the results of operations—an important part of the change in owner's equity. Accounting Software Co.'s income statement for the first seven days of December is: Accounting Software Co. Income Statement For the Five Days Ended December 7, 2017 Revenues Service Revenues Expenses Advertising Expense Temp service expense Total Expenses Net Income Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) 900 ______600 120 ______720 ______180 P a g e 81 | 201 lOMoARcPSD|11706204 Sole Proprietorship Transaction #8. On December 8, 2017 ASC receives P500 from the clients it had billed on December 6, 2017. The collection of accounts receivables has this effect on the accounting equation: Assets = Liabilities + Owner’s Equity No Effect + No Effect 500= -500 The company's asset (cash) increases and another asset (accounts receivable) decreases. Liabilities and owner's equity are unaffected. (There are no revenues on this date. The revenues were recorded when they were earned on December 6.) The general journal entry to record the increase in Cash, and the decrease in Accounts Receivable is: Date Account Name Debit 8-Dec, ‘17 Cash Credit 500 Accounts Receivable 500 The combined effect of the first eight transactions is shown here: Transaction Assets 1 2 3 4 5 6 7 8 Totals = Liabilities Owner’s Equity + 10,000 = No Effect + 10,000 -100 = No Effect + -100 +5,000 No Effect No Effect -5,000 +7,000 7,000+ No Effect -600 No Effect -600 +900 No Effect +900 No Effect +120 -120 +500 = No Effect No Effect -500 17,200 = 7,120 10,080 The totals for the first eight transactions indicate that the company has assets of P17,200. The creditors provided P7,120 and the owner provided P10,080. The accounting equation also indicates that the company's creditors have a claim of P7,120 and the owner has a residual claim of P10,080. Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 82 | 201 lOMoARcPSD|11706204 ASC's balance sheet as of midnight December 8, 2017 is: Accounting Software Co. Balance Sheet December 8, 2017 ASSETS LIABILITIES Cash 11,900 Accounts Payable Accounts Receivable 900 Notes Payable Equipment 5,000 Owner’s Equity J. Ott, Capital Total Assets 17,200 Total Liabilities Owner’s Equity Beginning owner’s equity + owner’s investment + Net Income Subtotal -Owner’s draws Ending owner’s equity, Dec 8 120 7,000 & 10,080 17,200 0 +10,000 ____180 +10,180 -___100 +10,080 **The income statement (which reports the company's revenues, expenses, gains, and losses during a specified period of time) is a link between balance sheets. It provides the results of operations—an important part of the change in owner's equity. The income statement for ASC for the eight days ending on December 8 is shown here: Accounting Software Co. Income Statement For the Five Days Ended December 8, 2017 Revenues Service Revenues Expenses Advertising Expense Temp service expense Total Expenses Net Income 900 ______600 120 ______720 ______180 Calculating a Missing Amount within Owner's Equity The income statement for the calendar year 2017 will explain a portion of the change in the owner's equity between the balance sheets of December 31, 2016 and December 31, 2017. The other items that account for the change in owner's equity are the owner's investments into the sole proprietorship and the owner's Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 83 | 201 lOMoARcPSD|11706204 draws (or withdrawals). A recap of these changes is the statement of changes in owner's equity. Here is a statement of changes in owner's equity for the year 2017 assuming that the Accounting Software Co. had only the eight transactions that we covered earlier. Accounting Software Co. State of Changes in Owner’s Equity For the Five Days Ended December 7, 2017 Owner’s equity at December 31, 2016 Add: Owner’s investment Net Income Subtotal Deduct: owner’s draws Owner’s equity at December 31, 2017 0 10,000 ______180 ___10,180 100 ___10,080 Example of Calculating a Missing Amount The format of the statement of changes in owner's equity can be used to determine one of these components if it is unknown. For example, if the net income for the year 2017 is unknown, but you know the amount of the draws and the beginning and ending balances of owner's equity, you can calculate the net income. (This might be necessary if a company does not have complete records of its revenues and expenses.) Let's demonstrate this by using the following amounts. Assets as of December 31, 2016 Liabilities as of December 31, 2016 Assets as of December 31, 2017 Liabilities as of December 31, 2017 Owner investment in business in 2017 Owner draws in 2017 100,000 40,000 128,000 34,000 10,000 40,000 Step 1. The owner's equity at December 31, 2016 can be computed using the accounting equation: Assets = 100,000 = 100,000-40,000 60,000 liabilities + Owner’s Equity 40,000 + Owner’s Equity Owner’s Equity Owner’s Equity Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 84 | 201 lOMoARcPSD|11706204 Step 2. The owner's equity at December 31, 2017 can be computed as well: Assets = 128,000 = 128,000 - 34,000 94,000 liabilities + Owner’s Equity 34,000 + Owner’s Equity Owner’s Equity Owner’s Equity at Dec. 31, 2017 Step 3. Insert into the statement of changes in owner's equity the information that was given and the amounts calculated in Step 1 and Step 2: Owner’s equity at December 31, 2016 Ass: Owner’s Investment Net Income Subtotal Deduct: owner’s draws Owner’s equity at December 31, 2017 60,000 +100,000 ? ? 40,000 94,000 Step 4. The "Subtotal" can be calculated by adding the last two numbers on the statement: P94,000 + P40,000 = P134,000. After this calculation we have: Owner’s equity at December 31, 2016 Ass: Owner’s Investment Net Income Subtotal Deduct: owner’s draws Owner’s equity at December 31, 2017 60,000 +10,000 ? 134,000 40,000 94,000 Step 5. Starting at the top of the statement we know that the owner's equity before the start of 2017 was P60,000 and in 2017 the owner invested an additional P10,000. As a result we have P70,000 before considering the amount of Net Income. We also know that after the amount of Net Income is added, the Subtotal has to be P134,000 (the Subtotal calculated in Step 4). The Net Income is the difference between P70,000 and P134,000. Net income must have been P64,000. Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 85 | 201 lOMoARcPSD|11706204 Step 6. Insert the previously missing amount (in this case it is the P64,000 of net income) into the statement of changes in owner's equity and recheck the math: Owner’s equity at December 31, 2016 Ass: Owner’s Investment Net Income Subtotal Deduct: Owner’s draws Owner’s equity at December 31, 2017 60,000 +10,000 64,000 134,000 - 40,000 94,000 Since the statement is mathematically correct, we are confident that the net income was P64,000. Illustration of the effects of the transaction in the accounting elements Assets invested by the owner. July 1 – Paolo Reyes started a delivery service on July 1, 2015. The following transactions occurred during the month of July. E invested PHP800,000 cash and Cars amounting to PHP200,000. ASSETS Cash Cars = 800,000 200,000 LIABILITIES + OWNER’S EQUITY Reyes, Capital 1,000,000 Borrowings from the bank July 2 – Reyes borrowed PHP100,00 cash from PNB use in his business. ASSETS Cash Cars Furnitures = LIABILITIES 855,000 Loans Payable 100,000 200,000 45,000 + OWNER’S EQUITY Reyes, Capital 1,000,000 Assets purchased on account July 15 – Various equipment were purchased on account form Fortune for PHP55,000. ASSETS Cash Cars Furnitures Equipment = LIABILITIES 855,000 Loans Payable 200,000 Accounts Payable 45,000 55,000 + OWNER’S EQUITY 100,000 Reyes, Capital 1,000,000 55,000 Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 86 | 201 lOMoARcPSD|11706204 Cash withdrawal by the owner July 18- Reyes made a cash withdrawal of PHP5,000 for personal use. ASSETS Cash Cars Furnitures Equipment = LIABILITIES + OWNER’S EQUITY 850,000 Loans Payable 100,000 Reyes, Capital 1,000,000 200,000 Accounts Payable 55,000 Reyes, Drawings (5,000) 45,000 55,000 Payment of liability July 20 – The account due to Fortune was paid in cash. ASSETS Cash Cars Furnitures Equipment = LIABILITIES + OWNER’S EQUITY 795,000 Loans Payable 100,000 Reyes, Capital 1,000,000 200,000 Reyes, Drawings (5,000) 45,000 55,000 The following table summarizes the effects of these transactions on the accounting equation Date Assets July Cash 1 2 Bal 7 800,000 200,000 100,000 900,000 200,000 (45,000) 855,000 200,000 Bal 15 Bal 18 Bal 20 Balances Cars 855,000 200,000 (5,000) 855,000 200,000 (55,000) 797,000 200,000 Furnitures Owner’s Equity Liabilities Equipment 45,000 45,000 Loans Payable Accounts Payable Reyes Drawings Reyes, Capital 100,000 I,000,000 100,000 I,000,000 100,000 I,000,000 45,000 55,000 55,000 100,000 45,000 55,000 100,000 45,000 55,000 1,095,000 55,000 55,000 55,000 (55,000) 100,000 0 1,095,000 I,000,000 (55,000) (55,000) I,000,000 (55,000) I,000,000 Determining profit through operation • Accrual basis of accounting vs Cash basis of accounting – accrual basis recognizes revenue when earned and recognizes expenses when incurred • Under the expense recognition principle, expenses can be recognized either as: (1) matching; (2) systematic allocation, or; (3) direct association. Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 87 | 201 lOMoARcPSD|11706204 • Profit measures the performance of the company. If the revenue exceeds expenses, then it is a net profit; otherwise, it is a net loss. Received cash for revenue earned July 21 – A customer hired the services of Reyes. Cash of PHP15,000 was received form the customers. ASSETS Cash = 15,000 LIABILITIES + OWNER’S EQUITY Service Revenue 15,000 Paid cash for expenses incurred July 22 – Cash was paid for the following : gas and oil, PHP500 and car repairs, PHP1,000. ASSETS Cash = (1,500) LIABILITIES + OWNER’S EQUITY Service (500) Repair Exp. (1,000) Revenue rendered on account July 24 – Another customer hired the services of Reyes and promised to pay PP16,000 on July 31. ASSETS Accounts Receivable = 16,000 LIABILITIES + OWNER’S EQUITY Service Revenue 16,000 Paid for expenses incurred July 25 – Paid PHP500 for telephone bill. ASSETS Cash = (500) LIABILITIES + OWNER’S EQUITY Telephone Expense (500) Revenue earned with a down payment, balance on account. July 27 – Another customer hired the services of Reyes. A bill was issued to them for PHP20,000, 50% of which was collected. ASSETS Cash Accounts Receivable = 10,000 10,000 LIABILITIES + OWNER’S EQUITY Service Revenue 20,000 Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 88 | 201 lOMoARcPSD|11706204 Customer’s account collected in cash July 30 – The customer on July 24 paid 50% of his account in cash. ASSETS = LIABILITIES + OWNER’S EQUITY Cash 8,000 Accounts Receivable (8,000) Paid cash for expenses incurred July 31 – Paid PHP10,000 for rental of office space, and salaries of PHP9,000 ASSETS = (19,000) Cash LIABILITIES + OWNER’S EQUITY Rent Expense (10,000) Salaries Expense (9,000) ENRICHMENT: For each transaction, tell whether the assets, liabilities and equity will increase (I), decrease (D) or is not affected (NE). A L E 1 The owner invests personal cash in the business. 2 The owner withdraws business assets for personal use. 3 The company receives cash form a bank loan 4 The company repays the bank that had lent money. 5 The company purchases equipment with its cash. 6 The owner contributes her personal truck to the business. 7 The company purchases supplies on credit. 8. The company purchases land by paying in cash and signing a note. 9 The owner withdraws cash for personal use. 10 The company repays the suppliers. Describe each transaction. Date Bal 1 2 3 4 5 6 7 Assets Cash 60,000 150,000 (20,000) (112,500) Liabilities Supplies 7,500 Equipment 300,000 75,000 Owner’s Equity 292,500 150,000 20,000 (112,500) 5,000 5,000 (15,000) (53,000) (8,000) Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) (8,000) P a g e 89 | 201 lOMoARcPSD|11706204 Answers: 1. The owner invested cash of PHP150,000 or the business earned PHP150,000 cash from providing services. 2. Purchased equipment at PHP20,000 for cash. 3. The owner withdrew cash of PHP112,500 or the business incurred PHP112,500 expenses and paid in cash. 4. The company purchased supplies on account. 5. The owner withdrew cash of PHP15,000 or the business incurred PHP15,000 expenses and paid in cash. 6. Paid liabilities worth PHP53,000. 7. The owner withdrew supplies worth PHP8,000 or the business used supplies worth PHP8,000. Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 90 | 201 lOMoARcPSD|11706204 Test 1. Fill in the blanks: Write the word of the correct answer. a. The basic accounting equation is Assets = Liabilities + __________ b. The financial statement with a structure that is similar to the accounting equation is the __________ c. the financial statement that reports the portion of change in owner's equity resulting from revenues and expenses during a specified time interval is the __________ 2. For each of the transactions indicate the two (or more) effects on the accounting equation of the business or company. a.The owner invests personal cash in the business. Assets (Increase / Decrease / No Effect) Liabilities (Increase / Decrease / No Effect) Owner's (or Stockholders') Equity (Increase / Decrease / No Effect) b.The owner withdraws cash from the business for personal use. Assets (Increase / Decrease / No Effect) Liabilities (Increase / Decrease / No Effect) Owner's (or Stockholders') Equity (Increase / Decrease / No Effect) c.The company receives cash from a bank loan. Assets (Increase / Decrease / No Effect) Liabilities (Increase / Decrease / No Effect) Owner's (or Stockholders') Equity (Increase / Decrease / No Effect) d.The company repays the bank that had lent money to the company. Assets (Increase / Decrease / No Effect) Liabilities (Increase / Decrease / No Effect) Owner's (or Stockholders') Equity (Increase / Decrease / No Effect) e.The company purchases equipment with its cash. Assets (Increase / Decrease / No Effect) Liabilities (Increase / Decrease / No Effect) Owner's (or Stockholders') Equity (Increase / Decrease / No Effect) Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 91 | 201 lOMoARcPSD|11706204 f.The owner contributes his/her personal truck to the business. Assets (Increase / Decrease / No Effect) Liabilities (Increase / Decrease / No Effect) Owner's (or Stockholders') Equity (Increase / Decrease / No Effect) g.The company purchases a significant amount of supplies on credit. Assets (Increase / Decrease / No Effect) Liabilities (Increase / Decrease / No Effect) Owner's (or Stockholders') Equity (Increase / Decrease / No Effect) h.The company purchases land by paying half in cash and signing a note payable for the other half. Assets (Increase / Decrease / No Effect) Liabilities (Increase / Decrease / No Effect) Owner's (or Stockholders') Equity (Increase / Decrease / No Effect) i. In May, Company X records the transaction by a debit to Accounts Receivable for P5,000 and a credit to Service Revenues for P5,000. What is the effect of this entry upon the accounting equation for Company X? Assets (Increase / Decrease / No Effect) Liabilities (Increase / Decrease / No Effect) Owner's (or Stockholders') Equity (Increase / Decrease / No Effect) j. In June, Company X receives the P5,000. What is the effect on the accounting equation and which accounts are affected at Company X? Assets (Increase / Decrease / No Effect) Liabilities (Increase / Decrease / No Effect) Owner's (or Stockholders') Equity (Increase / Decrease / No Effect) k. What is the effect on Client Q's accounting equation in May when Client Q records the transaction as a debit to Consultant Expense for P5,000 and a credit to Accounts Payable for P5,000? Assets (Increase / Decrease / No Effect) Liabilities (Increase / Decrease / No Effect) Owner's (or Stockholders') Equity (Increase / Decrease / No Effect) l. What is the effect on Client Q's accounting equation in June when Client Q remits the P5,000? Also, which accounts will be involved? Assets (Increase / Decrease / No Effect) Liabilities (Increase / Decrease / No Effect) Owner's (or Stockholders') Equity (Increase / Decrease / No Effect) Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 92 | 201 lOMoARcPSD|11706204 3. Multiple choice. Write the word of the correct answer. a. Which of the following will cause owner's equity to increase? Expenses Owner Draws Revenue b. Which of the following will cause owner's equity to decrease? Net Income Net Loss Revenue c. The accounting equation should remain in balance because every transaction affects how many accounts? Only One Only Two Two Or More 3. Jerome Garcia started a new business and completed these transactions during August: Aug. 1 Garcia invested PHP48,000 cash in the business. 1 Rented office space and paid PHP800 cash for the August rent. 3 Purchased exploration equipment for PHP22,000 by paying PHP12,000 cash and agreeing to pay the balance in 3 months. 5 Purchased office supplies by paying PHP1,500 cash. 6 Completed exploration work and immediately collected PHP420 cash for the work. 8 Purchased PHP1,350 of office equipment on credit. 15 Completed exploration work on credit in the amount of PHP8,000. 18 Purchased PHP700 of office supplies on credit. 20 Paid cash for the office equipment purchased on August 8. 24 Billed a client PHP2,400 for work completed; the balance is due in 30 days. 28 Received PHP5,000 cash for the work completed on August 15. 30 Paid the assistant’s salary of PHP1,100 cash for this month. 30 Paid PHP340 cash for this month’s utility bill. 30 Garcia withdrew PHP1,050 cash from the business for personal use. Required 1. Arrange the following asset, liability, and equity titles in a table: Cash; Accounts Receivable; Office Supplies; Office Equipment; Exploration Equipment; Accounts Payable; Jerome Garcia, Capital; Jerome Garcia, Withdrawals; Revenues; and Expenses. 2. Use additions and subtractions to show the effects of each transaction on the accounts in the accounting equation. Show new balances after each transaction. Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 93 | 201 lOMoARcPSD|11706204 Unit 8 Types of Major Accounts TYPES OF MAJOR ACCOUNTS The three major elements of accounting are: Assets, Liabilities, and Capital. These terms are used widely in accounting so it is necessary that we take a close look at each element. But before we go into them, we need to understand what an "account" is first. What is an Account? The term "account" is used often in this tutorial. Thus, we need to understand what it is before we proceed. In accounting, an account is a descriptive storage unit used to collect and store information of similar nature. For example, "Cash". Cash is an account that stores all transactions that involve cash receipts and cash payments. All cash receipts are recorded as increases in "Cash" and all payments are recorded as deductions in the same account. Another example, "Building". Suppose a company acquires a building and pays in cash. That transaction would be recorded in the "Building" account for the acquisition of the building and a reduction in the "Cash" account for the payment made. Now, let's take a look at the accounting elements. Account Type Overview The five account types are: Assets, Liabilities, Equity, Revenue (or Income) and Expenses. To fully understand how to post transactions and read financial reports, we must understand these account types. We'll define them briefly and then look at each one in detail: Assets: tangible and intangible items that the company owns that have value (e.g. cash, computer systems, patents) Liabilities: money that the company owes to others (e.g. mortgages, vehicle loans) Equity: that portion of the total assets that the owners or stockholders of the company fully own; have paid for outright Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 94 | 201 lOMoARcPSD|11706204 Revenue or Income: money the company earns from its sales of products or services, and interest and dividends earned from marketable securities Expenses: money the company spends to produce the goods or services that it sells (e.g. office supplies, utilities, advertising) The types of major accounts: Assets, Liabilities, Owner’s Equity, Income and Expense. • Assets are the resources owned and controlled by the firm. • Liabilities are obligations of the firm arising from past events which are to be settled in the future. • Equity or Owner’s Equity are the owner’s claims in the business. It is the residual interest in the assets of the enterprise after deducting all its liabilities. • Income is the increase in economic benefits during the accounting period in the form of inflows of cash or other assets or decreases of liabilities that result in increase in equity. Income includes revenue and gains. • Expenses are decreases in economic benefits during the accounting period in the form of outflows of assets or incidences of liabilities that result in decreases in equity. Assets Assets refer to resources owned and controlled by the entity as a result of past transactions and events, from which future economic benefits are expected to flow to the entity. In simple terms, assets are properties or rights owned by the business. They may be classified as current or non-current. Assets can be defined as objects or entities, whether tangible or intangible, that the company owns that have economic value. Tangible assets are physical entities that the business owns such as land, buildings, vehicles, equipment, and inventory. Intangible assets are things that represent money or value; things such as Accounts Receivables, patents, contracts, and certificates of deposit (CDs). Assets are also grouped according to either their life span or liquidity - the speed at which they can be converted into cash. Current assets are items that are completely consumed, sold, or converted into cash in 12 months or less. Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 95 | 201 lOMoARcPSD|11706204 Fixed assets are tangible assets with a life span of at least one year and usually longer. Fixed assets might include machinery, buildings, and vehicles. Fixed assets are typically not very liquid. And because of their higher costs, assets are not expensed, but depreciated, or "written off" over a number of years according to one of several depreciation schedules. The difference between Current vs. Non-Current Assets, and Tangible vs. Intangible Assets. • Current Assets are assets that can be realized (collected, sold, used up) one year after year-end date. Examples include Cash, Accounts Receivable, Merchandise Inventory, Prepaid Expense, etc. Current assets – Assets are considered current if they are held for the purpose of being traded, expected to be realized or consumed within twelve months after the end of the period or its normal operating cycle (whichever is longer), or if it is cash. Examples of current asset accounts are: Cash and Cash Equivalents – bills, coins, funds for current purposes, checks, cash in bank, etc. Receivables – Accounts Receivable (receivable from customers), Notes Receivable (receivables supported by promissory notes), Rent Receivable, Interest Receivable, Due from Employees (or Advances to Employees), and other claims • Allowance for Doubtful Accounts – This is a valuation account which shows the estimated uncollectible amount of accounts receivable. It is a contraasset account and is presented as a deduction to the related asset – accounts receivable. Inventories – assets held for sale in the ordinary course of business Prepaid expenses – expenses paid in advance, such as, Prepaid Rent, Prepaid Insurance, Prepaid Advertising, and Office Supplies • Non-current Assets are assets that cannot be realized (collected, sold, used up) one year after year-end date. Examples include Property, Plant and Equipment (equipment, furniture, building, land), long term investments, etc. Non-current assets – Assets that do not meet the criteria to be classified as current. Hence, they are long-term in nature – useful for a period longer that 12 months or the company's normal operating cycle. Examples of non-current asset accounts include: Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 96 | 201 lOMoARcPSD|11706204 Long-term investments – investments for long-term purposes such as investment in stocks, bonds, and properties; and funds set up for long-term purposes Land – land area owned for business operations (not for sale) Building – such as office building, factory, warehouse, or store Equipment – Machinery, Furniture and Fixtures (shelves, tables, chairs, etc.), Office Equipment, Computer Equipment, Delivery Equipment, and others • Accumulated Depreciation – This is a valuation account which represents the decrease in value of a fixed asset due to continued use, wear & tear, passage of time, and obsolescence. It is a contra-asset account and is presented as a deduction to the related fixed asset. Intangibles – long-term assets with no physical substance, such as goodwill, patent, copyright, trademark, etc. • Tangible Assets are physical assets such as cash, supplies, and furniture and fixtures. • Intangible Assets are non-physical assets such as patents and trademarks Other long-term assets Assets • Cash is money on hand, or in banks, and other items considered as medium of exchange in business transactions. • Accounts Receivable are amounts due from customers arising from credit sales or credit services. • Notes Receivable are amounts due from clients supported by promissory notes. • Inventories are assets held for resale • Supplies are items purchased by an enterprise which are unused as of the reporting date. • Prepaid Expenses are expenses paid in advance. They are assets at the time of payment and become expenses through the passage of time. • Accrued Income is revenue earned but not yet collected • Short term investments are the investments made by the company that are intended to be sold immediately Non-Current Assets Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 97 | 201 lOMoARcPSD|11706204 • Property, Plant and Equipment are long-lived assets which have been acquired for use in operations. • Long term Investments are the investments made by the company for long-term purposes • Intangible Assets are assets without a physical substance. Examples include franchise and copyright. Liabilities Liabilities are the debts and obligations of the company to another entity. Liabilities are economic obligations or payables of the business. Company assets come from 2 major sources – borrowings from lenders or creditors, and contributions by the owners. The first refers to liabilities; the second to capital. Liabilities represent claims by other parties aside from the owners against the assets of a company. The differences of Current vs. Non-Current Liabilities. Current Liabilities. Liabilities that fall due (paid, recognized as revenue) within one year after year-end date. Examples include Accounts Payable, Utilities Payable and Unearned Income. Like assets, liabilities may be classified as either current or non-current. A. Current liabilities – A liability is considered current if it is due within 12 months after the end of the balance sheet date. In other words, they are expected to be paid in the next year. If the company's normal operating cycle is longer than 12 months, a liability is considered current if it is due within the operating cycle. Liabilities Liabilities are the debts, or financial obligations of a business - the money the business owes to others. Liabilities are classified as current or long-term. Current liabilities are debts that are paid in 12 months or less, and consist mainly of monthly operating debts. Current liabilities are usually paid with current assets; i.e. the money in the company's checking account. A company's working capital is the difference between its current assets and current liabilities. Managing short- Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 98 | 201 lOMoARcPSD|11706204 term debt and having adequate working capital is vital to a company's long-term success. Long-term liabilities are typically mortgages or loans used to purchase or maintain fixed assets, and are paid off in years instead of months. Current liabilities include: Trade and other payables – such as Accounts Payable, Notes Payable, Interest Payable, Rent Payable, Accrued Expenses, etc. Current provisions – estimated short-term liabilities that are probable and can be measured reliably Short-term borrowings – financing arrangements, credit arrangements or loans that are short-term in nature Current-portion of a long-term liability – the portion of a long-term borrowing that is currently due. Example: For long-term loans that are to be paid in annual installments, the portion to be paid next year is considered current liability; the rest, non-current. Current tax liabilities – taxes for the period and are currently payable Non-current Assets are liabilities that do not fall due (paid, recognized as revenue) within one year after year-end date. Examples include Notes Payable, Loans Payable, Mortgage Payable, etc. B. Non-current liabilities – Liabilities are considered non-current if they are not currently payable, i.e. they are not due within the next 12 months after the end of the accounting period or the company's normal operating cycle, whichever is shorter. In other words, non-current liabilities are those that do not meet the criteria to be considered current. Hah! Make sense? Non-current liabilities include: • • • • Long-term notes, bonds, and mortgage payables; Deferred tax liabilities; and Other long-term obligations Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 99 | 201 lOMoARcPSD|11706204 The Account Titles used for Liability Accounts. Current Liabilities Accounts Payable are amounts due, or payable to, suppliers for goods purchased on account or for services received on account. Notes Payable are amounts due to third parties supported by promissory notes. Accrued Expenses are expenses that are incurred but not yet paid (examples: salaries payable, taxes payable)l Unearned Income is cash collected in advance; the liability is the services to be performed or goods to be delivered in the future. Non-Current Liabilities Loans Payable Mortgage Payable Owner’s Equity Owner’s Equity is the residual interest of the owner from the business. It can be derived by deducting liabilities from assets. 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: Initial and additional contributions of owner/s (investments), Withdrawals made by owner/s (dividends for corporations), Income, and 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. Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 100 | 201 lOMoARcPSD|11706204 In addition to the three elements mentioned above, there are two items that are also considered as key elements in accounting. They are income and expense. Nonetheless, these items are ultimately included as part of capital. Equity Equity is of utmost importance to the business owner because it is the owner's financial share of the company - or that portion of the total assets of the company that the owner fully owns. Equity may be in assets such as buildings and equipment, or cash. Equity is also referred to as Net Worth. For example, if you purchase a $30,000 vehicle with a $25,000 loan and $5,000 in cash, you have acquired an asset of $30,000, but have only $5,000 of equity. The Balance Sheet equation is: Assets = Liabilities + Owner's Equity We can see how this equation works with our example: $30,000 Asset = $25,000 Liability + $5,000 Owner Equity. Types of Equity Accounts and Their Various Names There are three types of Equity accounts that will meet the needs of most small businesses. These accounts have different names depending on the company structure, so we list the different account names in the chart below. Contribution (Money Invested): There are times when company owners must invest their own money into the company. It may be start-up capital or a later infusion of cash. When this occurs, a Capital or Investment account is credited. See the first row in the table below. Distribution or Draw (Money Withdrawn): If a business is profitable, the owners often want some of the profit returned to them. To track this activity, a Draw or Distribution account is debited. This is the only Equity account (noncontra) that receives debits. See the second row in the table below. Accumulation from Prior Years: To tracks a company's Net Income as it accumulates over the years, Retained Earnings or Owner's Equity is credited. On the first day of the fiscal year, most accounting programs automatically credit this account with the previous year's Net Income. See the third row of the table below. NOTE: Most single-owner companies enter journal entries to "close out" the Contribution and Draw accounts to Retained Earnings on the last day of the fiscal year. Partnerships, however, may choose not to close out these accounts so that a permanent record of partner activity is maintained. Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 101 | 201 lOMoARcPSD|11706204 Sole Proprietor Partnership Subchapter Corporation Money invested Owner's Investment - or Capital Contribution Partner A Capital Contribution, Partner B Capital Contribution, etc. Paid in Capital or Capital Contribution Money withdrawn Owner's Draw Partner A Draw, Distribution Partner B Draw, etc. Owner's Equity - Partner A Equity, Cumulative Earnings Retained or - Partner B Equity, (less $$ withdrawn) Earnings Owner's Capital etc. The Account Titles used for Equity Account. Define each account and differentiate one from the other. Capital is the value of cash and other assets invested in the business by the owner of the business. Drawing is an account debited for assets withdrawn by the owner for personal use from the business. Income 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. Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 102 | 201 lOMoARcPSD|11706204 Income or Revenue Income is money the business earns from selling a product or service, or from interest and dividends on marketable securities. Other names for income are revenue, gross income, turnover, and the "top line." Net income is revenue less expenses. Other names for net income are profit, net profit, and the "bottom line." Income is "realized" differently depending on the accounting method used. Accrual basis accounting counts the revenue as soon as an invoice is entered into the accounting system. Cash basis accounting does not count the revenue until the invoice is paid. Income accounts are temporary or nominal accounts because their balance is reset to zero at the beginner of each new accounting period, usually a fiscal year. Most accounting programs perform this task automatically. Income is the Increase in resources resulting from performance of service or selling of goods. Rule: Where Income increases and decreases in the accounting equation. Income increases equity. • Give examples of Income Accounts. Service revenue for service entities, Sales for merchandising and manufacturing companies Expense Expenses are expenditures, often monthly, that allow a company to operate. Examples of expenses are office supplies, utilities, rent, entertainment, and travel. Like revenue accounts, expense accounts are temporary accounts that collect data for one accounting period and are reset to zero at the beginning of the next accounting period. Most accounting programs perform this task automatically. A unique type of Expense account, Depreciation Expense, is used when purchasing Fixed Assets. Costly items, such as vehicles, equipment, and computer systems, are not expensed, but are depreciated or written off over the life expectancy of the item. A contra-account, Accumulated Depreciation, is used to Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 103 | 201 lOMoARcPSD|11706204 offset the Asset account for the item. Please see your Accountant for help with the depreciation of Assets. 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. Expense is the decrease in resources resulting from the operations of business Rule: Where Expense increases and decreases in the accounting equation. Expenses decreases Equity in the accounting equation • Examples of Expense Accounts Salaries Expense, Interest Expense, Utilities Expense Account Types Account ACCOUNTS PAYABLE ACCOUNTS RECEIVABLE ACCUMULATED DEPRECIATION ADVERTISING EXPENSE ALLOWANCE FOR UNCOLLECTIBLE ACCOUNTS AMORTIZATION EXPENSE AVAILABLE FOR SALE SECURITIES BONDS PAYABLE BUILDING CAPITAL STOCK CASH CASH OVER CASH SHORT CHARITABLE CONTRIBUTIONS PAYABLE COMMON STOCK COST OF GOODS SOLD Type Liability Asset Contra Asset Expense Contra Asset Debit Decrease Increase Decrease Increase Decrease Credit Increase Decrease Increase Decrease Increase Expense Asset Liability Asset Equity Asset Revenue Expense Liability Increase Increase Decrease Increase Decrease Increase Decrease Increase Decrease Decrease Decrease Increase Decrease Increase Decrease Increase Decrease Increase Equity Expense Decrease Increase Increase Decrease Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 104 | 201 lOMoARcPSD|11706204 CURRENCY EXCHANGE GAIN CURRENCY EXCHANGE LOSS DEPRECIATION EXPENSE DISCOUNT ON BONDS PAYABLE DISCOUNT ON NOTES PAYABLE DIVIDEND INCOME DIVIDENDS DIVIDENDS PAYABLE DOMAIN NAME EMPLOYEE BENEFITS EXPENSE EQUIPMENT FEDERAL INCOME TAX PAYABLE FEDERAL UNEMPLOYMENT TAX PAYABLE FREIGHT-IN FREIGHT-OUT FUEL EXPENSE GAIN HEALTH/CHILD FLEX PAYABLE INCOME SUMMARY INSURANCE EXPENSE INSURANCE PAYABLE INTEREST EXPENSE INTEREST INCOME INTEREST PAYABLE INTEREST RECEIVABLE INVENTORY INVESTMENT IN BONDS INVESTMENT INCOME INVESTMENTS LAND LOAN PAYABLE LOSS MEDICARE/MEDICAID PAYABLE MISCELLANEOUS EXPENSE NOTES PAYABLE NOTES RECEIVABLE OBLIGATION UNDER CAPITAL LEASE PAID-IN CAPITAL IN EXCESS OF PAR – COMMON Gain Loss Expense Liability Contra Liability Revenue Dividend Liability Asset Expense Asset Liability Liability Decrease Increase Increase Decrease Increase Decrease Increase Decrease Increase Increase Increase Decrease Decrease Increase Decrease Decrease Increase Decrease Increase Decrease Increase Decrease Decrease Decrease Increase Increase Part of Calculation of Net Purchases Expense Expense Gain Liability Not a Financial Statement Account Expense Liability Expense Revenue Liability Asset Asset Asset Revenue Asset Asset Liability Loss Liability Expense Liability Asset Liability Equity Increase Decrease Increase Increase Decrease Decrease Debited for Total Expenses Increase Decrease Increase Decrease Decrease Increase Increase Increase Decrease Increase Increase Decrease Increase Decrease Increase Decrease Increase Decrease Decrease Decrease Decrease Increase Increase Credited for Total Revenues Decrease Increase Decrease Increase Increase Decrease Decrease Decrease Increase Decrease Decrease Increase Decrease Increase Decrease Increase Decrease Increase Increase Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 105 | 201 lOMoARcPSD|11706204 PAID-IN CAPITAL IN EXCESS OF PAR – PREFERRED PATENT PAYROLL TAX EXPENSE PETTY CASH POSTAGE EXPENSE PREMIUM ON BONDS PAYABLE PREPAID INSURANCE PREPAID RENT PURCHASE DISCOUNTS PURCHASE DISCOUNTS LOST PURCHASES PURCHASE RETURNS RENT EXPENSE REPAIR EXPENSE RETAINED EARNINGS RETIREMENT CONTRIBUTION PAYABLE REVENUE SALARIES EXPENSE SALARIES PAYABLE SALES SALES DISCOUNTS SALES RETURNS SERVICE CHARGE SERVICE REVENUE SOCIAL SECURITY PAYABLE STATE INCOME TAX PAYABLE STATE UNEMPLOYMENT TAX PAYABLE SUPPLIES SUPPLIES EXPENSE TRADING SECURITIES TREASURY STOCK UNCOLLECTIBLE ACCOUNTS EXPENSE Equity Decrease Increase Asset Expense Asset Expense Liability Adjunct Account Asset Asset Reduces Calculation of Net Purchases Expense Part of Calculation of Net Purchases Reduces Calculation of Net Purchases Expense Expense Equity Liability Increase Increase Increase Increase Decrease Decrease Decrease Decrease Decrease Increase Increase Increase Decrease Decrease Decrease Increase Increase Increase Decrease Decrease Decrease Increase Increase Increase Decrease Decrease Decrease Decrease Increase Increase Revenue Expense Liability Revenue Contra Revenue Contra Revenue Expense Revenue Liability Liability Liability Decrease Increase Decrease Decrease Increase Increase Decrease Increase Increase Decrease Increase Decrease Increase Decrease Decrease Decrease Decrease Decrease Increase Increase Increase Increase Asset Expense Asset Contra Equity Expense Increase Increase Increase Increase Increase Decrease Decrease Decrease Decrease Decrease Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 106 | 201 lOMoARcPSD|11706204 UNEARNED REVENUE UNREALIZED GAIN UNREALIZED LOSS UNREALIZED GAIN – OTHER COMPREHENSIVE INCOME UNREALIZED LOSS – OTHER COMPREHENSIVE INCOME UTILITIES EXPENSE WARRANTY EXPENSE WARRANTY LIABILITY Liability Gain Loss Increase in Equity Via Other Comprehensive Income Decrease in Equity Via Other Comprehensive Income Expense Expense Liability Decrease Decrease Increase Decrease Increase Increase Decrease Increase Increase Decrease Increase Increase Decrease Decrease Decrease Increase II. Chart of Accounts. Setting up a Chart of Accounts: a. A chart of accounts is a listing of the accounts used by companies in their financial records. b. The chart of accounts helps to identify where the money is coming from and where it is going. c. The chart of accounts is the foundation of the financial statements. Steps in the preparation of a basic chart of accounts: 1. Create two columns. 2. Prepare the assets first, then liabilities, then equity, then revenue and expenses. 3. List all assets, liabilities, equity, revenue and expenses account in the first column. 4. On the second column, choose an account code (discretion of the company). 5. On the third column, write the description for each account on when to use it. Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 107 | 201 lOMoARcPSD|11706204 Example of a chart of accounts is given below: Account Assets Cash Accounts Receivable Inventory Prepaid Expenses Supplies Office Equipment Store Equipment Land Liabilities Accounts Payable Notes Payable Salaries Payable Capital Owner’s Capital Owner’s Withdrawal Service Revenue Salaries Expense Utilities Expense Account Code Description 1000 1200 1300 1400 1500 1600 1700 1800 Use for actual transactions Use for customers who will pay in the future Use for items held for sale Use for expenses paid in advance Use for items to be used in the future Use for equipment that are used in the office Use for equipment that are used in the store Use for land used in operations 2000 2100 2200 Used for the debts of the company Use for promissory notes issued by the company Use for salaries to be paid in the future 3000 4000 5000 6000 6100 Use for earnings Use for salaries incurred, regardless for payment Use for electricity and water expenses incurred Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 108 | 201 lOMoARcPSD|11706204 Test 1. Matching Type. Match Column A with Column B Column A Column B a. 1. It is the obligations of the company payable in Assets money, goods or services. b. 2. These are non-current tangible assets. Accounts Receivable c. 3. These assets are identifiable, non-monetary Intangible Assets assets without physical substance. d. 4. It is the claim of the owner also known as the Liabilities capital. e. 5. It is the most liquid asset and is the medium of Notes Receivable exchange for business transactions. f. 6. It is an expense for leased office space, Property equipment or assets rented from others g. 7. Examples of this are cash, account receivable Plant and and prepaid expenses. Equipment h. 8. It is a written promise from the customer to pay Owner’s Equity his receivables on a certain future date. Rent Expense Cash Prepaid Expense 2. For each item, indicate whether it is an Asset, a Liability, or Capital in Column. If the item is an asset or a liability, indicate if it is Current or Non-current in Column B. If the item is capital, place N/A in Column B. A – Asset B-Non-Current 1. Tools and equipment 2. Salaries payable 3. Additional investment of owner 4. Cash on hand 5. Cash deposited in Prime Bank 6. Delivery truck 1. Tools and equipment 2. Salaries payable 3. Additional investment of owner 4. Cash on hand 5. Cash deposited in Prime Bank 6. Delivery truck 7. Obligation to pay supplier 8. Loan from bank, 5 years Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 109 | 201 lOMoARcPSD|11706204 9. Investment in long-term bonds 10. Prepaid insurance 11. Patent (an intangible) 12. Withdrawals made by owner 13. Merchandise for sale 14. Building used as office space 15. Accounts receivable 3. For each item, indicate whether it is an Income or an Expense. If it is neither income nor expense, write its proper classification. Income 1. Rent revenue 2. Rent payable 3. Salaries of employees 4. Sales 5. Light, water, and electricity 6. Loss from flood 7. Accumulated depreciation 8. Prepaid advertising 9. Delivery costs 10. Gain on sale of land 4. For each of the following accounts, indicate whether it is an Asset, Liability, Income, or Expense. If it is an asset or a liability, specify whether it is current or non-current. Asset Current 1. Merchandise Inventory 2. Accounts Payable 3. Utilities Expense 4. Service Revenue 5. Computer Equipment 6. Office Supplies 7. Bonds Payable 8. Land 9. Cash 10. Furniture and Fixtures Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 110 | 201 lOMoARcPSD|11706204 5. Identify if the account is an asset, liability, equity, income or expense and indicate its normal balance. Account Asset Liabilities Owner’s Equity Income Expenses Balance Accounts Receivable Accumulated Depreciation Advertising Expense Bonds Payable Building Cash De Jesus, Capital Delivery Truck Interest Payable Inventories Land Mortgage Loans Notes Payable Notes Receivable Office Supplies Prepaid Expenses Rent Expenses Salaries Expense Salaries Payable Service Fees Income Supplies Expense Trading Securities Unearned Income Utilities Expenses 5. Indicate whether it is an increase (+), decrease (-), or no effect on the asset, liabilities and equity accounts. Assets Liabilities Equity Fundamentals of Accounting, Business Management 1 P a g e 111 | 201 Investment of cash in the business Purchase of computer equipment for cash Billed a customer for services rendered Paid salaries Purchased office supplies on credit Paid advertising expense Paid rent in advance for 3 months Received cash from customers on account Withdrew cash for personal use Invested land into the company Downloaded by Resty Quito (restyquito2290@gmail.com) lOMoARcPSD|11706204 6. Identify and classify the following items Account Title Current Asset Non-Current Asset Tangible Intangible Account Receivable Building Cash Computer Equipment Copyrights Delivery Truck Furniture & Fixtures Store Supplies Inventories Land Notes Receivable Office Supplies Accrued Income Prepaid Insurance Prepaid Rent Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 112 | 201 lOMoARcPSD|11706204 Unit 9 Book of Accounts Book of Accounts The two major types of books of accounts are journal and ledger. 1 The journal Companies initially record transactions and events in chronological order (the order in which they occur). Thus, the journal is referred to as the book of original entry. For each transaction the journal shows the debit and credit effects on specific accounts. There are two types of journals, the general journal and the special journal. GENERAL JOURNAL The general journal is the most basic journal. Typically, a general journal has spaces for dates, account titles and explanations, references, and two amount columns. The journal makes several significant contributions to the recording process: • It discloses in one place the complete effects of a transaction. • It provides a chronological record of transactions. • It helps to prevent or locate errors because the debit and credit amounts for each entry can be easily compared. Shown below is an example of a general journal Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 113 | 201 lOMoARcPSD|11706204 Date General Journal Account Title and Explanation Ref Debit Credit Journalizing process Entering transaction data in the journal is known as journalizing. Companies make separate journal entries for each transaction. A complete entry consists of: • The date of the transaction which is entered in the Date column. • The debit account title (that is, the account to be debited) which is entered first at the extreme left margin of the column headed “Account Titles and Explanation,” and the amount of the debit is recorded in the Debit column. • The credit account title (that is, the account to be credited) which is indented and entered on the next line in the column headed “Account Titles and Explanation,” and the amount of the credit is recorded in the Credit column. A brief explanation of the transaction which appears on the line below the credit account title. A space is left between journal entries. The blank space separates individual journal entries and makes the entire journal easier to read. • The column titled Ref. (which stands for Reference) which is left blank when the journal entry is made. This column is used later when the journal entries are transferred to the ledger accounts. To illustrate the recording of transactions in the general journal, let us use the following transactions as an example: • September 1, 2015 Mr. Ben Mabait invested PHP500,000 in a restaurant business by opening an account with SuperBank. • September 5, 2015 purchased kitchen appliances for his business amounting to PHP100,000 by issuing a check. • September 6, 2015 started his operations a made a sale for that day amounting to PHP20,000. Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 114 | 201 lOMoARcPSD|11706204 We will now record the above transactions in the general journal. Date 9/1/15 9/5/15 9/6/15 General Journal Account Title and Explanation Cash Ref Debit Credit 500,000 500,000 B. Mabait, Capital Kitchen Appliance Cash To record purchase of kitchen appliance. Cash Sales To record sales for the day. 100,000 100,000 20,000 20,000 Some entries involve only two accounts, one debit and one credit. An entry like these is considered a simple entry. Some transactions, however, require more than two accounts in journalizing. An entry that requires three or more accounts is a compound entry. All of the transactions in the above examples are simple entries. An example of a compound entry is the following: On September 7, 2015, Mr. Mabait purchased a motorcycle costing PHP80,000. He pays PHP30,000 cash and agrees to pay the remaining PHP50,000 on account (to be paid later). The compound entry is as follows: Date 9/7/15 General Journal Account Title and Explanation Ref Debit Credit Transportation Equipment 80,000 30,000 Cash 50,000 Accounts Payable To record purchase of motorcycle by paying cash and the balance on account. Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 115 | 201 lOMoARcPSD|11706204 SPECIAL JOURNALS Some businesses encounter voluminous quantities of similar and recurring transactions which may create congestion if these transactions are recorded repeatedly in a single day or a month in the general journal. Take the case of our example above, if Mr. Mabait will record the sales per day using the Official Receipt or Cash Sales Invoice issued, it would be unnecessary and impractical to credit “sales” account repeatedly. In order to facilitate efficient and practical recording of similar and recurring transactions, a special journal is used. The following are the commonly used special journals: • Cash Receipts Journal – used to record all cash that has been received • Cash Disbursements Journal – used to record all transactions involving cash payments • Sales Journal (Sales on Account Journal) – used to record all sales on credit (on account) • Purchase Journal (Purchase on Account Journal) – used to record all purchases of inventory on credit (or on account) Cash Receipts Journal is used to record transaction involving receipt or collection of cash. The following illustrate the format of a cash receipts journal: Cash Receipts Journal Ref Debit Credit Date Description (Particulars) Cash Sales Credit Credit Accounts Sundry Receivable • The date of the transaction is entered in the date column. • A brief explanation of the transaction is entered in the description column. • The column titled Ref. (which stands for Reference) which is left blank when the journal entry is made. This column is used later when the journal entries are transferred to the ledger accounts. • The Debit Cash column represents the amount of cash received for a particular transaction. Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 116 | 201 lOMoARcPSD|11706204 • Major categories of receipts, such as cash sales and collection of accounts receivable are provided with separate columns. These transactions are frequent and repetitive items; therefore, a separate column is provided. • The column sundry is used for various miscellaneous and less regular items, such as capital investment, receipt of loan proceeds, among others. • The source document for this journal is the Official Receipts or Cash Receipts issued by the business. Cash Disbursements Journal (CDJ) The cash disbursements journal is the opposite of the cash receipts journal. It is the journal where all cash payments are recorded. An example of a cash disbursement journal is shown below: Date Description (Particulars) Cash Disbursements Journal Ref Check or Credit Debit Voucher Number Cash Accounts Payable Debit Salaries Debit Credit Supplies Sundry • The date of the transaction is entered in the date column. • A brief explanation of the transaction is entered in the description column. • The column titled Ref. (which stands for Reference) which is left blank when the journal entry is made. This column is used later when the journal entries are transferred to the ledger accounts. • The Check or Voucher number represents the identifying number of the check issued for the related cash payment. Most of the time, a check or cash voucher accompanies the disbursement. The voucher number may be used as the alternative for this column. • The Debit Cash column represents the amount of cash received for a particular transaction. • Major categories of receipts, such cash sales and collection of accounts receivable are provided with separate columns. These transactions are frequent and repetitive items, therefore a separate column is provided. • The column sundry is used for various miscellaneous and less regular items, such as capital investment, receipt of loan proceeds, among others. Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 117 | 201 lOMoARcPSD|11706204 • The source documents used to update this journal are the check voucher or cash voucher, cash receipts or official receipts from suppliers or vendors. Sales Journal (Sales on Account Journal) The Sales Journal or Sales on Account Journal is used in recording several sales transactions on account. The source document for this journal is the charge invoice or sales invoice (for credit transactions) to various customers or clients. An example of a sales journal is shown below: Date Description (Particulars) Sales Journal Ref Charge Invoice or Sales invoice No. Debit Accounts Receivable Credit Sale • The date of the transaction is entered in the date column. • A brief explanation of the transaction is entered in the description column or the name of the customer. • The column titled Ref. (which stands for Reference) which is left blank when the journal entry is made. This column is used later when the journal entries are transferred to the ledger accounts. • The Charge Invoice Number or Sales Invoice Number represents the identifying number of the source document issued to the customer when the sale was made. • The Debit Accounts Receivable column represents the amount of the sale transactions indicated in the charge invoice. • The Credit Sales column represents the amount of the sale transactions indicated in the charge invoice. The source document for this journal is the Charge Invoice issued by the business. Purchase Journal (Purchases on Account Journal) Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 118 | 201 lOMoARcPSD|11706204 The Purchase journal or the Purchases on Account Journal is used to record recurring transactions of purchases on account. The source documents for purchase journal are the invoices from the supplier of the company. An example of a Purchase Journal is shown below: Date Purchase Journal Description (Particulars) Ref Charge Invoice or Sales invoice No. (from Suppliers) Debit Purchases Credit Accounts Payable • The date of the transaction is entered in the date column. • A brief explanation of the transaction is entered in the description column or the name of the supplier • The column titled Ref. (which stands for Reference) which is left blank when the journal entry is made. This column is used later when the journal entries are transferred to the ledger accounts. • The Charge Invoice Number or Sales Invoice Number represents the identifying number of the source document issued by the supplier when the items, goods or merchandise were delivered to the company when the purchase was made. • The Debit Purchases column represents the amount of the goods purchases as indicated in the charge invoice from the supplier • The Credit Accounts Payable column represents the amount of the goods or items purchased on credit from the supplier. The amount is indicated in the charge invoice issued by the supplier. • The source document for this journal is the charge invoice from the supplier or vendor. Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 119 | 201 lOMoARcPSD|11706204 2. The ledger The ledger refers to the accounting book in which the accounts and their related amounts as recorded in the journal are posted periodically. The ledger is also called the ‘book of final entry’ because all the balances in the ledger are used in the preparation of financial statements. This is also referred to as the T-Account because the basic form of a ledger is like the letter ‘T’. There are two kinds of ledgers, namely; the general ledger and the subsidiary ledgers. GENERAL LEDGER The general ledger (commonly referred by accounting professionals as GL) is a grouping of all accounts used in the preparation of financial statements. The GL is a controlling account because it summarizes all the activities that have taken place as recorded in its subsidiary ledger. The format of a general ledger is shown below: General ledger Account: CASH Date Item Ref Debit Account No..1000 Credit Balance • The account portion refers to the account title for example: cash, accounts receivable. • The account number is an assigned number for each account title to facilitate ease in recording and cross-referencing. • The Date column identifies when the transaction happened. • The item represents the source journal and the nature of the transactions • The Reference identifies the page number of the general our special journal from which the information was taken. • The Debit and Credit columns are used in recording the amount of transactions from the general journal or special journal. The Balance Column represents the running balance of the Account after considering the debit and credit amounts. If the running balance amount is • Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 120 | 201 lOMoARcPSD|11706204 positive, the account has a debit balance whereas if it has a negative running balance, the accounts has a credit balance. SUBSIDIARY LEDGER A subsidiary ledger is a group of like accounts that contains the independent data of a specific general ledger. A subsidiary ledger is created or maintained if individualized data is needed for a specific general ledger account. An example of a subsidiary ledger is the individual record of various payables to suppliers. The total amount of these subsidiary ledgers should equal the balance in the Accounts Payable general ledger. An example of a subsidiary ledgers are shown below: Accounts Payable Subsidiary Ledger Vendor/Supplier: Joy Food Corporation Address: Jose St, Sampaloc, Manila Item Ref Debit Date Vendor No.. 201 Credit Balance • The upper portion indicates the name and address of the vendor or supplier. • The vendor number is an assigned number for each vendor as reference in keeping the records of a supplier. • The Date column identifies when the transaction happened. • The description column describes the nature of transaction. • The Reference identifies the page number of the general our special journal from which the information was taken. • The Debit and Credit columns reflect the various effects of every transaction to the record of the supplier or vendor. The Balance column provides the running balance of every supplier. • Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 121 | 201 lOMoARcPSD|11706204 ENRICHMENT 1. Differentiate General Ledger from a Subsidiary Ledger Suggested Answer: A subsidiary ledger contains the details supporting the balance in the general ledger account. For example, a subsidiary ledger is maintained for all receivables from customers; the sum of balances per customer should equal the balance of Accounts Receivable Account in the general ledger account. 2. Differentiate General Journal from a General Ledger Suggested Answer: Accounting transactions are first recorded in the general journal and in order of their occurrence. A general ledger contains a summary at the account level of every transaction that a business has engaged in. The general journal records all the transactions whereas the general ledger the effect of these journal entries to every account title. The general journal is called the book of original entry while the general ledger is called the book of final entry. 3. Types of transactions recorded in the cash receipts journal: • cash received from a charge (on account) customer • cash received from a charge (on account) customer less a cash discount • cash sales • cash received from sale of other assets. • all other transactions that require the issuance of a Cash receipt or Official Receipt document 4. A sales journal is used when two conditions are met: • merchandise is sold • the sale is on account 5. A cash disbursements journal (cash payments journal) is used to record the following transactions: • purchase of merchandise for cash • payment to creditor, vendors or suppliers • all cash payments Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 122 | 201 lOMoARcPSD|11706204 Test 1. Match: Match column A with Column B. Column A a. Collected PHP10,000 from a customer in payment of his account. b. Bought 100 pieces of mugs to be sold in the store amounting to PHP1,500 on account c. Sold five pieces of mugs to X, PHP320 cash. Column B Cash Receipts Journal Purchase Journal. d. Sold two pieces of mugs to Y, PHP112 cash e. Purchased office supplies for cash, PHP500. f. Paid PHP20,000 monthly rental. g. Paid salary of staff, PHP15,000 h. Sold 100 pieces of mugs to Unicup, Inc., PHP5,600 on account. i. Sold 500 pieces of mugs to Bugsmore Corp. for PHP15,300 payable one month after delivery. j. Purchase on account 1,000 pieces of mugs for PHP12,400 Cash Receipts Journal Cash Receipts Journal Cash Disbursement Journal Cash Disbursements Journal Cash Disbursement Journal Sales Journal Sales Journal Purchase Journal 2. Enumerate all special journals. (4 points) 3. Essay. Why do companies use special journals? Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 123 | 201 lOMoARcPSD|11706204 Unit 10 Business Transactions and their Analysis s applied to the accounting Cycle of a)Service business b) Rules of debts and credits c)Journalizing d) Posting e)Preparation of Trial Balance The nature of a service business A service business provides a needed service for a fee. In general, service businesses actually have no physical product sold to clients. Their services are designed to facilitate the work of clients and in return are paid. Service businesses include salons or barbershops, laundry services, car repairs, medical centers and services of professionals like lawyers and doctors. The revenue of a service business is usually realized once the service has been substantially completed. Aside from the minor supplies, the service business does not maintain a high level of inventory as compared to merchandising and manufacturing businesses. In relatively small service businesses, all transactions are on cash payments. This means sales are collected immediately while most expenses are paid outright in the form of cash or checks. The typical financial transactions recorded for a service company include collecting a deposit from the customer, providing the service and receiving payment. Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 124 | 201 lOMoARcPSD|11706204 What events or transactions usually occur in a repair shop. Discuss the accounting cycle of a service business THE ACCOUNTING CYCLE The accounting cycle is a continuous process of accumulating, summarizing and reporting financial information. The steps include: Step 1 - Transactions and/or Events Identification and measurement of external transactions and internal events. At this stage, the documents used by the business are analyzed whether it has financial impact or effect. Recall the rule that only financial transactions are recorded and that the amount can be measured. These two conditions must exist in order that a particular transaction is recognized or recorded. As defined, financial transactions are those activities that change the value of an asset, liability or an equity. Examples of financial transactions: • Receipt of cash from a client as advance payment to repair a computer. In this case (asset) will increase. At the same time, the advances from client (liability) will also increase. The advances from client is a liability because the business has the obligation to render future service to the client. • Payment of electric bill is a financial transaction. This will decrease the cash (asset) and reduce the income of the business at the same time. Examples of non-financial transactions: • hiring and termination of employees • recognition from the government as most outstanding business • death of owner Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 125 | 201 lOMoARcPSD|11706204 The information needed when recording transactions are taken from forms used to document these transactions. In a typical service business, the following are the business documents used: 1. Official Receipt or Cash Receipt. This document is used when a business receives money or a check. An Official Receipt or Cash Receipt is a document that acknowledges that money or a check have been received. SAMPLE OFFICIAL RECEIPT 2. Charge Invoice or Sales Invoice. A charge invoice is a document used when a service has been rendered, but the client will be billed only after a certain number of days from the date of service. Often, a company will issue a statement of account to a customer, with the charge or sales invoice attached. For example: in a laundry business, a customer may avail of the services of the business. However, that customer and the owner of the business had a prior agreement that all services availed by the customer will be paid only after 30 days. In this case, a charge invoice is issued on the day the client availed of the services. Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 126 | 201 lOMoARcPSD|11706204 Sample Sales Invoice 3. Check or Cash Voucher. The check voucher is a document used when a check is issued to pay a certain supplier or vendor. For example, in a laundry business, for the payment of monthly electricity bills, the business may pay either in cash or check. But the company must prepare a cash or check voucher to support this payment. This document will serve as a record of payment and, at the same time, as proof that payment has been made by the company. SAMPLE CHECK VOUCHER Step 2 - Preparation of Journal Entries (journalization) Through the use of specialized journals (such as those for sales, purchases, cash receipts, and cash disbursements) and the general journal, transactions and events are entered into the accounting records. These are called the books of original entry. Debits and Credits are an integral part of the journalization process. In accounting, debits or credits are abbreviated as DR and CR respectively. Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 127 | 201 lOMoARcPSD|11706204 When to Debit and when to Credit: An increase in an asset account is called a debit and an increase in a liability or equity account is called a credit. Likewise, if we decrease an asset account we credit that account. On the other side of the equation, if we decrease a liability or equity account we debit those accounts. Rules on Debits and Credits • The name of the account to be debited is always listed first. The debited account is listed on the first line with the amount in the left side of the register. • The credited account is listed on the second line and is usually indented. The credited amount is recorded on the right side of the register. • The total amount of debit should always equal the total amount of credit. EXAMPLE: Let us take the case of Pedro Matapang, a computer technician. Pedro decided to open his computer repair shop on February 14, 2016, naming it Matapang Computer Repairs. Pedro knows that business transactions should be separated from personal finances. Thus, he decided to invest PHP200,000 in this business. He deposited the amount with Nation Bank. Entry: General Journal Account Title and Explanation Ref Date 2/14/16 Cash Matapang, Capital To record the initial investment of owner P. Matapang. Debit Credit 200,000 200,000 Notice that we have debited Cash, an asset account and credited Matapang, Capital, an equity account. February 15, 2016 – Pedro purchased one computer unit from XY Computer Store to be used for the business. He issued check number 001 amounting to PHP25,000. Entry General Journal Account Title and Explanation Date 2/14/16 Office Equipment Cash To record the purchase of one computer unit. Ref Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) Debit Credit 25,000 25,000 P a g e 128 | 201 lOMoARcPSD|11706204 Notice that the debit to office equipment increased the asset account and the credit to cash decreased the asst account. February 16, 2016- Pedro hired Juan Magaling, an experienced secretary. Entry: No entry. This is not a financial transaction. February 17, 2016 – Repaired the computer of Jean and collected PHP 10,000 General Journal Account Title and Explanation Date 2/17/16 Cash Service Revenue To record receipt of cash from customer. Ref February 18, 2016 -a Repaired Mike’s computer. PHP15,000 on March 18, 2016 Debit Credit 10,000 10,000 However, Mike will pay General Journal Account Title and Explanation Ref Date 2/18/16 Accounts Receivable Service Revenue To record service rendered to a customer on account. Debit Credit 15,000 15,000 February 19, 2016 – Pedro purchased Office Supplies form MM Merchandise amounting to PHP5,000 on account. Pedro will pay this on march 30, 2016 General Journal Account Title and Explanation Ref Date 2/19/16 Supplies Expense Accounts Payable To record purchase of office supplies on account. Debit Credit 5,000 5,000 February 25, 2016 – Paid the salary of Juana amounting to PHP4,000. General Journal Account Title and Explanation Date 2/25/16 Salaries Expense Cash To record payment of salary of Juana. Ref Debit Credit 4,000 4,000 Journal Entries in a Corporate Set-up The example above assumed that the business is a sole proprietorship. How are transactions recorded if the owner of the business is a Corporation? Basically, the Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 129 | 201 lOMoARcPSD|11706204 same entries are made, except for transactions affecting capital or equity accounts. To illustrate, let us take the following case: Sweeper Corporation was established to provide janitorial services to clients for a fee. The corporation issued 5,000 shares of common stock, at PHP100 par value to shareholders. The issue price paid by the shareholders on January 3, 2016 equal the par value. The entry to record this transaction is: General Journal Account Title and Explanation Ref Date 1/3/16 Cash Share Capital-Common To record issuance of 5,000 shares at par value of Php100 Debit Credit 500,000 500,000 In the above example, if the issue price is PHP120 per share, what is the entry? General Journal Account Title and Explanation Ref Date 1/3/16 Cash Share Capital-Common Share Premium - Common To record issuance of 5,000 shares at 120 per share, Php100 par value Debit Credit 500,000 500,000 100,000 Step 3 – Posting The summary (in specialized journals) or individual transactions (in the general journal) are then posted from the journals to the general ledger (and subsidiary ledgers). Nothing should ever get posted to the ledgers without first being entered in a journal. Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 130 | 201 lOMoARcPSD|11706204 Recall the lesson on the general ledger. We will now post the previous transactions of Pedro to the general ledger. For purposes of discussion, we will be using the three-column ledger. General Ledger Account: Date 2/14/16 2/15/16 2/17/16 2/25/16 CASH Item Investment of Owner Purchase of Computer Repair Income – Jean Payment of Juana Salary Ref Account No. 1000 Debit Credit Balance 200,00 200,000 25,000 175,000 10,000 185,000 4,000 181,000 General Ledger Account: ACCOUNTS RECEIVABLE Item Date 2/18/16 Repair Income - Mike Ref Account No. 1200 Debit Credit Balance 15,000 15,000 General Ledger Account: OFFICE EQUIPMENT Item Date 2/15/16 Purchase of Computer Ref Account No. 1600 Debit Credit Balance 25,000 25,000 General Ledger Account: ACCOUNTS PAYABLE Item Date 2/19/16 Purchase – office supplies Ref Account No. 2000 Debit Credit Balance 15,000 5,000 5,000 General Ledger Account: MATAPANG CAPITAL Item Date 2/14/16 Investment of owner Ref Debit Account No. 3000 Credit Balance 200,000 200,000 General Ledger Account: SERVICE REVENUE Item Date 2/19/16 Repair income - Jean Repair income – Mike 2/18 Ref Debit Account No. 4000 Credit Balance 10,000 10,000 15,000 25,000 General Ledger Account: SUPPLIES EXPENSE Item Date 2/19/16 Purchase – office supplies Ref Account No. 6150 Debit Credit Balance 5,000 5,000 Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 131 | 201 lOMoARcPSD|11706204 General Ledger Account: SALARIES EXPENSE Item Date 2/19/16 Payment of Juana’s salary Ref Debit 4,000 Account No. 6100 Credit Balance 4,000 Step 4 - Unadjusted Trial Balance At the end of an accounting period (for example, one month or one year) the working trial balance is prepared. This involves copying each account name and account balance to a worksheet (working trial balance). The resulting first two columns of the worksheet are called the unadjusted trial balance. In the preparation of the unadjusted trial balance, the balances in all the general ledgers at the end of the reporting date are forwarded to the appropriate column. The unadjusted trial balance for the transactions in our example from Step 3 is the following: MATAPANG COMPUTER REPAIRS Unadjusted Trial Balance February 29, 2016 Account Title Debit Credit Balance Sheet Accounts Cash 181,000 Accounts Receivable 15,000 Office Equipment 25,000 Accounts Payable 5,000 Matapang, Capital 200,000 Income State Accounts Service Revenue Supplies Expense Salaries Expense 25,000 5,000 4,000 230,000 230,000 Notice that all asset accounts are presented first, followed by liabilities, equity (or capital account), income accounts and lastly, expenses accounts. Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 132 | 201 lOMoARcPSD|11706204 Review of the Accounting Equation The basic accounting equation is what drives double-entry bookkeeping. The equation reflects the accounts reported in the balance sheet. The basic accounting equation is as follows: ASSETS = LIABILITIES + OWNERS' EQUITY This is a very simple algebraic equation that reflects how the assets of an entity must be supported by either debt or equity. As in algebra, if we add or subtract something from one side of the equation we must add or subtract the same amount from the other side. For example, if we were to increase cash (an asset) we might have to increase note payable (a liability account) so that the basic accounting equation remains in balance. ASSETS = LIABILITIES + OWNERS' EQUITY PHP 500 = PHP 500 . Applying, the formula to our transactions in Step 3 above, the effects of these transactions to the equation are shown below: Date 2/14/2016 2/15/2016 2/17/2016 2/18/2016 2/19/2016 2/25/2016 Transactions Investment of Owner, Pedro Matapang Purchase of computer Assets = +200,000 Liabilities + Equity Repair the computer of customer Jean and collected the payment Repair the computer of Mike on account Purchase of office supplies on account Payment of salary of Juana +10,000 +10,000 +15,000 +15,000 +25,000 -25,000 +5,000 -4,000 -5,000 -4,000 Notice that at all times, the effects of the transaction to the right and left side of the formula should be equal. If not, the journal entry is erroneous. Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 133 | 201 lOMoARcPSD|11706204 Practice Set 1 Mr. Laban Deyro opened his laundry business in Iloilo City on January 2, 2016. The following transactions occurred during the month of January 2016: Date 1/2/16 1/3/16 1/4/16 1/5/16 1/7/16 1/8/16 1/9/16 1/10/16 1/12/16 1/15/16 1/19/16 1/20/16 1/21/16 1/22/16 1/25/16 1/26/16 1/27/16 1/28/16 1/29/16 Transactions Invested PHP500,000 to his business. The trade name of the business was “MR. LABANDERO” Hired Allan and Allie who will manage his business Collections from various customers for the day - PHP3,000 Purchase store supplies from Labada Store - PHP10,000 Collections from various customers for the day - PHP8,000 MR. LABANDERO entered into an exclusive contract with Sikat Hotel where the business will do all the laundry of the hotel. Sikat Hotel availed the services of MR. LABANDERO amounting to PHP15,000. Payment will be made on January 20, 2016. Collections from various customers for the day - PHP12,000 Purchase a washing machine amounting to PHP50,000 Collections from various customers for the day - PHP20,000 Paid electricity bill for the month amounting to PHP18,000 Received payment from Sikat Hotel amounting to PHP15,000 Paid salaries of Allan and Allie - PHP15,000 Mr. Laban Deyro needed money for the hospitalization of his son. He withdrew PHP18,000 from the business. Paid airfare ticket of PHP1,500 for the travel of Mr. Deyro to Manila to negotiate a contract with Sosyal Hotel Paid taxes to the City of Iloilo, PHP4,000 Purchased office supplies amounting to PHP12,500 Collections from various customer for the day - PHP5,000 Sosyal Hotel availed the services of MR. LABANDERO amounting to PHP15,000 payable on Feb 25, 2016 Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 134 | 201 lOMoARcPSD|11706204 Practice Set 2 On June 1, Maya Cruz opened the Ganda Beauty Salon. During the first month, the following selected transactions occurred: 1. Deposited PHP5,000 cash in the City Bank in the name of the business 2. Paid PHP800 cash for beauty supplies 3. Purchased equipment at a cost of PHP12,000 paying PHP2,000 in cash and the balance on account 4. Received PHP1,200 cash for services rendered 5. Paid PHP500 cash as a salary to a beautician 6. Withdrew PHP400 cash for personal expenses ENRICHMENT Compound Journal Entry What has been discussed in the above illustration required the learners to prepare a simple journal entry. A simple journal entry has one account title on the debit side and one account title on the credit side. However, there are instances where in one particular transaction, two or more accounts on either the debit or credit side are affected. In this case, the business may prepare a compound journal entry. A compound journal entry combines one or more accounts on the debit side or the credit side. Required Task Using the following format, identify the effects of above transactions to the accounting equation: ASSETS = LIABILITIES + OWNERS' EQUITY Example: ASSETS = LIABILITIES + OWNERS' EQUITY +200 = + 200 . To illustrate, assume that Jose Magalang decided to open a barbershop business in Makati City. He invested his old computer and PHP25,000 for this venture with a fair value of PHP15,000 to start the business. Notice that two account titles, Office Equipment and Cash, were debited in this entry. On September 7, 2016, Jose purchased various store equipment to be used in the business. The total cost of the equipment is PHP150,000. The supplier required Jose to pay 30% as down payment, with the balance payable 30 days after. Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 135 | 201 lOMoARcPSD|11706204 Notice that you have two account titles, Cash and Accounts Payable, affected on the credit side. General Journal Account Title and Explanation Date 2/17/16 Office Equipment Cash Magalang Capital General Journal Account Title and Explanation Date 2/17/16 Store Equipment Cash Accounts payable Ref Debit Credit 15,000 25,000 40,000 Ref Debit Credit 150,000 45,000 105,000 Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 136 | 201 lOMoARcPSD|11706204 Test 1. Indicate in each independent case whether the account is to be debited (DR) or to be credited (CR) a. b. c. d. e. f. g. h. i. j. Increase in Accounts Payable Decrease in Capital account Increase in Service Revenue Increase in Cash Decrease in Accounts Receivable Increase in Salaries Expense Increase in Office Equipment Increase in unpaid Salaries Increase in Owner’s drawing account Increase in Interest Income 2. Prepare the entries to record the following independent transactions with explanations. 1. On Jan 4, 2016, received PHP20,000 from a customer in payment for services rendered. 2. Payment to X Supplier amounting to PHP4,000 for office supplies purchased on Jan 3, 2016. 3. Maria invested PHP60,000 on Jan 18, 2016 to start a barbershop in Iligan City. 4. On Jan 3, 2016 paid PHP10,000 rental amount for the month of Jan 2016,. 5. On Jan 15, 2016, Peter Pawn withdrew PHP30,000 from his business to pay for the tuition of his son. 6. Collected PHP20,000 of the accounts receivable from Malakas Company on Jan 17, 2016. 7. Paid the salary of the office secretary amounting to PHP15,000 on Jan 18, 2016. 8. Purchased office equipment worth PHP20,000 by paying 40% down payment and the balance on account. 9. Paid PHP2,000 of the accounts payable on Jan 28, 2016. 10. Rendered services to clients on Jan 18, 2016 amounting to PHP15,600. Fill up the missing amount for each. 1. Asset = 120,000 Liabilities = 15,000 Equity = ? 2. Asset = ? Liabilities = 18,250 Equity = 98,360 3. Asset = 1,000,000 Liabilities = 370,000 Equity = ? 4. Asset = 780,508 Liabilities = ? Equity = 619,000 Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 137 | 201 lOMoARcPSD|11706204 Unit 11 Business Transactions and their Analysis as applied to the accounting Cycle of a Service Business • Adjusting Entries • Adjusted Trial Balance • Preparation of Basic Financial Statements (Income Statement) The Accounting Sycle Steps 5 to 8 of the Accounting Cycle Step 5 – Worksheet This step is simply about plotting the items in the unadjusted trial balance on the worksheet. In a manual accounting system, a worksheet is a large columnar sheet of paper specifically designed to conveniently arrange all the accounting information required at the end of a period. The worksheet is used to check whether ledger accounts are balanced and adjusted. The satisfactory completion Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 138 | 201 lOMoARcPSD|11706204 of a worksheet provides assurance that all the details of the end-of-period accounting procedures were properly brought together. The worksheet serves as the source in the preparation of financial statements and other closing and adjusting entries. The body of the worksheet contains five pairs of money columns. A sample of a worksheet is shown below: Name of the Company Worksheet For the period Unadjusted (Monthly/year) ended Trial Balance _____,20__ DR CR Adjustments DR CR Adjusted Trial Balance Position DR CR Statement Statement of Income of Financial DR CR DR Statement of Financial Position Accounts Cash Accounts Receivable Inventory Office Equipment Accum Deprn - Off Eqpt Land Intangible Assets Accounts Payable Owner’s, Capital Owner’s, Withdrawal Income Statement Accounts Sales Sales Returns and Allowances Sales Discounts Interest Income Purchases Purchase Returns and Allowances Purchase Discounts Freight In Salaries Expense Supplies Expense Utilities Expense Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 139 | 201 CR lOMoARcPSD|11706204 Recall our example in Chapter 10, about Pedro Matapang who started his Matapang Computer Repairs business on February 14, 2016. The following transactions transpired in February 2016: 1. February 14, 2016 - Pedro Matapang invested PHP200,000 into his Matapang Computer Repair business. 2. February 15, 2016 - Pedro purchased one computer unit from XY Computer Store to be used for his business. He issued check number 001 amounting to PHP25,000. 3. February 16, 2016 - Pedro hired Juana Magaling, an experienced secretary. 4. February 17, 2016 – Repaired the computer of Jean and collected PHP10,000. 5. February 18, 2016 – Repaired the computer of Mike; however, Mike will pay PHP15,000 only on March 18, 2016. 6. February 19, 2016 – Pedro purchased Office Supplies from MM Merchandise amounting to PHP5,000 on account. Pedro will pay this on March 30, 2016. 7. February 25, 2016 – Paid the salary of Juana amounting to PHP4,000. The entries to record the above transactions are on the right: Date 2/14/16 2/15/16 2/17/16 2/18/16 2/19/16 2/25/16 GENERAL JOURNAL Account Title and Explanation Cash Matapang, Capital To record the initial investment of owner P. Matapang Office Equipment Cash To record the purchase of 1 computer unit Cash Service Revenue To record receipt of cash from customer Accounts Receivable Service Revenue To record services rendered to a customer on account Supplies Expense Accounts Payable To record purchase of office supplies on account Salaries Expense Cash To record payment of salary of Juana Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) Ref Debit Credit 200,000 200,000 25,000 25,000 10,000 10,000 15,000 15,000 5,000 5,000 4,000 4,000 P a g e 140 | 201 lOMoARcPSD|11706204 Recall that after posting to the general ledger, the unadjusted trial balance was: MATAPANG COMPUTER REPAIRS Unadjusted Trial Balance February 29, 2016 Account Title Balance Sheet Accounts Cash Accounts Receivable Office Equipment Accounts Payable Matapang, Capital Income State Accounts Service Revenue Supplies Expense Salaries Expense Debit Credit 181,000 15,000 25,000 5,000 200,000 25,000 5,000 4,000 230,000 230,000 This now represents the first two money columns in the worksheet. Step 6 – Adjusting Entries At the end of the accounting period, some accounts in the general ledger would require updating. The journal entries that bring the accounts up to date are called adjusting entries. One purpose of adjusting entries is for income and expenses to be reported in the correct period. Adjusting entries ensure that both the revenue recognition and matching principles are followed. Prior to your lecture, recall the previous discussion on accounting principles and concepts, specifically the matching principle. Revenue Recognition – accounting standards require that revenue is recognized when it is earned and the amount can be measured reliably. To illustrate: • Assume that you are preparing the financial statements for Feb 2016. Matapang Computer Repairs rendered services amounting to PHP25,000 for the repair of the computer units of Mr. Tamad on Feb 26, 2016. However, the payment for these services of Matapang will be made on Mar 15, 2016. Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 141 | 201 lOMoARcPSD|11706204 Question: when should you recognize the PHP25,000 as revenue or income, in February or March? Applying the revenue recognition principle, it should be reported as revenue for February 2016. • Assume that you are preparing the financial statements for February 2016. On February 28, 2016, Matapang Repairs received payment from Mr. Tamad amounting to PHP25,000. This payment is for the repair of the computer units of Mr. Tamad on March 5, 2016. Question: when should you recognize the PHP25,000 as revenue or income, in February or March? Applying the revenue recognition principle, it should be reported as revenue in March 2016. Take note that since the service will be rendered in March, the revenue should also be earned in March. What about February 2016? The amount is recorded as a liability because Matapang Repairs has the obligation to render this service in the future. Matching Principle - this principle directs a business to report an expense on its income statement within the same period as its related income. To illustrate: • Assume that you are preparing the financial statements for February 2016. The business gives a commission of 10% service income to its employees. The commission is paid the following month. On February 2016, the total service income for the month is PHP100,000. Thus, the employees are entitled to a commission of PHP10,000. This amount will be paid on March 12, 2016. Question: when should the commission expense be recorded in the book of accounts of the business, in March or in February? Applying the matching principle, the answer is in February. Adjusting entries are made at the end of each accounting period. Adjusting entries make it possible to report correct amounts on the statement of financial position and on the income statement. All adjusting entries affect at least one income statement account and one statement of financial position account. Thus, an adjusting entry will always involve an income or an expense account and an asset or a liability account. Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 142 | 201 lOMoARcPSD|11706204 There are five basic sources of adjusting entries: 1. Depreciation expense 2. Deferred expenses or prepaid expenses 3. Deferred Income or unearned income 4. Accrued expenses or accrued liabilities 5. Accrued income or accrued assets #1 Depreciation. Depreciation is a method of allocating the cost of an asset to an expense over the accounting periods that make up the asset’s useful life. Examples of assets subject to depreciation are: Store, Office, Building, and Transportation equipment. These types of assets lose their ability to provide useful service as time passes. Depreciation can also be referred to as the decrease in the usefulness of these types of assets. Take note that Land is not subject to depreciation because the value of land mostly increases as time passes. Exercise on Adjusting entries to record Depreciation Recall that Matapang acquired office equipment on February 15, 2016 for his repair shop business. The cost of the equipment is PHP25,000. It was estimated to have a useful life of five years. It is estimated that after five years, the office equipment can be sold at a scrap value of PHP1,000. The company uses the straight line method of depreciation. Depreciation is a means of allocating the cost of an asset to an expense over the accounting period that will benefit the use of the asset. In the exercise above, the equipment will be used by Matapang for five years. Proper accounting procedures dictates that the cost of PHP25,000 should be spread over five years. There are several methods or formulas to compute the amount of depreciation. The simplest is the straight line method. The formula is Annual Depreciation : ( Acquisition Cost – Salvage or Residual Value) / Useful Life. Applying this formula to the exercise: Annual Depreciation = (25,000-1,000) / 5 = PHP4,800 Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 143 | 201 lOMoARcPSD|11706204 If the accounting period being reported by Matapang is for the month ending February 29, 2016, the adjusting entry to record this depreciation in the books of Matapang is: General Journal Account Title and Explanation Ref Date 2/29/16 Depreciation Expense Accumulated Depreciation – Office Eqpt Debit Credit 200 200 The depreciation expense of PHP200 was derived by computing the monthly depreciation of PHP400 (Annual Depreciation of PHP4,800/12 months) and multiplying the PHP400 by one-half since the equipment was acquired in the middle of February. #2 Deferred Expenses or Prepaid Expenses. These are items that have been initially recorded as assets but are expected to become expenses over time or through the operations of the business. Exercise - Adjusting entries to record deferred expenses or prepaid expenses Recall that on February 19, 2016 Matapang purchased PHP5,000 worth of office supplies on account. By the end of the month, PHP2,000 worth of these supplies are still unused. The February 19, 2016 entry to record the purchase on the account of office supplies was already posted to the general ledger and included in the balances, as shown in the unadjusted trial balance above. The entry was shown only for illustration purposes. General Journal Account Title and Explanation Ref Date 2/19/16 Supplies Expense Account Payable To record the purchased of office supplies on account 2/29/16 Supplies Supplies Expense To se-up value of unused suplies Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) Debit Credit 5,000 5,000 2,000 2,000 P a g e 144 | 201 lOMoARcPSD|11706204 The “Supplies” account debited on February 29, 2016 above is an asset account and represents the value of supplies unused as of the end of February 2016. If these journal entries are posted to the general ledger, the following should be the balance of each account: Account Title Supplies Account Payable Supplies Expense Debit Credit 2,000 5,000 3,000 Notice that even with the different approaches in recording the transactions in the journal entries, the balances in the general ledger will always be the same whether you used the first approach or the second approach. #3 Deferred Income or Unearned Income. These are items that have been initially recorded as liabilities but are expected to become income over time or through the operations of the business. Exercise – Adjusting entries to record deferred or unearned income On February 15, 2016 Matapang entered into a contract with Makisig to maintain the computers of Makisig for two months starting on February 15, 2016 up to April 15, 2016. On the same date, Makisig paid the total contract amount of PHP40,000 in full. The entries to record and adjust the books are: In the February 29, 2016 entry above, as of end of February 2016, Matapang has already earned the service revenue for the first 15 days, thus an adjusting entry is recorded. Date 2/15/16 2/29/16 General Journal Account Title and Explanation Ref Cash Unearned Service Revenue To record receipt of full payment for the two-month service contract with Makisig Unearned Service Revenue Service Revenue To record service income earned from Feb 15-29, 2016; P40,000 x (1/2 month /2 months) Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) Debit Credit 40,000 40,000 10,000 10,000 P a g e 145 | 201 lOMoARcPSD|11706204 #4 Accrued Expenses or Accrued Liabilities. These are items of expenses that have been incurred but have not been recorded and paid. Exercise – Adjusting entries to record Accrued expenses or accrued liabilities On February 29, 2016, Matapang received the electric bill for the month of February amounting to PHP3,800. Matapang will pay this bill on March 2016. The electric bill represents the cost of electricity used (or incurred) for February. Although the said bill is still unpaid and thus was not recorded, the matching principle and accrual basis of accounting dictates that the same should be recorded in February. Otherwise, your expense will be understated and thus the company will be reporting an overstated income (or an erroneous income). Needless to say, erroneous information may lead to wrong decisions. The entry to record the accrual of this expense is: Date 2/29/16 General Journal Account Title and Explanation Ref Debit Credit 3,800 Utilities Expense Utilities Payable To accrue the cost of electricity incurred for the month of February. 3,800 #5 Accrued Income or Accrued Assets These are income items that have been earned but have not been recorded and paid by the customer. In short, these are receivables of the business. Exercise – Adjusting entries to record accrued income or accrued assets On February 28, 2016, Matapang repaired the computer of Pedro for PHP15,000. Pedro was on an outof- town trip so he could not pay Matapang . He told Matapang that he will pay for their services on March 1, 2016. Matapang has already earned the PHP15,000 but was not paid as of the end of February 2016. Therefore, an income should be properly recognized in February 2016 for this transaction. The entry to record this is: Date 2/29/16 General Journal Account Title and Explanation Accounts Receivable Service Income To accrue the cost of electricity incurred for the month of February. Ref Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) Debit Credit 15,000 15,000 P a g e 146 | 201 lOMoARcPSD|11706204 Enter all adjustments to the worksheet: Note: The entry to record the receipt of PHP40,000 from Makisig on February 15, 2016 was reflected in the unadjusted trial balance columns. Matapang Computer Repairs Worksheet For the month ending February Unadjusted Trial Adjustments 29, 2016 Balance DR CR DR CR Balance Sheet Accounts Cash Accounts Receivable Supplies Office Equipment Accum. Deprn-Off Eqpt Accounts Payable Utilities Payable Unearned Service Revenue Matapang, Capital Income Statement Accounts Service Revenue Supplies Expense Salaries Expense Utilities Expense Depreciation Expense 221,000 15,000 Adjusted Trial Balance Position DR CR 221,000 30,000 2,000 25,000 15,000 2,000 25,000 200 200 5,000 3,800 30,000 200,000 5,000 3,800 40,000 200,000 10,000 25,000 25,000 2,000 5,000 4,000 50,000 3,000 4,000 3,800 3,800 270,000 270,000 200 31,000 31,000 200 289,000 289,000 Step 7 - Preparation of the Financial Statements. Using the information from the worksheet, the financial statements are prepared. The following are the financial statements to be prepared: 1. Statement of Financial Position (SFP) - Also known as the balance sheet. This statement includes the amounts of the company’s total assets, liabilities and owner’s equity which in totality provides the financial position of the company on a specific date. 2. Statement of Comprehensive Income (SCI) – Also known as the income statement. Contains the results of the company’s operations for a specific period of time. This can be prepared on a monthly, quarterly or yearly basis. Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 147 | 201 lOMoARcPSD|11706204 3. Statement of Changes in Equity (SCE) - This statement is prepared prior to preparation of the Statement of Financial Position in order to obtain the ending balance of the equity to be used in the SFP. All changes, whether increases or decreases to the owner’s interest on the company during the period, are reported here. 4. Cash Flow Statement - Provides an analysis of inflows and/or outflows of cash from/to operating, investing and financing activities. The income statement is prepared first so that net income can then be recorded in the statement of changes in equity. The statement of changes in equity is then prepared to determine the ending balance of equity or capital account. Once the ending balance is determined, the statement of financial position is prepared. The cash flow statement is prepared last. Based on the worksheet on the right, the income statement of Matapang for February 2016 should appear as follows: Matapang Computer Repairs Worksheet For the month ending February 29, 2016 Balance Sheet Accounts Cash Accounts Receivable Supplies Office Equipment Accum. Deprn-Off Eqpt Accounts Payable Utilities Payable Unearned Service Revenue Matapang, Capital Income Statement Accounts Service Revenue Supplies Expense Salaries Expense Utilities Expense Depreciation Expense Adjusted Trial Balance DR CR Income Statement DR CR 221,000 15,000 2,000 25,000 200 5,000 3,800 30,000 200,000 50,000 50,000 3,000 4,000 3,800 3,000 4,000 3,800 200 200 11,000 Net Income Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) 50,000 39,000 P a g e 148 | 201 lOMoARcPSD|11706204 Matapang Computer Repairs Statement of Comprehensive Income For the month ended February 29, 2016 SERVICE REVENUE LESS: EXPENSES Supplies Expense Salaries Expense Utilities Expense Depreciation Expense Total Expenses Net Income 50,000 3,000 4,000 3,800 200 11,000 39,000 Step 8 - Journalize the Closing Journal Entries The income, expense, withdrawal (equity) accounts are called temporary accounts or nominal accounts. They are called temporary because they accumulate the transactions of only one accounting period. At the end of this accounting period, the changes in owner’s equity accumulated in these temporary accounts are transferred into the owner’s capital account. This process serves two purposes: (1) to update the balance of the owner’s capital; and (2) it returns the balance of the temporary accounts to zero, so that they are ready to measure the income, expenses and drawings of the next accounting period again. The owner’s capital account and other statement of financial position accounts are referred to as permanent or real accounts because their balances continue to exist beyond the current accounting period. Closing the books is the process of transferring the balances of the temporary accounts to the owner’s permanent capital account. The closing journal entries should consist of the following: • All of the nominal revenue accounts should be closed to the income summary account by a Debit to revenue and a Credit to income summary. • All of the nominal expense accounts should be closed to the income summary by a Credit to expense and a Debit to income summary. • The balance in the income summary account should now reflect the net income for the accounting period. The next journal entry should close the income summary account to the equity or capital account. If there is a net profit this entry will be a Debit to income summary and a Credit to owner’s capital account. • Once the closing journal entries have been entered into the general journal, the information should be posted to the general ledger. When this is accomplished, all of the nominal accounts in the general ledger should have zero balances. To double check on this, we should prepare another trial balance based on the new Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 149 | 201 lOMoARcPSD|11706204 balances in the general ledger. If we have any nominal accounts with positive balances, a mistake was made along the way and will need to be corrected before proceeding to the next accounting period. To illustrate: General Journal Date Account Title and Explanation 2/29/16 Service Revenue Income Summary To close nominal revenue accounts Ref Debit Credit 50,000 50,000 Income Summary Supplies Expense Salaries Expense Utilities Expense Depreciation Expense 11,000 3,000 4,000 3,800 200 After the above entries, the balance for these accounts are: Supplies Expense DR CR 3,000 3,000 0 Salaries Expense DR CR 4,000 4,000 0 Utilities Expense DR CR 3,800 3,800 0 Depreciation Expense DR CR 200 200 0 Revenue Accounts DR CR 50,000 50,000 0 Income Summary DR CR 11,000 50,000 39,000 Notice that the ending balance of the Income Summary Account amounting to PHP39,000 credit represents the net income for the period of Matapang. The balance of the Income Summary Account is then closed to the Capital Account by this entry: Date General Journal Account Title and Explanation Income Summary 39,000 Matapang, Capital Ref Debit Credit 39,000 39,000 PRACTICE: Exercise 1 Spencer Company has a fiscal year-end of June 30th. The following adjusting journal entries must be prepared in order to bring the accounting records up to date for the preparation of year-end financial statements. Interest on notes payable of PHP400 is accrued. Fees earned but unbilled total PHP1,400. Salaries earned by employees of PHP700 have not been recorded. Bad debt expense for year is PHP900. Each adjustment is journalized (using general journal format) as follows: Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 150 | 201 lOMoARcPSD|11706204 Date 6/30/016 6/30/16 6/30/16 6/30/16 General Journal Account Title and Explanation Ref Interest expense Interest payable To accrue interest on note payable through June 30, 2016 Accounts receivable Service revenue To record service revenue for services unbilled at year-end Salaries expense Salaries payable To accrue salaries through June 30, 2016. Bad debt expense Allowance for doubtful accounts To record bad debt expense for the year-ended June 30, 2016. Debit Credit PHP400 PHP400 PHP1,400 PHP1,400 PHP700 PHP700 PHP900 PHP900 Exercise 2 (Depreciation) Compute the depreciation expense for the following independent cases. Use the straight line method of depreciation. 1. Pedro Reyes purchased a delivery vehicle on January 1, 2016 amounting to PHP250,000. It is estimated that the vehicle will be useful for 10 years. The vehicle can be sold for PHP10,000 at the end of its useful life. If the accounting period being reported by Pedro is one (1) year from January – December 2016, how much is the depreciation expense? Solution: Annual Depreciation = (Acquisition Cost – Salvage or Residual Value) / Useful Life Annual Depreciation = (250,000 -10,000) / 10 Answer = PHP24,000 2. Pedro Reyes purchased a delivery vehicle on April 1, 2016 amounting to PHP250,000. It is estimated that the vehicle will be useful for 10 years. The vehicle can be sold for PHP10,000 at the end of its useful life. If the accounting period being reported by Pedro is one (1) year from January-December 2016, how much is the depreciation expense? Solution: Annual Depreciation = (Acquisition Cost – Salvage or Residual Value) / Useful Life Annual Depreciation = (250,000 -10,000) / 10 Annual Depreciation = PHP 24,000 Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 151 | 201 lOMoARcPSD|11706204 Multiply the Annual Depreciation of PHP24,000 to the number of months in used/12, thus 24,000 x (9/12) Where the ‘9’ represents the number of month from April to December. Answer = PHP18,000 3. Pedro Reyes purchased a delivery vehicle on January 1, 2016 amounting to PHP250,000. It is estimated that the vehicle will be useful for 10 years. The vehicle can be sold for PHP10,000 at the end of its useful life. If the accounting period being reported by Pedro is one (1) month (January 2016), how much is the depreciation expense for the month? Solution: Annual Depreciation = (Acquisition Cost – Salvage or Residual Value) / Useful Life Annual Depreciation = (250,000 -10,000) / 10 = P24,000 Answer = PHP24,000 / 12 = PHP2,000 for January 2016 Exercise 3 For each of the following items, write the journal entry first (if one is needed) to record the transactions; and then the adjusting entry, if any is required, for the end of the accounting year of Ron Car Rental Company on December 31, 2016. 1. On December 1, borrowed PHP300,000 cash from Nation Bank by issuing a promissory note with an interest of 12% per annum payable in three months. Answer: Journal Entry Adjusting Entry Cash 300,000 Interest Expense 3,000 Notes Payable 300,000 Interest Payable (or Accrued 3,000 Expense) Computed as: PHP300,000 x 12% x (1/12) Hint: when a promissory note is issued Hint: the formula to compute interest to support a is Principal x Interest Rate x Time borrowing, the note payable account is used. In the above situation, the amount of interest to be accrued on December 31 is good for one month only (covering Dec 1 to Dec 31, 2016) Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 152 | 201 lOMoARcPSD|11706204 2. On December 1, paid rental for six months beginning December 1, 2016 to May 31, 2017, at PHP3,000 per month. Answer: Journal Entry Rental Expense Cash Adjusting Entry 18,000 Interest Expense 15,000 18,000 Interest Payable (or Accrued 15,000 Expense) Computed as: PHP300,000 x 12% x (1/12) Hint: the amount of advance rental paid Hint: the amount of prepaid expenses is was for six the 5 month rental after December 31, month (P3,000/month x 6 months) 2016 (that is from January 2017 to May 2017), thus P3,000 per month x 5 months is P15,000. The PHP15,000 becomes an asset of the company as of December 31, 2016 but will be expensed the following accounting year. 3. On December 31, 2016, received telephone bills for the month December amounting to PHP5,600. The bill will be paid on January 2017. Answer: Adjusting Entry Utilities Expense Utilities Expense 15,000 15,000 Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 153 | 201 lOMoARcPSD|11706204 ENRICHMENT Kay Travel was organized on September 1, 2016. Assume that the accounts are closed and financial statements are prepared each month. The company occupies rented office space but owns office equipment estimated to have a useful life of 10 years from date of acquisition, September 1, 2016. The unadjusted trial balance for Kay at November 30, 2016 is shown below: Account Title and Explanation Unadjusted Trial Balance Debit Credit Cash Accounts Receivable Office Equipment Accum. Deprn-Off Eqpt Accounts Payable Kay, Capital Kay, Withdrawal Service Revenue Advertising Expense Salaries Expense Rent Expense 1,750 1,210 4,800 80 1,640 7,490 500 4,220 800 3,600 770 13,430 13,430 Additional Information: The rent expense amounting to PHP770 covers rental for the month of November and December 2016 Instructions: 1. Prepare the adjusting entries necessary for the above problem 2. Prepare an adjusted trial balance 3. Prepare an income statement ending November 30, 2016 4. Prepare closing entries Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 154 | 201 lOMoARcPSD|11706204 Solution: Adjusting Entries Date General Journal Account Title and Explanation Prepaid Expenses Rental Expense Depreciation Expense Accumulated Deprn – Office Eqpt Statement of Comprehensive Income: KAY TRAVEL Statement of Comprehensive Income For the month ended November 30, 2016 SERVICE REVENUE 4,220 LESS: EXPENSES Advertising Expense 800 Salaries Expense 3,600 Rental Expense 385 Depreciation Expense 40 Total Expenses 4,825 NET LOSS (605) Ref Debit Credit 385 385 40 40 Adjusted Trial Balance: Account Title Cash Accounts Receivable Prepaid Expenses Office Equipment Accum. Deprn-Off Eqpt Accounts Payable Kay, Capital Kay, Withdrawal Service Revenue Advertising Expense Salaries Expense Rent Expense Depreciation Expense Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) Adjusted Trial Balance Debit Credit 1,750 1,210 385 4,800 120 1,640 7,490 500 4,220 800 3,600 385 40 13,470 13,470 P a g e 155 | 201 lOMoARcPSD|11706204 Closing Entries Date 2/29/16 General Journal Account Title and Explanation Ref Debit Service Revenue Income Summary To close nominal revenue accounts Income Summary Advertising Expense Salaries Expense Rental Expense Depreciation Expense To close the expense accounts Kay, Capital Kay, Withdrawal To close the withdrawal account Kay, Capital Income Summary To close the income summary account Credit 4,220 4,220 4,825 800 3,600 385 40 500 500 605 605 EVALUATION Problem 1. Evergreen Laundry carried out the following transactions during May. Which of these transactions represented expenses in May? Explain. 1. Paid an attorney PHP500 for legal services rendered in April. Answer: This is an April expense because it was incurred in April although payment was made in May. 2. The owner withdrew PHP1,600 from the business for personal use. Answer: Not an expense. This should be recorded as a withdrawal made by the owner. Owner’s withdrawals are considered separate from the transactions of the business. The learner may use the business entity principle as reason. 3. Purchased a copying machine for PHP25,000 cash. The machine has a useful life of 25 months. Answer: Part of the cost of the machine is an expense for May (depreciation) of PHP25,000/25 months which is PHP1,000 per month. The machine will benefit more than one accounting period. 4. Paid PHP450 gasoline for the delivery truck used in business during May. Answer: This is a May expense incurred during the month. 5. Paid salaries of employees for time worked during May - PHP3,000. Answer: An expense of May incurred during the month. Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 156 | 201 lOMoARcPSD|11706204 Problem 2. On April 1, 2016, Mar Cruz, a lawyer, opened his own legal practice. The business adjusts and closes its accounts at the end of each month. The following trial balance was prepared after one month of operations. More information: No interest has yet been paid on the note payable. Accrued interest at April 30 amounts to PHP200. Salaries earned by the office staff but not yet recorded or paid amounted to PHP970 by April 30. Many clients are asked to make advance payment for legal services to be rendered in future months. These advances are credited to the Unearned Service Revenue account once received. During April, PHP5,020 of these advances were earned by the business. Office supplies on hand by April 30 amounted to PHP400. The office equipment was purchased on April 1 and is being depreciated over an estimated useful life of 10 years with no residual value. Instructions: 1. Prepare the adjusting entries for April 30. 2. Prepare a statement of income for April 2016. Account Title and Explanation Cash Accounts Receivable Prepaid Expenses Supplies Office Equipment Accum. Deprn-Off Eqpt Notes Payable Interest Payable Unearned Service Revenue Cruz, Capital Cruz, Withdrawal Service Revenue Supplies Expense Salaries Expense Unadjusted Trial Balance Debit Credit 10,060 0 7,800 1,460 26,400 0 16,000 Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) 15,020 20,000 3000 1,580 2,680 1,200 52,600 52,600 P a g e 157 | 201 lOMoARcPSD|11706204 Suggested solution: Date 2/29/16 General Journal Account Title and Explanation Interest Expense Accrued Expense (Interest Payable) Salaries Expense Salaries Payable Unearned Service Revenue Service Revenue Supplies Supplies Expense Depreciation Expense Accum Deprn – Office Eqpt Ref Debit Credit 200 200 970 970 5,020 5,020 400 400 220 220 LAW OFFICE OF MAR CRUZ Statement of Comprehensive Income For the month ended April 30, 2016 SERVICE REVENUE 6,600 LESS: EXPENSES Supplies Expense 2,420 Salaries Expense 2,170 Interest Expense 200 Depreciation Expense 220 Total Expenses 5,010 NET INCOME Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) 6,600 2,420 2,170 200 220 5,010 1,590 P a g e 158 | 201 lOMoARcPSD|11706204 Unit 12 Accounting Cycle of a Merchandising Business Transactions in a merchandising business. Possible answers: • buying of stocks or items for resale • payment of expenses related to operations • purchase of equipment • obtaining a loan to finance the business • investment of owners Merchandising business in their community. Possible answers: • supermarkets • pharmacies • grocery stores . Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 159 | 201 lOMoARcPSD|11706204 Nature and examples of merchandising company. A merchandising company is an enterprise that buys and sells goods to earn a profit. Examples of merchandising businesses: • Mercury Drug • Puregold • ACE Hardware • grocery stores Merchandise (or merchandise inventory) refers to goods that are held for sale to customers in the normal course of business. This includes goods held for resale. For example: • Candies, canned goods, noodles sold at a grocery store • Juice, biscuits sold in a grocery store • Medicines sold in a pharmacy If a grocery store decided to sell an old computer used in the office, this would not be merchandise because grocery stores do not normally sell computers and the store is simply selling off old office equipment. But a computer would be merchandise for a computer store who resells computer units. Merchandise for one firm may be a fixed asset (or property and equipment) for another. In another example, a pharmacy decided to sell a table used in their display area. This table is not merchandise of a pharmacy. However, to a retail furniture store a table is merchandise because the business of a furniture store involves the buying and selling of tables. A merchandiser’s primary source of revenue is sales revenue or sales. Expenses for a merchandising company are divided into two categories: 1. Cost of goods sold (COGS) – the total cost of merchandise sold during the period; and 2. Operating expenses (OP) - expenses incurred in the process of earning sales revenue that are deducted from gross profit in the income statement. Examples are sales salaries and insurance expenses. Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 160 | 201 lOMoARcPSD|11706204 Gross profit (GP) is equal to Sales Revenue less the Cost of Goods Sold. Income measurement process for a merchandiser follows as: Sales - COGS = Gross Profit - Operating Exp = Net Income (Loss) The Operating Cycles for a merchandiser: Merchandising Company operating cycle (cash to cash) involves: 1. buy merchandise inventory 2. sell inventory 3. obtain Accounts Receivable 4. receive cash JOURNALIZING THE TRANSACTIONS IN A MERCHANDISING BUSINESS Prior to the discussion on the journal entries, recall the first step in the accounting cycle discussed in previous chapters on financial and non-financial transactions. In step 1, transactions are identified and measured. At this stage, the documents used by the business are analyzed to see whether these transactions have financial impact or effect. Recall the rule that only financial transactions are recorded and that the amount can be measured. These two conditions must exist in order for a particular transaction to be recognized or recorded. As defined, financial transactions are those activities that change the value of an asset, liability or equity. Step 2 is the Preparation of Journal Entries (Journalization) A merchandising company may use special and general journals to record its transactions. SPECIAL JOURNALS Some businesses encounter voluminous quantities of similar and recurring transactions, which may create congestion if these transactions are recorded repeatedly in a single day or monthly in the general journal. The use of special journals will eliminate this problem. The following are the commonly used special journals: 1. Cash Receipts Journal –used to record all cash that had been received 2. Cash Disbursements Journal –used to record all transactions involving cash payments 3. Sales Journal (Sales on Account Journal) –used to record all sales on credit (on account) Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 161 | 201 lOMoARcPSD|11706204 4. Purchase Journal (Purchase on Account Journal) –used to record all purchases of inventory on credit (or on account) INVENTORY SYSTEMS Maintaining inventory items is a unique set-up in a merchandising business. There are two methods of accounting for inventory, namely: Perpetual Inventory System and Periodic Inventory System. Merchandising entities may use either of the following inventory systems: 1. Perpetual System — Detailed records of the cost of each item are maintained, and the cost of each item sold is determined from records when the sale occurs. For example, a car dealership has separate inventory records for each vehicle. • Record purchase of Inventory. • Record revenue and record cost of goods sold when the item is sold. • At the end of the period, no entry is needed except to adjust inventory for losses, etc. 3. Periodic System — Cost of goods sold is determined only at the end of an accounting period. This system involves: 4. • Record purchase of Inventory. • Record revenue only when the item is sold. • At the end of the period, you must compute cost of goods sold (COGS): 1. Determine the cost of goods on hand at the beginning of the accounting period (Beginning Inventory = BI), 2. Add it to the cost of goods purchased (COGP), 3. Subtract the cost of goods on hand at the end of the accounting period 4. (Ending Inventory = EI) illustrated as follows: Sales - COGS = Gross Profit - Operating Exp = Net Income (Loss) Additional Considerations: • Perpetual systems have traditionally been used by companies that sell merchandise with high unit values such as automobiles, furniture, and major home appliances. With the use of computers and scanners, many companies now use the perpetual inventory system. • The perpetual inventory system is named because the accounting records continuously — perpetually —show the quantity and cost of the inventory that Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 162 | 201 lOMoARcPSD|11706204 should be on hand at any time. The periodic system only periodically updates the cost of inventory on hand. • A perpetual inventory system provides better control over inventories than a periodic inventory, since the records always show the quantity that should be on hand. Then, any shortages from the actual quantity and what the records show can be investigated immediately. Note: The periodic inventory system will be used in all illustrations of this chapter while the perpetual system will be included in the “enrichment” portion of this guide. PERIODIC INVENTORY SYSTEM Recording purchases and related transactions under the Periodic Inventory System PURCHASES OF MERCHANDISE: PERIODIC SYSTEM 1. When merchandise is purchased for resale to customers, the account, Purchases, is debited for the cost of goods purchased. 2. Like sales, purchases may be made for cash or on account (credit). 3. The purchase is normally recorded by the purchaser when the goods are received from the seller. • • • Each credit purchase should be supported by a purchase invoice. A purchase invoice received by the buyer is actually a sales invoice or a charge invoice prepared by the supplier or vendor. Note that only purchases of merchandise are debited to the ‘Purchase’ account. Acquisition (purchases) of other assets: supplies, equipment, and similar items are debited to their respective accounts. TO ILLUSTRATE: Magaling Computer Store started its operations on January 2, 2016. The store is located in Sikat Mall in Bicol. The owner invested PHP500,000 to start the business. On January 3, 2016, Magaling purchased 20 units of computers on account for PHP10,000 each. Upon delivery of the units, the supplier, Delta, Inc., issued Charge Invoice No. 145 to Magaling. Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 163 | 201 lOMoARcPSD|11706204 Entry Date 1/3/16 General Journal Account Title and Explanation Ref Debit Purchases Accounts Payable To record purchase of 20 units of computers at PHP10,000 per unit from Delta, Inc. as per Charge Invoice 145. Credit 200,000 200,000 PURCHASE RETURNS AND ALLOWANCES • A purchaser may find the merchandise received to be unsatisfactory because the goods are: • damaged or defective • of inferior quality • not in accord with the purchaser’s specifications • The purchaser initiates the request for a reduction of the balance due through the issuance of a debit memorandum. The debit memorandum is a document issued by a buyer to inform a seller that the seller’s account has been debited because of unsatisfactory goods. • A return of the merchandise (a deduction from the purchase price when unsatisfactory goods are kept) is shown by the entry where Accounts Payable is debited and Purchase Returns and Allowances is credited to show that the purchases was reduced with a return or an allowance. • The Purchase Returns and Allowances account is a “contra purchases” account when merchandise is returned to a supplier. TO ILLUSTRATE: Out of the 20 computer units purchased last January 3, 2016, it was found after inspection on the same day that one unit was damaged during shipment. Magaling issued a debit memorandum (DM 01) and informed the supplier that it will return the one damaged item. Entry: Date 1/3/16 General Journal Account Title and Explanation Ref Debit Accounts Payable Purchase Returns and Allowances To record return of 1 unit of computers worth PhP10,000 from Delta, Inc. as per DM 01 Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) Credit 10,000 10,000 P a g e 164 | 201 lOMoARcPSD|11706204 ACCOUNTING FOR FREIGHT COSTS The sales agreement should indicate whether the seller or the buyer is to pay the cost of transporting the goods to the buyer’s place of business. The two most common arrangements for freight costs are FOB SHIPPING POINT AND FOB DESTINATION. FOB Shipping Point: • • • • • Goods placed free on board (FOB) the carrier by seller. Buyer pays freight costs. Freight-In is debited if buyer pays freight. Cash is credited if the goods come on cash on delivery (COD), for example, and was paid immediately. Accounts Payable would be credited if on account. Ownership over the goods is transferred to the buyer once it is out of the premises of the seller. FOB Destination • Goods placed free on board (FOB) at buyer’s business. • Seller pays freight costs. • Delivery Expense is debited if seller pays freight on outgoing merchandise to a buyer. This is an operating expense to the seller. • Ownership over the goods is transferred to the buyer once the goods are delivered and received by the buyer. TO ILLUSTRATE: Assume the supplier of Magaling is based in Manila. In order to bring the 20 computer units to Bicol, it will cost PHP3,000 to deliver the goods. If the terms is FOB Shipping Point, the entry to record, assuming Magaling paid the common carrier in cash on January 4, 2016 is : Entry: Date 1/4/16 General Journal Account Title and Explanation Ref Debit Freight-In Cash To record freight costs for the purchase of 20 units of computers Credit 3,000 3,000 If the terms is FOB Destination, no entry is recorded in the books of Magaling. The PHP3,000 will be paid by the seller, in this case Delta, Inc. Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 165 | 201 lOMoARcPSD|11706204 PURCHASE DISCOUNTS: • • • Credit terms (specify the amount of cash discount and time period during which a discount is offered) may permit the buyer to claim a cash discount for the prompt payment of a balance due. If the credit terms show 2/10, n/30 means a 2% discount is given if paid within 10 days (called the discount period); otherwise, the invoice is due in 30 days. The buyer calls this discount a purchase discount. A purchase discount is normally based on the invoice cost less returns and allowances, if any. TO ILLUSTRATE The credit terms for the purchase of 20 computer units (total cost PHP200,000) is 2/10, n/30. This means that if Magaling pays on or before January 13, 2016, it is entitled to a 2% discount, otherwise Magaling will have to pay the full amount on or before February 4, 2016 (30 days after purchase). On January 10, 2016, Magaling paid the account in full with Delta. Entry: Date 1/10/16 General Journal Account Title and Explanation Ref Debit Accounts Payable Purchase Discount Cash To record full payment of Delta, Charge Invoice No. 145 with 2% discount computed as PhP200,000 x 2 Credit 200,000 4,000 196,000 Assuming that instead of paying on January 10, 2016, Magaling paid on February 4, 2016, thus forfeiting the 2% discount, the entry to record is: Date 1/4/16 General Journal Account Title and Explanation Ref Debit Accounts Payable Purchase Discount To record full payment of Delta, Charge Invoice No. 145 Credit 200,000 4,000 196,000 Recording of sales and related transactions under the Periodic Inventory System SALES TRANSACTIONS: REVENUE ENTRIES FOR A MERCHANDISER • Revenues are reported when earned in accordance with the revenue recognition principle, and in a merchandising company, revenues are earned when the goods are transferred from seller to buyer. Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 166 | 201 lOMoARcPSD|11706204 • All sales should be supported by a document such as a cash register tape (to provide evidence of cash sales) or cash receipt, or office receipt for cash sales, and charge invoice for credit sales, or sales on account. • One entry is made with each sale: Debit — Accounts Receivable (if a credit sale) or Cash (if a cash sale) which increases assets for the sales amount Credit — Sales which increases revenues • The sales account is credited only for sales of goods held for resale. Sales of assets not held for resale (such as equipment, buildings, land, etc.) are credited directly to the asset account. TO ILLUSTRATE : For the month of January, Magaling made the following sale: 1/10/2016 Official Receipt (OR) No. 001 Sold two units for cash to Marie Cruz for PHP36,000 (PHP18,000 per unit), FOB Destination 1/15/2016 Charge Invoice (ChI) No. 001 Sold five units on account to Rafael Reyes for PHP97,500 (PHP19,500 per unit) with terms 3/10, n/ 30, FOB Shipping Point Entry: Date General Journal Account Title and Explanation 1/10/16 Cash Ref Debit Credit 36,000 Sales To record OR No. 001 cash sale - Marie Cruz Date 1/15/16 General Journal Account Title and Explanation 36,000 Ref Debit Accounts Receivable Sales To record Charge Invoice No. 001 Rafael Reyes on account with terms 3/10, n/30 Credit 97,500 97,500 FREIGHT TERMS: FOB DESTINATION — SELLER PAYS FREIGHT • An entry is made when seller pays the freight to deliver goods to a customer or buyer. If the buyer will pay for the freight, no entry is made. • Debit — Delivery Expense and credit — Cash or Accounts Payable Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 167 | 201 lOMoARcPSD|11706204 TO ILLUSTRATE: On January 10, 2016 Magaling paid MM Express, PHP500 to deliver the two units to Marie Cruz. Date 1/10/16 General Journal Account Title and Explanation Ref Debit Delivery Expense Cash To record full payment of Delta Charge Invoice No. 145 Credit 500 500 Take note that no entry will be made regarding the sale to Rafael Reyes since the term is FOB Shipping Point. SALES RETURNS AND ALLOWANCES: • Sales Returns result when customers are dissatisfied with merchandise and are allowed to return the goods to the seller for credit or a refund. • Sales Allowances result when customers are dissatisfied, and the seller allows a deduction from the selling price. • To grant the return or allowance, the seller prepares a credit memorandum to inform the customer that a credit has been made to the customer’s account receivable. • Sales Returns and Allowances is a contra revenue account to the Sales account. A contra account is a reduction to a particular account. • A contra account is used, instead of debiting sales, to disclose the amount of sales returns and allowances in the accounts. • This information is important to management as excessive returns and allowances suggest inferior merchandise, inefficiencies in filling orders, errors in billing customers, and mistakes in delivery or shipment of goods. • The normal balance of Sales Returns and Allowances is a debit. • One entry is made with each sales return and allowance: The entry to record the sales return or allowance: • Debit — Sales Return and Allowances which decreases revenues for the amount of the sale • Credit — Accounts Receivable (if a credit sale) or Cash (if a cash sale) which decreases assets Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 168 | 201 lOMoARcPSD|11706204 TO ILLUSTRATE: On January 16, 2016, Rafael Reyes returned one unit of the computers purchased last January 15, 2016 under Charge Invoice 001. The unit returned was in good condition. However, Rafael Reyes returned the unit because it is one unit more than what they need. The return was approved and accepted by Magaling. The price will be deducted from the account of Rafael Reyes. Entry: Date 1/10/16 General Journal Account Title and Explanation Ref Debit Sales Return & Allowances Accounts Receivable To record return of one unit of computers from Rafael Reyes under Charge Invoice 001 Credit 19,500 19,500 SALES DISCOUNTS 1. A sales discount is the offer of a cash discount to encourage customers to pay the balance at an earlier date. 2. An example of a discount term is commonly expressed as: 2/10, n/30, which means that the customer is given 2% discount if payment is made within 10 days. After 10 days there is no discount, and the balance is due in 30 days. 3. Sales Discounts is a contra revenue account with a normal debit balance. Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 169 | 201 lOMoARcPSD|11706204 TO ILLUSTRATE: Assume that Magaling purchased on cash, five units of computers at PHP10,000 per unit from a supplier on January 17, 2016. These units were subsequently sold to Jun Cruz on January 18, 2016 under Charge Invoice (ChI) No. 002 amounting to PHP90,000 (PHP18,000 per unit) with terms 2/10, n/30, FOB Shipping Point. On January 23, 2016, Cruz paid the said account in full. Date 1/17/16 1/18/16 1/23/16 General Journal Account Title and Explanation Ref Debit Purchases Cash To record purchased on cash five units of computers Accounts Receivable Sales To record sales on account under Charge Invoice No. 002 to Jun Cruz with terms 2/10, n/30 Cash Sales Discount Accounts Receivable To record collection of accounts receivable from Jun Cruz net of 2% sales discount Credit 50,000 50,000 90,000 90,000 88,200 1,800 90,000 Notice in the entry on January 23, 2016 that the cash received from Jun Cruz was net of the 2% discount because he made the payment within the discount period. Take note that the discount period in this case was from January 19, 2016 to January 28, 2016 (10 days). What If Jun Cruz paid the account on January 30, 2016 instead of January 23, 2016? The entry would be: Date 1/30/16 General Journal Account Title and Explanation Ref Debit Cash Accounts Receivable To record collection of accounts receivable from Jun Cruz Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) Credit 90,000 90,000 P a g e 170 | 201 lOMoARcPSD|11706204 Determining Cost of Goods Sold under Periodic Inventory System The Cost of Goods Sold under the periodic inventory system is determined at the end of the period (monthly or yearly) by a short computation, as follows: Cost of goods sold: Merchandise Inventory, Beginning Purchases Less: Purchases returns and allowances Purchases discounts Net purchases Add: Freight in Cost of goods purchased Cost of goods available for sale Merchandise Inventory, Ending Cost of goods sold Cost of goods sold: 100,000 250,000 5,000 2,000 7,000 243,000 6,000 249,000 349,000 118,570 230,250 In a periodic inventory system, separate ledger accounts are maintained for various items composing the cost of goods sold (Purchases, Purchase Returns & Allowances, Freight-In, Purchase Discounts). At the end of the accounting period, a physical count of inventory is necessary to establish the ending balance of the inventory. PRACTICE COMPLETE ACCOUNTING CYCLE FOR A MERCHANDISING BUSINESS Agila Merchandising, owned by Lito Agila, sells ready-to-wear shirts and dresses to its customers. It started its operations on January 1, 2016. The company issues the following documents : • Official Receipts - for all cash collections • Charge Sales Invoice – for all sales on account • Check Voucher – for all cash disbursements Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 171 | 201 lOMoARcPSD|11706204 Step 1 & 2 –Understanding and Journalizing the transactions For the month of January 2016, the special journals of Agila are shown below: Sales Journal Date DESCRIPTION Charge Invoice or Debit Credit (CUSTOMER Sales Invoice Accounts Sales NAME) No. Receivable 1/5/2016 Dax 1 2,102 2,102 1/7/2016 Marie 2 3,060 3,060 1/9/2016 Astro 3 1,475 1,475 CANCELLED 4 1/11/2016 PNSC 5 8,960 8,960 1/15/2016 PECO 6 7,125 7,125 1/16/2016 Ipedcare 7 4,560 4,560 1/19/2016 Te 8 1,250 1,250 1/21/2016 Joshua 3,125 3,125 9 1/22/2016 Joseph 4,510 4,510 10 1/24/2016 Jesper 2,080 2,080 11 1/28/2016 Nelcie 1,180 1,180 12 1/29/2016 Ryan 900 900 13 1/30/2016 Arlen 3,450 3,450 14 1/30/2016 Art 3,125 3,125 15 Total for January 2016 Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) 45,255 45,255 P a g e 172 | 201 lOMoARcPSD|11706204 CASH RECEIPTJOURNAL Date 1/2/2016 1/4/2016 1/6/2016 1/7/2016 1/7/2016 1/8/2016 1/8/2016 1/10/2016 1/15/2016 1/16/2016 1/17/2016 1/21/2016 1/22/2016 1/23/2016 1/24/2016 1/24/2016 1/25/2016 1/29/2016 1/30/2016 Description (Particulars) Ana Maria Peter Jun Karen Jane May April PNSC Ana Juan Rafael Ray Te Geo Dax Angela Clyde Joseph Total Official Receipt No. 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 Date Account Title and Explanation 1/2/2016 1/10/2016 1/29/2016 XYS Clothing RTW Super Store Dresses Unlimited Total Debit Credit Credit Debit Cash Sales Account Receivable Sales Discount 1,000 1,890 1,289 3,456 1,290 3,876 4,561 5,600 1,000 1,890 1,289 3,456 1,290 3,876 4,561 5,600 8,060 8,060 4,245 2,010 3,410 893 1,250 3,452 2,102 1,000 345 4,000 53,719 2,010 3,410 893 1,250 3,452 2,102 1,000 345 4,510 16,822 38,307 Purchase Journal Ref Charge Invoice or Debit Sales Invoice No. (from supplier) SI 102 SI611 SI341 SI 102 SI611 SI341 Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) 228,560 133,070 98,120 459,750 510 1,410 Credit 228,560 133,070 98,120 459,750 P a g e 173 | 201 lOMoARcPSD|11706204 CASH DISBURSEMENTS JOURNAL Date 1/2/16 1/5/16 1/15/16 1/16/16 1/16/16 1/25/16 Description (Particulars) Check or Voucher Number St Realty Rental for Jan-Feb 2016 Del Suppliesoffice supplies XYS Clothingpayment of account Jean Guzmansalary Jan 115, 2016 Sonic PromoAdvertising Goldmic Supplies TOTAL CV01 10,000 CV02 3,500 CV03 220,000 CV04 7,500 CV05 4,800 CV06 1,990 Cash 254,290 Accounts Payable Debit Salaries Exp Debit Supplies Exp Debit Advertising Exp Debit Rental Exp Credit Ruch Disct 10,000 3,500 228,560 8,560 7,500 4,800 1,990 228,560 14,000 5,490 4,800 10,000 8,560 In addition to the above special journals, the company maintains a general journal. The General Journal had the following entries for January Date 1/2/16 1/2/16 General Journal Account Title and Explanation Ref Debit Cash Credit 500,000 Agila, Capital To record initial investment of Agila Transportation equipment 500,000 Additional Information: • The delivery vehicle purchased in January 2, 2016 is estimated to be useful for 10 years with no residual or salvage value. • A physical count of merchandise inventory was conducted on January 30, 2016. The cost of the inventory on hand was PHP438,700. • On January 30, 2016, Agila received a statement of account from Gus Oil Center reflecting a total bill of PHP2,180, representing fuel purchases on January 2016 that were still unpaid as of the said date. Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 174 | 201 lOMoARcPSD|11706204 Step 3 – Posting to the General Ledger. From the summary of transactions in the special journals and general journals, the entries will now be posted in each general ledger account: General Ledger Account: CASH Date Item 1/2/16 Investment of owner Purchase of Vehicle From the Cash receipts Journal From the Cash Disbursement Journal Ref Account No. 1000 Debit Credit Balance 500,000 500,000 150,000 350,000 53,719 403,719 254,290 149,429 General Ledger Account: ACCOUNT RECEIVABLE Date Item From the Sales Journal From the Cash Receipts Journal Ref General Ledger Account: AGILA, CAPITAL Date Item Ref Initial Investment – Gen Journal Debit 45,255 Account No. 1200 Credit Balance 45,255 16,822 28,433 Debit Account No. 3000 Credit Balance 500,000 (500,000) General Ledger Account: SALES Date Item From the Sales Journal From the Cash Receipts Journal Ref Debit Account No. 4100 Credit Balance 45,255 (45,255) 38,307 (83,562) General Ledger Account: SALES Discounts Date Item From the Cash Receipts Journal Ref General Ledger Account: Purchases Date Item Ref From the Cash Receipts Journal Account No. 4100 Debit Credit Balance 1,410 1,410 Account No. 100 Debit Credit Balance 459,750 459,750 General Ledger Account: PURCHASE DISCOUNT Date Item From the Cash Disbursement Journal Ref Debit Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) Account No. 5102 Credit Balance 8,560 (8,560) P a g e 175 | 201 lOMoARcPSD|11706204 General Ledger Account: SALARIES EXPENSE Date Item From the Cash Disbursement Journal Ref Account No. 6100 Debit Credit Balance 14,000 14,000 General Ledger Account: SUPPLIES EXPENSE Date Item From the Cash Disbursement Journal Ref General Ledger Account: ADVERTISING EXPENSE Date Item Ref From the Cash Receipts Journal Account No. 6150 Debit Credit Balance 5,490 5,490 Account No.6400 Debit Credit Balance 4,800 4,800 General Ledger Account: RENTAL EXPENSE Date Item From the Cash Receipts Journal Ref Debit 10,000 Account No. 6300 Credit Balance 10,000 Step 4 & 5– Prepare the unadjusted trial balance, and preparation of worksheet. The balances in the general ledger for each account will be extended to the first two money columns of the worksheet. The unadjusted trial of Agila is: AGILA MERCHANDISING Worksheet For the month ending January 30, 2016 Account Title Unadjusted Trial Balance Debit Credit Balance Sheet Account Cash Accounts Receivable Merchandise Inventory Transportation Equipment Accum. Deprn-Off Eqpt Accounts Payable Agila, Capital Income Statement Accounts Sales Sales Discounts Purchases Purchase Discount Salaries Expense Supplies Expense Advertising Expense Rental Expense Depreciation Expense Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) 149,429 28,433 0 150,000 0 231,190 500,000 83,562 1,410 459,750 8,560 14,000 5,490 4,800 10,000 0 823,312 823,312 P a g e 176 | 201 lOMoARcPSD|11706204 Step 6 – Prepare adjusting entries. Recall in Chapter 11, the five basic sources of adjusting entries: 1. Depreciation expense 2. Deferred expenses or prepaid expenses 3. Deferred income or unearned Income 4. Accrued expenses or accrued liabilities 5. Accrued income or accrued assets Identify transactions in the books of Agila that will require adjustments: • Depreciation of transportation equipment purchased on January 2, 2016 Monthly Depreciation = (Cost – Salvage or Residual Value) / 120 months = (150,000-0) / 120 = 1,250 Adjusting entry : Depreciation Expense 1,250 Accum. Deprn- Transpo Eqpt 1,250 • Deferred or Prepaid Expenses In the cash disbursement journal, the rental payment made on January 2, 2016 is for the month of January and February 2016 amounting to PHP10,000. The entire amount was charged to rental expense which is not proper because one half (1/2) of the said payment is considered as an advance payment of rental. Thus, an asset should be recognized. The adjusting entry is: Prepaid Expenses 5,000 Rental Expense 5,000 Note: With this entry, the correct rental expense of PHP5,000 and a prepaid expense of PHP5,000 ( an asset account) are recognized. • Accrued Expenses On January 30, 2016, fuel expenses incurred amounting to PHP2,180 should be recorded as an expenses and liability. The entry to adjust is: Fuel Expenses 2,180 Accrued Expenses 2,180 Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 177 | 201 lOMoARcPSD|11706204 AGILA MERCHANDISING Worksheet For the month ending January 30, 201 Account Title Unadjusted Trial Balance Debit Debit Balance Sheet Account Cash 149,429 Accounts Receivable 28,433 Merchandise Inventory Prepaid Expenses Transportation Equipment 150,000 Accum. Deprn-Off Eqpt Accounts Payable 231,190 Accrued Expenses Agila, Capital 500,000 Income Statement Accounts Sales 83,562 Sales Discounts 1,410 Purchases 459,750 Purchase Discount 8,560 Salaries Expense 14,000 Supplies Expense 5,490 Advertising Expense 4,800 Rental Expense 10,000 Depreciation Expense Fuel Expense 823,312 823,312 Adjustments Debit Credit Adjusted Trial Balance Credit Credit 149,429 28,433 5,000 5,000 150,000 1,250 1,250 231,190 2,180 500,000 2,180 83,562 1,410 459,750 8,560 5,000 1,250 2,180 8,430 8,430 14,000 5,490 4,800 5,000 1,250 2,180 826,742 826,742 Step 7 - Preparation of Financial Statements. The first statement prepared is the income statement. All income statement accounts are extended to the appropriate column. Using the periodic inventory system, the beginning balance of merchandise inventory account is also extended to the debit side, while the result of the physical count to determine the ending inventory is reflected on the credit side. The total debit and total credit are determined and if credit balance is higher than the debit side, the difference is added to the debit side. The difference is actually the income for the period. However, if the total debit side exceeds the total credit side, the difference is added to the credit side and this is the net loss of the business. The statement of financial position is then prepared. All assets, liabilities and equity accounts are extended. The ending merchandise inventory is extended to the debit side. Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 178 | 201 lOMoARcPSD|11706204 The worksheet for these two financial statements are presented below: AGILA MERCHANDISING Worksheet For the month ending January 30, 2016 Account Title Adjusted Trial Balance Debit Debit Balance Sheet Account Cash 149,429 Accounts Receivable 28,433 Merchandise Inventory Prepaid Expenses 5,000 Transportation Equipment 150,000 Accum. Deprn-Off Eqpt 1,250 Accounts Payable 231,190 Accrued Expenses 2,180 Agila, Capital 500,000 Income Statement Accounts Sales 83,562 Sales Discounts 1,410 Purchases 459,750 Purchase Discount 8,560 Salaries Expense 14,000 Supplies Expense 5,490 Advertising Expense 4,800 Rental Expense 5,000 Depreciation Expense 1,250 Fuel 2,180 Net Income 826,742 826,742 Income Statement Debit Credit 438,700 Statement of Financial Position Credit Credit 149,429 28,433 438,700 5,000 150,000 1,250 231,190 2,180 500,000 83,562 1,410 459,750 8,560 14,000 5,490 4,800 5,000 1,250 2,180 493,880 36,942 530,822 Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) 530,822 530,822 771,562 P a g e 179 | 201 36,942 771,562 lOMoARcPSD|11706204 The proper format of the income statement and the schedule of cost goods sold of Agila for January 2016 are presented below: AGILA MERCHANDISING Schedule of Cost of Goods Sold For the month ended January 30, 2016 Merchandise Inventory, Beginning Add: Purchases Less: Purchase Discount Cost of Goods Available for Sale Less: Merchandise Inventory, Ending -0459, 970 8, 560 ————————— 451, 190 ________(438, 700) AGILA MERCHANDISING Income Statement For the month ended January 30, 2016 GROSS SALES Less: Sales Discounts NET SALES Less: Cost of Goods Sold (see above schedule) GROSS PROFIT LESS: EXPENSES Salaries Expense Salaries Expense Advertising Expense Rental Expense Depreciation Expense Fuel Expense Total Expense NET INCOME 83,562 ______(1,410) 82,152 _____(12,490) 69, 662 14,000 5, 490 4,800 5,000 1,250 ________2,180 32,270 ______36,942 Step 8 – Closing Entries. The closing journal entries consist of the following: • All of the nominal revenue accounts should be closed to the income summary account by a Debit to revenue and credit to income summary. • All of the nominal expense and cost of goods sold accounts should be closed to the income summary by a Credit to expense and a debit to income summary. • The Merchandise Inventory, Beginning is closed to Income summary account by a debit to Income Summary and a credit to Merchandise Inventory. • The Merchandise Inventory, Ending is set up in the books by a debit to Merchandise Inventory, Ending and a credit to Income Summary. Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 180 | 201 lOMoARcPSD|11706204 The amount that will be used is the result of the physical count. • The balance in the income summary account should now reflect the net income for the accounting period. The next journal entry should close the income summary account to the equity or capital account. If there is a net profit this entry will be a debit to income summary and a credit to owner’s capital account. Once the closing journal entries have been entered into the general journal, the information should be posted to the general ledger. When this is accomplished, all of the nominal accounts in the general ledger should have zero balances. To double check on this, we prepare another trial balance based on the new balances in the general ledger. If we have any nominal accounts with positive balances, a mistake was made along the way and will need to be corrected before proceeding to the next accounting period. The closing entries of Agila are: Date 1/30/16 General Journal Account Title and Explanation Sales Sales Discounts Income Summary To close nominal revenue accounts Income Summary Purchase Discount Purchases Salaries Expense Supplies Expense Advertising Expense Rental Expense Depreciation Expense Fuel Expense To close nominal expense and cost of goods sold account accounts Merchandise Inventory, Ending Income Summary 438,700 To set up merchandise inventory ending Ref Debit 83, 562 Credit 1,410 82,152 483,910 8,560 459,750 14,000 5,490 4,800 5,000 1,250 2,180 438,700 438,700 After these entries, the income summary account has a balance of: Total Credits (82,152 + 438,700) = 520,852 Total Debit = 83,910 Net (credit balance) 36,942 Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 181 | 201 lOMoARcPSD|11706204 The last closing entry is to close the balance of income summary to the capital account: Date 1/30/16 General Journal Account Title and Explanation Income Summary Agila, Capital Ref Debit 36, 942 Credit 36, 942 ENRICHMENT As mentioned above, there are two methods in accounting for inventory: the periodic inventory system and perpetual inventory system. PERPETUAL INVENTORY SYSTEM Recording Purchases and related transactions under the Perpetual Inventory System PURCHASES OF MERCHANDISE: PERPETUAL SYSTEM • When merchandise is purchased for resale to customers, the account, Merchandise Inventory, is debited for the cost of goods purchased. • Like sales, purchases may be made for cash or on account (credit). • The purchase is normally recorded by the purchaser when the goods are received from the seller. • Each credit purchase should be supported by a purchase invoice. • A purchase invoice received by the buyer is actually a sales invoice or a charge invoice prepared by the supplier or vendor. • Note that only purchases of merchandise are debited to Merchandise Inventory. Purchases of other assets: supplies, equipment, and similar items) are debited to their respective accounts. TO ILLUSTRATE: Magaling Computer Store started its operations on January 2, 2016. The store is located in Sikat Mall in Bicol. The owner invested PHP500,000 to start the business. On January 3, 2016, Magaling purchased 20 computer units on account for PHP10,000 each. Upon delivery of the units, the supplier Delta, Inc. issued a Charged Invoice No. 145 to Magaling. Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 182 | 201 lOMoARcPSD|11706204 Entry: Date 1/3/16 General Journal Account Title and Explanation Inventory (Merchandise Inventory) Accounts Payable To record purchase of 20 units of computers at PHP10,000 per unit from Delta Inc., as per Charge Invoice 145 Ref Debit 200,000 Credit 200,000 ACCOUNTING FOR FREIGHT COSTS The sales agreement should indicate whether the seller or the buyer is to pay the cost of transporting the goods to the buyer’s place of business. The two most common arrangements for freight costs are FOB SHIPPING POINT AND FOB DESTINATION. PURCHASE RETURNS AND ALLOWANCES • A purchaser may be dissatisfied with merchandise received because the goods are: • damaged or defective • of inferior quality • not in accordance with the purchaser’s specifications • The purchaser initiates the request for a reduction of the balance due through the issuance of a debit memorandum. The debit memorandum is a document issued by a buyer to inform a seller that the seller’s account has been debited because of unsatisfactory goods. • A return of the merchandise (a deduction from the purchase price when unsatisfactory goods are kept) is shown by the entry where Accounts Payable is debited and Merchandise Inventory is credited to show that the cost of the Merchandise Inventory is reduced with a return or an allowance. TO ILLUSTRATE: Out of the 20 units of the computers purchased last January 3, 2016, it was found out after inspection on the same day that one unit was damaged during shipment. Magaling issued a debit memorandum (DM 01) and informed the supplier that it will return the one damaged unit. Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 183 | 201 lOMoARcPSD|11706204 Entry : Date 1/3/16 General Journal Account Title and Explanation Accounts Payable Inventory To record return of 1 unit computer, PHP10,000 unit from Delta, Inc. as per DM 01 Ref Debit 10,000 Credit 10,000 ACCOUNTING FOR FREIGHT COSTS The sales agreement should indicate whether the seller or the buyer is to pay the cost of transporting the goods to the buyer’s place of business. The two most common arrangements for freight costs are FOB SHIPPING POINT AND FOB DESTINATION. FOB Shipping Point Goods placed free on board (FOB) the carrier by seller. • Buyer pays freight costs. • Merchandise Inventory is debited if buyer pays freight. • Cash is credited if the goods come on cash on delivery (COD), for example, and was paid immediately. Accounts Payable would be credited if on account. • Ownership over the goods is transferred to the buyer once it is out of the premises of the seller. FOB Destination • Goods placed free on board (FOB) at buyer’s business. • Seller pays freight costs. • Delivery Expense is debited if seller pays freight on outgoing merchandise to a buyer which is an operating expense to the seller. • Ownership over the goods is transferred to the buyer once the goods are delivered and received by the buyer. Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 184 | 201 lOMoARcPSD|11706204 TO ILLUSTRATE: Assuming the supplier of Magaling is based in Manila and in order to bring the 20 computer units to Bicol it will cost PHP3,000 to deliver the goods. 1. If the terms is FOB Shipping Point, the entry to record, assuming Magaling paid in cash the common carrier on January 4, 2016 is : 2. Entry: Date 1/4/16 General Journal Account Title and Explanation Inventory 3,000 Cash 3,000 To record freight costs for the purchase of 20 units computer Ref Debit 3,000 Credit 3,000 2. If the terms is FOB Destination, no entry is recorded in the books of Magaling. The PHP3,000 will be paid by the seller, in this case Delta, Inc. PURCHASE DISCOUNTS: • Credit terms (specify the amount of cash discount and time period during which a discount is offered) may permit the buyer to claim a cash discount for the prompt payment of a balance due. If the credit terms show 2/10, n/30 means a 2% is discount is given if paid within 10 days (called the discount period); otherwise the invoice is due in 30 days. • The buyer records this discount as a reduction to Merchandise Inventory. • A purchase discount is normally based on the invoice cost less returns and allowances, if any. Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 185 | 201 lOMoARcPSD|11706204 TO ILLUSTRATE The credit terms for the purchased of 20 computer units (total cost PHP200, 000) is 2/10, n/30. This means that if Magaling pays on or before January 13, 2016, it is entitled to a 2% discount. Otherwise, they will have to pay the full amount on or before February 4, 2016 (30 days after purchase). On January 10, 2016, Magaling paid in full the account with Delta. Entry: Date 1/10/16 General Journal Account Title and Explanation Accounts Payable Merchandise Inventory Cash To record full payment of Delta Charge Invoice No. 145 with 2% discount computed as PHP200,000 x 2% Ref Debit 200,000 Credit 4,000 196,000 Assuming that instead of paying on January 10, 2016, Magaling paid on February 4, 2016, thus forfeiting the 2% discount, the entry to record is: Date 1/4/16 General Journal Account Title and Explanation Accounts Payable Cash To record full payment of Delta Charge Invoice No. 145 Ref Debit 200,000 Credit 200,000 Recording of Sales and related transactions under the Perpetual Inventory System SALES TRANSACTIONS: REVENUE ENTRIES FOR A MERCHANDISER • Revenues are reported when earned in accordance with the revenue recognition principle; and in a merchandising company, revenues are earned when the goods are transferred from seller to buyer. • All sales should be supported by a document such as a cash register tape (provide evidence of cash sales) or cash receipt or office receipt for cash sales, and charge invoice for credit sales or sales on account. • Two entries are made with each sale: • The first entry records the sale: Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 186 | 201 lOMoARcPSD|11706204 • Debit — Accounts Receivable (if a credit sale) or Cash (if a cash sale) which increases assets for the sales amount • Credit — Sales which increases revenues • The second entry records the cost of the merchandise sold: • Debit — Cost of Goods Sold which increases expenses • Credit — Merchandise Inventory which decreases assets • The sales account is credited only for sales of good held for resale. Sales of assets not held for resale (such as equipment, buildings, land, etc.) are credited directly to the asset account. TO ILLUSTRATE : Assume that no freight costs were incurred when the 20 computer units were purchased. For the month of January, Magaling made the following sale: 1/10/2016 Official Receipt (OR) No. 001 Sold two units for cash to Marie Cruz for PHP36, 000 (PHP18,000 per unit), FOB Destination 1/15/2016 Charge Invoice (ChI) No. 001 Sold five units on account to Rafael Reyes for PHP97,500 (PHP19,500 per unit) with terms 3/10, n/ 30, FOB Shipping Point. Entry: Date 1/10/16 General Journal Account Title and Explanation Cash Sales Cost of Goods Sold Inventory To record OR No. 001 cash sale-Marie Cruz Ref Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) Debit 36,000 Credit 36,000 20,000 20,000 P a g e 187 | 201 lOMoARcPSD|11706204 Date 1/15/16 General Journal Account Title and Explanation Accounts Receivable Sales Cost of Goods Sold Inventory To record Charge Invoice No. 001 Rafael Reyes on account with terms 3/10, n/30 Ref Debit 97,500 Credit 97,500 50,000 50,000 FREIGHT TERMS: FOB DESTINATION — SELLER PAYS FREIGHT • An entry is made when seller pays the freight to deliver goods to a customer or buyer. If the buyer will pay for the freight, no entry is made. • Debit — Delivery Expense and credit — Cash or Accounts Payable. TO ILLUSTRATE: On January 10, 2016 Magaling paid MM Express, PHP500 to deliver the two units to Marie Cruz. Date 1/10/16 General Journal Account Title and Explanation Delivery Expense Cash To record full payment of Delta Charge Invoice No. 145 Ref Debit 500 Credit 500 Take note that no entry will be made as to the sale to Rafael Reyes since the term is FOB Shipping Point. SALES RETURNS AND ALLOWANCES: • Sales Returns result when customers are dissatisfied with merchandise and are allowed to return the goods to the seller for credit or a refund. • Sales Allowances result when customers are dissatisfied, and the seller allows a deduction from the selling price. • To grant the return or allowance, the seller prepares a credit memorandum to inform the customer that a credit has been made to the customer’s accounts receivable. Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 188 | 201 lOMoARcPSD|11706204 • Sales Returns and Allowances is a contra revenue account to the Sales account. A contra account is a reduction to a particular account. • A contra account is used, instead of debiting sales, to disclose in the accounts the amount of sales returns and allowances. • This information is important to management, as excessive returns and allowances suggest inferior merchandise, inefficiencies in filling orders, errors in billing customers, and mistakes in delivery or shipment of goods. • The normal balance of Sales Returns and Allowances is a debit. • Two entries are made with each sale return and allowance: • The first entry records the sales return or allowance: • Debit —Sales Return and Allowances which decreases revenues for the amount of the sale • Credit — Accounts Receivable (if a credit sale) or Cash (if a cash sale) which decreases assets • The second entry records the increase in Merchandise Inventory: • Debit — Merchandise Inventory which increases assets • Credit — Cost of Goods Sold which decreases expenses TO ILLUSTRATE: On January 16, 2016, Rafael Reyes returned one unit of the computers purchased last January 15, 2016 under Charge Invoice 001. The unit returned was in good condition. However, Rafael Reyes returned the unit because it is one unit more than what they need. The return was approved and accepted by Magaling. The price will be deducted from the account of Rafael Reyes. Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 189 | 201 lOMoARcPSD|11706204 Entry: Date 1/16/16 General Journal Account Title and Explanation Sales Return and Allowances Accounts Receivable Ref Merchandise Inventory Cost of Goods Sold To record return of one unit computer from Rafael Reyes under Charge Invoice No. 001 Debit 19,500 Credit 19,500 10,000 10,000 SALES DISCOUNTS 1. A sales discount is the offer of a cash discount to a customer to encourage them to pay the balance at an earlier date. 2. An example of a discount term is commonly expressed as: 2/10, n/30, which means that the customer is given 2% discount if payment is made within 10 days. After 10 days there is no discount, and the balance is due in 30 days. 3. Sales Discounts is a contra revenue account with a normal debit balance. Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 190 | 201 lOMoARcPSD|11706204 TO ILLUSTRATE: Assume Magaling purchased five units of computers on cash for PHP10,000 per unit from a supplier on January 17, 2016 that were subsequently sold to Jun Cruz on January 18, 2016 under Charge Invoice (ChI) No. 002 amounting to PHP90,000 (PHP18,000 per unit) with terms 2/10, n/30, FOB Shipping Point. On January 23, 2016, Cruz paid the said account in full. Date 1/17/16 1/18/16 1/23/16 General Journal Account Title and Explanation Inventory Cash To record five units of computers purchased on cash 1/ Accounts Receivable Sales Cost of Goods Sold Inventory To record sales on account under Charge Invoice No. 002 to Jun Cruz with terms 2/10, n/30 Cash Sales Discount Accounts Receivable To record collection of accounts receivable from Jun Cruz, net of 2% sales discount Ref Debit 50,000 Credit 50,000 90,000 90,000 50,000 50,000 88,200 1,800 90,000 Notice in the entry on January 23, 2016 that the cash received from Jun Cruz was net of the 2% discount because he made the payment within the discount period. Take note that the discount period in this case is from January 19, 2016 to January 28, 2016 (10 days). Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 191 | 201 lOMoARcPSD|11706204 What If Jun Cruz paid the account on January 30, 2016 instead of January 23, 2016? The entry should be: Date 1/23/16 General Journal Account Title and Explanation Cash Accounts Receivable To record collection of accounts receivable from Jun Cruz. Ref Debit 90,000 Credit 90,000 Determining Cost of Goods Sold under the Perpetual Inventory System The Cost of Goods Sold under the perpetual inventory system is determined by getting the running balance in the general ledger of the account. Recall the previous discussion on posting the journal entries to the general ledger. At any point in time, you can determine the cumulative cost of goods sold under the perpetual inventory system because in this system a separate general ledger for “Cost of Goods Sold” is maintained. THE FLOW OF INVENTORY COSTS Under the periodic inventory system, physical count is necessary to determine the ending balance of merchandise inventory. After the count, the costs of these inventory items will be computed. There are instances that the unit prices for merchandise purchased are different. Consider this scenario: Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 192 | 201 lOMoARcPSD|11706204 Geo San is in the business of buying and selling canned sardines. On January 2016, Geo had the following transactions: 1/1/16 1/10/16 1/20/16 Merchandise inventory on hand 1,000 cans @ PHP10/can Purchased 5,000 cans @ PHP11 /can Purchased 4,000 cans @ PHP12/can Total PhP 10,000 55,000 48,000 Php113,000 During the month of January the total sales in units is 7,000. Therefore, the ending inventory in units is 3,000 cans of sardines (1,000+5,000+4,000-7,000). The problem now is the unit cost that will be used to determine the value of the ending inventory. This is where the cost flow assumption is needed. The two most commonly used cost flow assumptions are: • Average Cost Using the above example, average unit cost is simply computed by dividing the total cost (PHP113,000) by total quantities (1,000+5,000+4,000) 11,000. Average unit cost is PHP11.30 The cost of merchandise inventory ending is 3,000 x PHP11.30 = PHP33,900 • First in, First Out (FIFO) As the name implies, FIFO involves the assumption that goods sold are the first units that were purchased - that means the oldest goods on hand. Thus, the remaining inventory is comprised of the most recent purchases. Applying this to the problem above, the 7,000 units sold were taken from: 1,000 @ PHP10 5,000 @ PHP11 1,000 @ PHP12 ———————7,000 units Therefore, the ending inventory will come from the January 20 purchases: 3,000 @ PHP12 = PHP36,000 Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 193 | 201 lOMoARcPSD|11706204 Test 1. A company had the following transactions during December: • Sold merchandise on credit for PHP5,000, terms 3/10, n/30. The items sold had a cost of PHP3,500. • Purchased merchandise for cash, PHP720. • Purchased merchandise on credit for PHP2,600, terms 1/20, n/30. • Issued a credit memorandum for PHP300 to a customer who returned merchandise purchased on November 29. The returned items had a cost of PHP210. • Received payment for merchandise sold on December 1. • Received a credit memorandum for the return of faulty merchandise purchased on December 4 for PHP600. • Paid freight charges of PHP200 for merchandise ordered last month (FOB shipping point). • Paid for the merchandise purchased on December 4, less the portion that was returned. • Sold merchandise on credit for PHP7,000, terms 2/10, n/30. The items had a cost of PHP4,900. • Received payment for merchandise sold on December 24. Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 194 | 201 lOMoARcPSD|11706204 Required: Prepare the general journal entries to record these transactions using a perpetual inventory system. (Record all purchases initially at the gross invoice amount) Suggested Solution: Accounts Receivable Sales Cost of Goods Sold Merchandise Inventory Merchandise Inventory Cash Merchandise Inventory Accounts Payable Sales Returns and Allowances Accounts Receivable Merchandise Inventory Cost of Goods Sold Cash Sales Discounts Accounts Receivable Accounts Payable Merchandise Inventory Merchandise Inventory Cash Accounts Payable Merchandise Inventory (PHP2,000 x .01) Cash Accounts Receivable Sales Cost of Goods Sold Merchandise Inventory Cash Sales Discounts Accounts Receivable Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) 5,000 5,000 3,500 3,500 720 720 2,600 2,600 300 300 210 210 4,850 150 5,000 600 600 200 200 2,000 20 1,980 7,000 7,000 4,900 4,900 6,860 140 7,000 P a g e 195 | 201 lOMoARcPSD|11706204 2. The following data was taken from ledger account balances and supplementary data for the XYZ Company. Merchandise inventory, beginning Merchandise inventory, ending Purchases Purchases discounts Purchases returns and allowances Sales Sales discounts Sales returns and allowances Freight-in PHP 20,000 23,000 215,000 6,000 3,000 400,000 3,200 1,800 10,000 Required: Show the computation, in proper format, of net sales, cost of goods sold, and gross profit for the year ended December 31, 2016. Suggested Solution: XYZ COMPANY Income Statement For the Year Ended December 31, 2016 Revenue from sales: Gross sales Less: Sales discounts Sales returns and allowances Net sales Cost of goods sold: Merchandise inventory, 1/1/16. Purchases Less: Purchase discounts Purchase returns and allowance Net purchases Add Freight-in Cost of goods purchased Goods available for sale Merchandise inventory, 12/31/16 Cost of goods sold Gross profit from sales 400,000 3,200 1,800 5,000 395,000 20,000 215,000 6,000 3,000 ___ 9,000 206,000 10,000 Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) 216,000 236,000 23,000 213,000 182,000 P a g e 196 | 201 lOMoARcPSD|11706204 ADDITIONAL PRACTICE SETS Practice Set 1 Listed below are some of the accounts relating to the income of Leather Plus (owned by Abner Bravo) for the three month period ended March 31, 2016: Sales Sales Returns and Allowances Sales Discounts Purchases Purchase Returns and Allowances Supplies Expense Salaries Expense 500,000 Merchandise Inventory, beginning 15,000 Merchandise Inventory, Ending 7,800 Purchase Discounts 302,000 Freight-In 4,9000 Rental Expense 170,100 1,200 Delivery Expense 18,000 Utilities 2,100 8,000 165,000 1,800 5,000 5,000 Instructions: 1. Prepare a schedule of cost of goods sold for the three-month period ended March 31, 2016. 2. Prepare a statement of income for the period ended March 31, 2016. 3. Prepare closing entries. Suggested Answers: Leather Plus Schedule of Costs of Goods Sold For the three-month period ended March 31, 2016 Merchandise Inventory, Beg Add: Net Purchases Purchases Less: Purch Returns & Allow Purch Discounts Add: Freight-In Cost of Goods Available for Sale Less; Merchandise Inventory, End Cost of Goods Sold 170,100 302,000 (4,900) __(1,800) Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) 295,300 ___5,000 470,400 (165,000) __305,400 P a g e 197 | 201 lOMoARcPSD|11706204 Leather Plus Income Statement For the three-month period ended March 31, 2016 Gross Sales Less: Sales Returns & Allow Sales Discounts Net Sales Less: Cost of Goods Sold Gross Profit Less: Expenses Supplies Expense Salaries Expense Rental Expense Delivery Expense Utilities Expense Total Expenses Net Income 500,000 (15,000) ____(7,800) 477,200 ___305,400 171,800 1,200 18,000 5,000 2,100 8,000 ___34,300 __137,500 Closing Entries Sales 500,000 Sales Returns & Allow Sales Discounts Income Summary 15,000 7,800 477,200 Income Summary Purchase Returns & Allow Purchase Discounts Purchases Freight-In Supplies Expense Salaries Expense Rental Expense Delivery Expense Utilities Expense 334,600 4,900 1,800 Income Summary Merchandise Inventory, Beg 170,100 Merchandise Inventory, End Income Summary 165,000Income 165,000 Income Summary Bravo, Capital 137,500 302,000 5,000 1,200 18,000 5,000 2,100 8,000 170,100 Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) 137,500 137,500 137,500 P a g e 198 | 201 lOMoARcPSD|11706204 Practice Set 2 Canto Merchandising sells facsimile, copiers and other types of office equipment. Transactions during the month of September 2016 are as follows: Instructions: Sept 1 Sept 2 Sept 7 Sept 10 Sept 14 Sept 15 Sept 20 Sept 30 Purchased five units of copiers on account from Machina Corp at a cost of PHP8,000 per unit. Payment is due 30 days after. Borrowed from Nation Bank, PHP50,000 at 10% interest per annum due in three months . Canto issued a promissory note for this borrowing. Paid one –year insurance covering the period Sept 1, 2016 – August 31, 2017 for PHP24,000 Purchased 10 units of facsimile machines on cash from Tiktac Corp for a total price of PHP20,000. Sold three units of copiers to Jane Nay on account for a total amount PHP45,000. The terms of the sale is 2/10, n 30. Paid PHP5,600 for office supplies Collected from Jane Nay the full amount relating to September 7 sales. Paid PHP10,000 salaries of office staff Sold on cash, two units of facsimile machines to Juan for PHP5,000 Purchased delivery truck worth PHP300,000 with an estimated useful life of 10 years with no residual value. Canto paid PHP200,000 cash and balance payable 30 days after. Instructions: 1. Prepare journal entries to record the above transactions, assuming Canto uses periodic inventory system. 2. Prepare necessary adjusting entries on September 30, 2016. Sept 1 Sept 1 Sept 1 Sept 2 Sept 7 Purchases Accounts Payable Cash Notes Payable Insurance Expense Cash Purchases Cash Accounts Receivable Sales Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) 40,000 40,000 50,000 50,000 24,000 24,000 20,000 20,000 45,000 45,000 P a g e 199 | 201 lOMoARcPSD|11706204 Sept 10 Sept 14 Sept 15 Sept 20 Sept 30 Supplies Expense Cash Cash Sales Discount Accounts Receivable Salaries Expense Cash Cash Sales 5,600 5,600 44,100 900 45,000 10,000 10,000 5,000 5,000 Transportation Equipment Cash Accounts Payable 300,000 200,000 100,000 Adjusting entries: Prepaid Expense Insurance Expense 22,000 22,000 Hint: learner may use Prepaid Insurance instead of Prepaid Expense . Expense should be PHP2,000 for September (PHP24,000/12months) Alternative solution: If the entry to record 9/1/16 was: Prepaid Expenses Cash 24,000 Adjusting entry should be: Insurance Expense Prepaid Expense 2,000 Accrual of interest on 9/1/16 borrowing: Interest Expense Accrued Expenses (Interest Payable) 416.67 24,000 2,000 416.67 Computation: PHP50,000 x 10% x 1/12; for one month only Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 200 | 201 lOMoARcPSD|11706204 References: Anastacio, Ma. Flordeliza. Fundamentals of Financial Management (with Industry Based Perspective) .( Manila: Rex Book Store, 2011). Gilbertson, Claudia. Fundamentals of Accounting . 8th ed. (Australia: Cengage Learning, 2010). Padillo, Nicanor, Jr. Financial Statements Preparation, Analysis and Interpretation . (Manila: GIC Enterprises, 2011). Pefianco, Erlinda C. The Accounting Process: Principles and Problems . (Makati: Goodwill Trading, 1996). Young, Felina C. Principles of Marketing . (Manila: Rex Book Store, 2008). Fundamentals of Accounting, Business Management 1 Downloaded by Resty Quito (restyquito2290@gmail.com) P a g e 201 | 201
