Table of Contents Chapter 1………………………………………………...Accounting Overview Chapter 2……………………………………………......Journalizing Chapter 3………………………………………………..Posting Chapter 4………………………………………………..Adjusting Entries Chapter 5…………..……………………..Completion of the Accounting Style Chapter 6…………………………………………….....Merchandising Chapter 7………………...…………..Special Journals and Subsidiary Leader SINGLE PROPREITORSHIP ACCOUNTING is a challenging technical subject which requires analysis and data-interpretation concerning financial activities needed for decision-making. This Module 1 in Basic Accounting will help students understand the accounting cycle with the purpose of preparing the income statement for the operation of the business entity and the balance sheet for the condition of enterprise. This joined effort of the authors is prepared to be an efficient learning reference for students and teachers as well. The basic presentation is designed to complement readers in knowledge-skills development in comprehensive manner. CHAPTER 1: ACCOUNTING OVERVIEW 1.1 The importance of Records: The human brain can store a huge amount of information, however remembering all the day to day transactions would be very difficult, if not impossible. As a result, written records must be kept to monitor all significant activities. Just like historians who record valuable events of the past, any person dealing with money needs records or past information so that he may have reliable basis regarding his way of spending or his actions in the debts on time. By keeping records, he will have the ability to assess which transactions provided him income and which transactions resulted to expenses. He can also assess if he will have the ability to pay his debts on time. Records may be done at the option of an individual person or by a compulsory requirement of the government. A mother may choose to make a family budget through a record keeping method, that is, at her own initiative. A businessman is required by law to prepare some records for tax and regulatory purposes.A business entity may put all its plans in writing to be used as a guide in the actual operation of the business, either for short-range or long-range.Short-range planning usually reflects the activities for a year. Long-range planning is more dynamic as it involves forecast of the results of future operation, usually three to five years. In business planning, data from the past plays a significant role to anticipate the future of the business. Even our government is required to make records in order to account on how they use the money being paid by the people. In the business arena, accounting is the language. It would not be easy to account for economic transactions without records. The records will tell the story concerning the progress and position of the business. By means of written data, a businessman can take steps to correct some errors within his company and improve his operations. The basic accounting courses will open your eyes to the story behind the basics of recording economic transactions. It will widen your grasp on how to assess the company’s condition and performance. The present law that governs the accounting in the Philippines is Republic Act No. 9298, known as the Philippine Accountancy Act of 2004. As a whole, accountants use rules, procedures, practice and standards followed in the preparation and presentation of financial statements known as Generally Accepted Accounting Principles (GAAP). The accounting standards promulgated by the Financial Reporting Standards Council (FRSC) constitute the GAAP in the Philippines. Standards created by the FRSC are currently known as Philippine Accounting Standards (PAS) and Philippine Financial Reporting Standards (PFRS). 1.2 Accounting Defined Authorities in accounting define “accounting” as: “The process of identifying measuring and communicating economic information to permit informed judgment and decision by users of the information.” 1.3 Accounting Elaborated From the definition of accounting, it covers three functions as follows: IDENTIFYING is the process of recognition and nonrecognition of business activities as “accountable” events. Accountable events occur when it affects an entity’s assets, liabilities and equity. In accounting, activities such as hiring of employees, death of a company officer, inquiring inventory prices, placing an order, etc. are not accountable because they cannot be quantified or expressed in terms of a unit of measure. MEASURING is the process of assigning of peso amounts to the accountable economic transactions and events. In the Philippines, Philippine peso is the unit of measuring accountable economic transactions. COMMUNICATING is the process of preparing and disturbing accounting reports to possible users of accounting information. Implicit in the communication process are the recording, classifying and summarizing aspects of accounting. a) Recording. Another name for recording is bookkeeping or journalizing. It refers to writing business data such as economic transactions and events on the books of the business systematically. b) Classifying. Similar items are grouped under a common characteristic: assets (mga pagmamay-ari), liabilities (mga utang), capital (halagang inilgay sa negosyo), revenue (benta) and expenses (gastos). Sub- groupings within these major categories are also possible. For example, sales may be sorted by each department likes Sales-Men’s Dept., Sales-Women’s Dept., and Sales-Children’s Dept. In listing the accounts, it is suggestive to arrange them according to their liquidity or permanent nature or if they are operating or non-operating. c) Summarizing. This is the preparation of financial statements which include: the balance sheet income statement, cash flow statement, statement of changes in equity or statement of recognized gains and losses and notes to financial statements. This kind of work is usually performed by an accountant. 1.4 Forms of Business Organization There are three common forms of business organization. These are as follows: a) Single Proprietorship. This is the simplest form of business as it is owned solely by an individual. The owner may be a one-army man, that is, he is the general manager, salesman, and cashier at the same time. b) Partnership. If two or more persons owned jointly a business organization, it is called a partnership. Of course, the owners must agree on their capital contribution, profit or loss distribution and other relevant matters. Once, a partnership is formed, according to law, it has a separate identity from the owners. c) Corporation. When five or more persons register a business entity to the Securities and Exchange Commission (Philippines) and ownership, in general, is evidenced by readily transferable shares of stock, such entity shall acquire an artificial legal personality distinct and specific from the owners. This kind of business organization is called a Corporation. Forms of Business Usually, business organizations may enter into a business such as: a) Service Provider- this business gives their customers services instead of tangible products. Examples of this business are: advertising company, repair shops, spa houses, graphic designing, barber shops, restaurants, etc. b) Merchandising- commonly known as buy and sell or trading business. The purchased products and the products being sold are the same. Common buy and sell businesses are: Rice retailing, Sari- sari stores, Books shops, etc. c) Manufacturing- this kind of business buys raw materials and transforms it into finished products. Common manufacturing businesses are: Dole, Universal Robina, Furniture shops, etc. In chapter 1 to 5, accounting for single proprietorship providing service will be illustrated. Accounting Assumptions These are the basic notions of fundamental premises on which the accounting process is based. Accounting assumptions are also known as postulates. The Financial Reporting Standards Council conceptual framework mentions two assumptions, namely ACCRUAL and GOING CONCERN. However, basic assumptions such as accounting entity, time period and monetary unit are implicitly included in accounting. ACCRUAL ● Accrual accounting means that income is recognized when earned regardless of when received and expense is recognized when incurred regardless of when paid. GOING CONCERN or CONTINUITY ● This assumption looks on a business that it will continue its operations for the foreseeable future. ACCOUNTING ENTITY ● Under this assumption, the business enterprise is separate from the owners, managers, and employees who comprise the firm. TIME PERIOD remaining accounts are totaled to reflect equal debits and credits Remaining accounts are called permanent accounts. These accounts are reflected in the Balance Sheet. 9. Reversing Entries- At the beginning of the next period, some adjusting entries are reversed to facilitate normal recording. ● This postulate requires that a business must present its financial reports on financial position, performance and cash flows for a “one-year period”. Calendar Year- is one year period that starts from January 1 and ends up December 31. Fiscal Year- is one year period of any consecutive months. (e.g. June 30July 1) Natural Year- is a one-year period that ends when business operations are at their lowest level of annual cycle. 1.8 Elements of Financial Statements. In accounting parlance, transaction can be defined as any exchange of economic value that must be recorded. Value is anything susceptible of monetary estimate that can affect the elements of financial statements. a) Assets (Balance sheet account) are defined as “resources controlled by the enterprise as a result of past transactions or events and from which future economic benefits are expected to flow to the enterprise”.. To cite examples, cash, inventory, land, machinery, equipment, patents, copyrights are called assets. b) Liabilities ( Balance sheet account) are “present obligations of the enterprise arising from past transactions or events, the settlement of which is expected to result in an outflow from the enterprise of resources embodying economic benefits”. In actual business, liabilities are often called payables. c) Capital or Equity (Balance sheet account) is the “residual interest in the assets of the enterprise after deducting all its liabilities. Other names for capital are proprietorship, owner’s equity, net worth, or equity. d) Drawings (Balance sheet account) are withdrawals made by an owner from the enterprise. Drawings decrease total owner’s equity. This account is used only in Sole proprietorship, owner’s equity, net worth, or equity. e) Income (Income statement account) is the inflow of future economic benefits that increase equity, other than contributions or investments from owners. Income encompasses both revenues and gains. f) Expenses (Income statement account) are the outflows o consumption of future economic benefits that decrease equity, other than distributions or dividends paid to owners. Expenses also include losses. Sometimes, financial statements are made less than one year (semiannually or quarterly) for internal uses or government requirements. This is called interim reporting which uses interim period. MONETARY UNIT Monetary unit imposes that financial statements must be stated in the Philippine peso, any changes in the value of peso may be ignored. 1.7 Accounting Process. The accounting processes also known as the accounting cycle defined above can be expanded into the following detail: (AJPUAFCPR) 1. Analyzing- transactions are checked if it affects the elements of financial statements and if it can be measured reliably. 2. Journalizing- economic transactions are recorded in Journals upon transaction. 3. Posting- Recorded transactions are classified and balances are computed. 4. Unadjusted Trial Balance- All account balances are totaled to reflect equal debits and credits. 5. Adjusting Entries- Some account balances are updated to reflect their true balances. 6. Financial Statement (FS) Preparation- To communicate to financial uses, financial statements are prepared to show the company’s condition and performance. 7. Closing Entries- All income Statement accounts are closed. This is why income statement accounts are also called temporary accounts. 8. Post- Closing Trial Balance- After the closing entries are posted, 1.9 Fundamentals of Bookkeeping As defined, bookkeeping is the systematic and chronological recording of business transactions or events. Transaction means exchange of values. Values referred to are “value received” and “value parted with”. The value received refers to the left-side entry called debit, usually abbreviated as “dr”. The value parted with is the right-side entry called credit usually abbreviated as “cr”. Double- entry bookkeeping is the common method of recording. It requires every economic event to be recorded with debit ad credit. In reason, every economic event result to a value received and value parted with. To illustrate, when purchasing a car in cash amounting P100,000 a person receives an automobile and pays cash. Thus, automobile is debited, and cash is credited: Automobile Cash 100,000 100,000 This will be discussed thoroughly in Chapter 2. 1.10 Accounting Equation The basic accounting equation is: ASSETS=LIABILITIES + PROPRIETORSHIP Algebraically, the following formulas can be derived: LIABILITIES = PROPRIETORSHIP = 1.11 ASSETS ASSETS - PROPRIETORSHIP - LIABILITIES Accounting Equation Illustrated. PNB is assumed by the business. The accounting equation is: Proprietorship = Assets = P60, 000 Proprietorship = P55,000 Liabilities P5,000 1.12 Financial Statements are the means by which the information accumulated and processed in financial accounting is periodically communicated to the users. In other words, the financial statements are the end product or main output of the financial accounting process. The objective of general purpose financial statements is to provide information about the financial position, financial performance and cash flows of an entity that is useful to a wide range of users in making economic decisions. Financial statements also show the outcome of management’s stewardship of the wealth entrusted to it. The complete set of basic financial statements includes the following components: 1. Income statement 2. Balance sheet 3. Statement of changes in equity or statement of recognized gains and losses. 4. Cash flow statement 5. Notes, comprising a summary of significant accounting policies and explanatory notes. Case 1. Assume that Mr. Emer Patiu invested P10,000 cash as initial capital for a vulcanizing business called Patiu vulcanizing Shop. The business also took charge of the P2,000 payable of the furniture and equipment it is using. Accounting equation then is: Year- end financial statements must be prepared, although interim statements or statements of less than one year may be prepared for internal purposes. Usual interim statements are quarterly financial statements or for a period of three months. Assets The financial statements are prepared to cater to its users. Typically, users of financial statements are: Assets = = = Liabilities P2,000 P12,000 + + Proprietorship P10,000 Case 2. Assume that Mr. Ruben Viray invested assets worth P50,000 for handicraft business. However, actual assets he invested is only P40,000. Accounting equation will be: Liabilities = Assets = P50,000 Liabilities = P10,000 - Proprietorship P40,000 Case 3. Assume that Mr. Nick Ligon gave cash and goods for a buy-and-sell business amounting to P60,000. However, a P5,000 notes payable by him to a) Investors- they use the financial statements to decide whether they will put in money to the business, hold or withdraw their capital. b) Employees- they are interested in information regarding how the company provide remuneration/salary, retirement benefits and employment opportunities. c) Lenders- Lenders are keen on data that provides them information that will help them assess whether their loans and accompanying interest will be paid on time. d) Suppliers and other trade creditors- these users use financial information regarding the promptness of the company to pay their liabilities.e) Customers- customers are interested in information on how will the enterprise operate, especially when there is a long-term involvement or dependency on the business. f) Government and their agencies- financial statements are mandated by the government to regulate business entities, determine taxation policies and as a basis for national statistics for economic monitoring. g) Public- generally, a business may affect the public in different aspects like employment, community development, business opportunities, etc. 1.13 Income Statement An income statement is a formal statement showing the financial performance of the enterprise for a given period of time. The income the statement presents income and expenses. Accounts in the income statement are called nominal or temporary accounts. These accounts are all closed at the end of the period. Thus, no income statement account can be seen at the books every start of the next period. To illustrate an income statement, consider that Mr. Chit Manlunas established an advertising business on December 1, 2008. For the whole month of December, below are the pertinent data: 1. Total service revenues for the month is 2. The following are the expenses: a) Advertising expense b) Rent expense c) Salaries expense d) Other expenses Net Income To illustrate a balance sheet, assume that Mr. Chit Manlunas has the following information in his journal as of December 31, 2008 1. Total Cash 2. Receivable from customer 3. Delivery equipment for business 4. Table, chairs, and other fixtures 5. Payable to Cyrex Commercial 6. Initial capital of P22,000 decrease by personal withdrawal of 7. Profit for the month 1,000 3,185 Assets P5, 225 400 800 500 Cash Accounts Receivable Delivery Equipment Furniture & Fixture P10,110 P5,225 400 800 _ 500 6,925 P5, 235 750 16, 500 1, 950 250 CHIT MANLUNAS Balance Sheet As of December 31, 2008 P10,000 CHIT MANLUNAS Income Statement For the Period December 31, 2008 Service Revenues Less: Expenses: Advertising Expenses Rent Expenses Salaries Expenses Other expenses 1.14 Balance Sheet A balance sheet is a formal statement showing the financial position of the enterprise as of a particular date. The balance sheet reflects the three elements of financial position, namely assets, liabilities and capital. All accounts in the balance sheet are called real or permanent accounts. These accounts are not closed at the end of the period. 6,925 P3, 185 The heading of an income statement is composed of a name of a business or an owner's name of statement, and date for a given period. The body of the income statement is composed of the service revenue above and the expenses deducted from revenues to arrive at net income or loss. The effect of the income statement will be forwarded to the balance sheet. Total Assets Liabilities and Proprietorship Liabilities Accounts Payable-Cyrex Proprietorship Manlunas, Capital P22,000 Less: Withdrawal 1,000 P21,000 3,185 24,185 Add: Net Profit Total Liabilities and Proprietorship P5, 235 750 16, 500 1, 950 P 24, 435 250 24,185 P24, 435 The heading balance sheet is composed of the name of the owner or business owners, the name of the statement, and the date of the statement. It should be noted that a balance sheet is as of a given date. COMMUNICATING – occurs through the preparation and distribution of financial and other accounting reports. Financial statement is the most popular accounting report. The body of a balance sheet is composed of the assets, liabilities and proprietorship. Other names for balance sheet are “statement of Assets and Liabilities”, “Statement of financial Position”, or “Statement of Financial Condition”. NATURE OF ACCOUNTING LESSON 1: INTRODUCTION TO ACCOUNTING A. INTRODUCTION There are numerous successful businesses both locally and internationally. Some top – of – mind companies include Microsoft, Apple, Coca– Cola and Procter and Gamble. Here in the Philippines, surging businesses include Puregold, Petron, Globe and many others. Obviously, these businesses offer products which are distinct from one another. Have you ever wondered about the secret formula for a company’s success? This discussion can go on for days without yielding definite answers.Nonetheless, there is a common factor among these businesses that contribute to their success – 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 link between business activities and decision makers. It measures business activities by recording data about them for future use. Then through data processing, the data is stored and processed to become useful information. Lastly the information is communicated, through reports like financial statements, income statements and cash flow statements to those who can use it in making 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. B. LESSON PROPER WHAT IS ACCOUNTING? “Accounting is the process of IDENTIFYING, RECORDING, and COMMUNICATING economic events of an organization to interested users.” (Weygandt, J. et. al) 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 REMEMBER: To be identified as a relevant economic event there should be… TRANSFER OF THINGS WITH VALUE 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. For example: Source documents are the original business documents that are used to track business transactions. Documents like invoices, purchase orders, and receipts all track and keep a record of the original transaction; Information processors, like computers and software programs, take the raw data from the input devices and post it to ledgers, journals, and reports that can be used by decision makers. 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. WHAT IS THE FUNCTION OF ACCOUNTING IN BUSINESS? Why accounting is considered the language of 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 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 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. Let us now discuss the function of accounting in business. The American Accounting Association (AAA) defines accounting as the process of identifying, measuring and communicating economic information to permit informed judgements and decisions by the users of information. Meanwhile, the American Institute of Certified Public Accountants (AICPA) defines as the art of recording, classifying and summarizing in a significant manner and in terms of money, transactions and events which are part at least of a financial character and interpreting the results thereof. From the foregoing definitions, the main functions of accounting can be summarized as follows: 1. Keeping systematic records of business transactions ● Records should be systematic enough to enable easy understanding of readers ● No matter how comprehensive the records are, if they are not produced systematically, then they provide little to no value. 2. Protecting properties of the business ● Records serve as the evidence that properties of a business do exist or how much of a particular resource does a company have. ● Helps in preventing employee fraud and misappropriation of company resources 3. Communicating results to various parties in or connected with the business ● Used by the management in their decision-making function as well as External users (e.g., potential investors, government agencies) 4. Meeting legal requirements ● In the Philippines, the government requires some companies particularly those with public accountability to provide financial reports quarterly, semi – annually or annually. This procedures aim to protect the public by providing them the necessary information to make sound decisions. For example: 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? Possible Answers: a. Is my business earning? (profitability) b. How much daily or monthly sales do I need in order to recover my fixed cost? (break-even) c. Do I need to hire additional workers to help me with my production? d. Can I afford to set up a new store in another place? Where Do I get the funds? e. Can I afford to pay a bank loan? 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. Following is 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. ● 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). ● The Present - The Development of Modern Accounting Standards and Commerce. At present times, accounting standards are already available to guide accountants in their practice of the profession. Some of these standards include the PFRS (Philippine Financial Reporting Standard) and the PAS (Philippine Accounting Standard).