Assets, Liabilities, Owner's Equity
Saturday, October 16, 2021
10:28 AM
Accounting - provides financial information necessary in making economic decisions
Balance sheets
Purpose - provides the financial position of the company necessary for users to evaluate it's
ability to pay obligations, salaries, and it's future benefits to users.
- Companies makes comparative statement of the history of the companies balance sheet to
know if sale's decline or if there's an improvement for the past years.
Problems in sales may arise from the marketing department
Possible solution - give quota to sale employees
Cost-cutting to employees salaries
- Firing of employees
- Rotational shifts for employees (MWF-TTHSAT)
- Accountant - controller - highest paying job in the company - is able to read financial
statements to make right decisions
Assets - economic resources owned by the business expected for future gain.
Current Assets - mainly assets owned by the company with the intention to hold for 1 year
only or can be redeemed within 1 year. Held primarily for the purpose of being traded.
- Cash or cash equivalent unless it is restricted from being exchanged or used to settle a
liability for at least twelve months after the balance sheet date
- Expected to be realized in, or is intended for sale or consumption in, the entity's normal
operating cycle
- are classified and presented accordingly to liquidity with the most liquid followed by
those with lesser liquidity.
1. Cash
- Includes coins, currencies, checks, bank deposits, and other cash items readily
available for use in the operations of the business. (petty cash of the business,
cash on hand)
- Dates on checks should be acceptable for deposits for the current
accounting period.
- Restriction from being exchanged or used to settle a liability for at
least twelve months after the balance sheet date falls on noncurrent assets
- Most liquid asset of the company
2. Cash Equivalents - short-term investments that are readily convertible to known
amounts of cash which are subject to an insignificant risk to changes in value.
- PAS 7, Paragraph 7 - an investments normally qualifies as a cash equivalent only
when it has a short maturity of three months or less from the date of acquisition
3. Trades, non-trades and other receivables - amounts collectible by the business
Trades receivables - refers to any receivable generated by selling a product or
providing a service to a customer.
▪ Accounts receivables - amounts collectible from the customer to whom
sales have been made or services have been rendered on account or
credit.
▪ Notes receivable - receivables with written record or promissory note
issued by the client or the customer in exchange for services or goods
received as evidence of his/her obligation to pay.
Non-Trade receivables - when someone owes the company money not related
to providing a service or selling a product.
▪ Advances to employees - certain amount of money loaned to employees
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▪ Advances to employees - certain amount of money loaned to employees
payable in cash or through salary deduction
▪ Accrued income - income already earned but not yet received.
▪ Interest receivable - amount of interest collectible on promissory notes
received from customers and clients.
▪ Refundable taxes
▪ Claims from insurance
4. Inventories - unsold goods at the end of the accounting period. Applicable only to
merchandising business.
5. Prepaid expenses - include supplies bought for use in the business or services and
benefits to be received by the business in the future paid in advance.
6. Contra-asset accounts - accounts deducted from the related asset accounts
▪ Allowance for bad-debts/doubtful accounts - losses due to uncollectible
accounts.
7. Marketable Securities - are stocks and bonds purchased by the enterprise and are to
be held for only a short span of time or duration. Example: buying of stocks for small
prices and then selling it when there is a rise on its value for profit.
8. Short-term investments - investments made with the intention of holding it for less
than or within a year or an accounting period.
Non-current assets - A noncurrent asset is an asset that is not expected to be consumed
within one year.
1. Long-term investments - interests, royalties, dividends, rentals, stocks, real estates,
cash that the company intends to hold for more than one year.
2. Cash surrender value of life insurance - is the sum of money an insurance company
pays to a policyholder or an annuity contract owner if their policy is voluntarily
terminated before its maturity or an insured event occurs. Internal value of an
insurance policy at any point that is equal to the value of the accumulation account
minus a surrender charge.
3. Properties, plants, and equipment - tangible assets that are held by an enterprise for
use in the production or supply of goods or services, or for administrative purposes.
These assets are expected to be used for more than one period.
▪ Land - a piece of lot or real estate owned by the enterprise on which a building
can be constructed for business purposes.
▪ Building - structure used to accommodate the office, store, or factory of
business enterprise in the conduct of its operations.
▪ Equipment - may be office equipment, store equipment, delivery equipment,
transportation equipment, office equipment.
▪ Furniture and fixtures - are larger items of movable equipment that are used to
furnish an office. Examples are bookcases, chairs, desks, filing cabinets, and
tables. (Account titles - office furniture and fixtures, store furniture and fixtures)
4. Intangible assets - identifiable, non-monetary assets without physical substance held
for use in the production or supply off goods and services, for rental to others or for
administrative purposes.
May be indefinite (stays with the company for as long as it continues operation)
or definite (An example of a definite intangible asset would be a legal
agreement to operate under another company's patent, with no plans of
extending the agreement. The agreement thus has a limited life)
▪ Goodwill - reputation of the company to earn more than the others.
Relationships with customers, vendors and the community, and its participation
in trade-related activities.
▪ Patents - a government authority or license conferring a right or title for a set
period, especially the sole right to exclude others from making, using, or selling
an invention
▪ Copyrights - is a legal term used to describe the rights that creators have over
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▪ Copyrights - is a legal term used to describe the rights that creators have over
their literary and artistic works. Works covered by copyright range from books,
music, paintings, sculpture, and films, to computer programs, databases,
advertisements, maps, and technical drawings.
▪ Franchises and Licenses - Franchises and licenses are intangible assets that
legally entitle a business to sell a product or service developed by another
entity. Profit advantage over similar businesses by virtue of the franchise.
Franchise - A franchise is a contract that grants a business the right to
operate using the name and products of an established brand.
Franchise (base on government) - a right granted by a government or
corporation to an individual or group of individuals. (fishing rights, flight
rights, broadcasting rights)
(product franchising, manufacturing franchising, business-format
franchising, trade-name franchising, product distribution franchising, pure
franchising)
Licenses - is similar to a franchise, in that it grants someone the right to
legally use someone else’s intellectual property or goods. (Patent
licensing, copyright licensing, trademark licensing, trade secret licensing)
▪ Trademarks - a symbol, word, or words legally registered or established by use
as representing a company or product.
▪ Brand names - identifies a specific company, product or service and
differentiates it from similar brands within a category
▪ Secret processes, methods and formulas - A trade secret is any practice or
process of a company that is generally not known outside of the company.
Information considered a trade secret gives the company a competitive
advantage over its competitors and is often a product of internal research and
development.
▪ Contracts - Certain contracts, such as employment, affiliation, advertising, or
sales contracts, can be treated as intangible assets because they add value to a
company.
▪ Subscription list
▪ Non-competition agreement - Certain contracts, such as employment,
affiliation, advertising, or sales contracts, can be treated as intangible assets
because they add value to a company.
5. Long-term Contra-current Assets
Accumulated depreciation - is the cumulative depreciation of an asset up to a
single point in its life.
Liabilities - are any debts your company has, whether it's bank loans, mortgages, unpaid bills,
IOUs, or any other sum of money that you owe someone else. If you've promised to pay someone
a sum of money in the future and haven't paid them yet, that's a liability.
- Are classified and presented based on their maturity. Obligations presently due for payment
are listed first.
Current Liabilities - are a company's short-term financial obligations that are due within one
year or within a normal operating cycle.
1. Trade and other payables
Trade payables - obligations to pay for goods or services that have been
acquired from suppliers in the ordinary course of business.
Notes on accounts payable and trades payable*
Although some people use the phrases "accounts payable" and "trade
payables" interchangeably, the phrases refer to similar but slightly
different situations. Trade payables constitute the money a company
owes its vendors for inventory-related goods, such as business supplies or
materials that are part of the inventory. Accounts payable include all of
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materials that are part of the inventory. Accounts payable include all of
the company's short-term debts or obligations.
For example, if a restaurant owes money to a food or beverage company,
those items are part of the inventory, and thus part of its trade payables.
Meanwhile, obligations to other companies, such as the company that
cleans the restaurant's staff uniforms, fall into the accounts payable
category. Both of these categories fall under the broader accounts
payable category, and many companies combine both under the term
accounts payable.
▪ Accounts payable - Includes debts arising from the purchase of an asset or
the acquisition of services on accounts.
▪ Notes payable - includes debts arising from the purchase of an asset or
the acquisition of services on account with the issue of a note.
▪ Unearned revenues - obligations of the business arising from advance
payments received before goods or services are provided to the customer.
Non-Trade and Other Payables - payables which are not related directly to the
core operating business of the company.
▪ Accrued liabilities - include amounts owed to others for expenses already
incurred but are not yet paid. (Salaries payable, utilities payable, taxes
payable, interest payable)
▪ withholding tax payable is the amount an employer withholds from an
employee's wages and pays directly to the government.
2. Short-term debt - also called current liabilities, is a firm's financial obligations that are
expected to be paid off within a year. Common types of short-term debt include shortterm bank loans, accounts payable, wages, lease payments, and income taxes payable.
3. Current portion of long-term debt - the amount of unpaid principal from long-term
debt that has accrued in a company's normal operating cycle (typically less than 12
months). It is considered a current liability because it has to be paid within that
period.
4. Income tax payable - It is compiled of taxes due to the government within one year.
Non-current liabilities - long term liabilities or obligations which are payable for a period
longer than one year.
Long term loans - are generally over a year in duration and sometimes much longer.
1. Mortgage payable - is a long-term debt of the business with security or collateral in
the form of real properties. In case the business fails to pay the obligation, the
creditor can foreclose or cause the mortgaged asset to be sold and use the proceeds
of the sale to settle the obligation.
2. Debentures - is a type of bond or other debt instrument that is unsecured by
collateral. Since debentures have no collateral backing, they must rely on the
creditworthiness and reputation of the issuer for support.
--3. Long-term lease obligation - is the amount due for asset lease agreements that are
due in more than one year from balance sheet date.
4. Pension benefit obligation - the present value of retirement benefits earned by
employees.
5. Bonds payable - are a form of long term debt usually issued by corporations, hospitals,
and governments. The issuer of bonds makes a formal promise/agreement to pay
interest usually every six months (semiannually) and to pay the principal or maturity
amount at a specified date some years in the future. The agreement containing the
details of the bonds payable is known as the bond indenture.
6. Deferred tax liabilities - a listing on a company's balance sheet that records taxes that
are owed but are not due to be paid until a future date. The liability is deferred due to
a difference in timing between when the tax was accrued and when it is due to be
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a difference in timing between when the tax was accrued and when it is due to be
paid.
Owner's equity
Capital - an account bearing the name of the owner representing the original and additional
investment of the owner of the business increased by the amount of net income earned during
the year. It is decreased by cash or other assets withdrawn by the owner as well as the net loss
incurred during the year
Drawing - represents the withdrawals made by the owner of the business either in cash or other
assets
Income Summary - a temporary account used at the end of the accounting period to close income
and expense accounts.
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The accountancy profession
Thursday, November 4, 2021
3:52 PM
Accounting Standards Council - PICPA
Accounting is a service activity.
Committee on accounting terminology of the American institute of certified public accountant - AICPA
Accounting is an art
American accounting association
Accounting is a process
Objective of accounting
To provide quantitative financial information about a business that is useful to statement users
particularly owners and creditors in making economic decisions
Task of an accountant
To supply financial information so that the statement users could make informed judgement and
better decision.
REPUBLIC ACT NO. 9298 - Philippine Accountancy act of 2004 (law regulating the practice of
accountancy in the Philippines)
Board of Accountancy (BOA) - is the body authorized by law to promulgate rules and regulations
affecting the practice of the accountancy profession in the Philippines. Responsible for preparing and
grading LECPA
PRC - Professional regulation commission
Three main areas of accounting
1. Public accounting - practice of the accountancy profession
a. Auditing/External Auditing - examination of financial statements by independent certified
public accountant for the purpose of expressing an opinion as to the fairness with which the
financial statements are prepared.
(attest functions of independent CPAs)
b. Taxation service - includes the preparation of annual income tax returns and determination
of tax consequences of certain proposed business endeavor.
c. Management Advisory service - service to clients on matters of accounting, finance,
business policies, organization procedures, product costs, distribution and other phases of
business conduct and operations.
2. Private accounting - CPAs are employed in business entities in various capacity as accounting staff,
chief accountant, internal auditor and controller. Objective: to assist management in planning and
controlling the operations of entity. (See more from the book for more objective)
Controller - Highest accounting officer in a business entity
3. Government accounting - encompasses the process of analyzing, classifying, summarizing and
communicating all transactions involving the receipt and disposition of government funds and
property and interpreting the results thereof. Focus: custody and administration of public funds.
Republic act no. 10912 - law mandating and strengthening the continuing professional development
program for all regulated professions
Continuing professional education - inculcation and acquisition of advanced knowledge, skill,
proficiency, and ethical and moral values after the initial registration of the certified public accountant.
CPD (Continuing professional development) credit units - CPD credit hours required for the renewal of
CPA license and accreditation of a CPA to practice the accountancy profession every three years.
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CPA license and accreditation of a CPA to practice the accountancy profession every three years.
CPA - 120 CPD credit units for accreditation to practice accountancy
15 CPD - required for renewal of CPA license
CPD is required for both accreditation and renewal.
A CPA shall be permanently exempted from CPD requirements for renewal upon reaching the age of 65.
Auditing is one of the area of accounting specialization.
Accounting ceases when financial statements are already prepared. The work of an auditor begins when
the work of the accountants ends.
Bookkeeping is procedural and largely concerned with development and maintenance of accounting
records.
It is the HOW of accounting.
Accounting is conceptual and concerned with the why, reason or justification for any action adopted.
Financial accounting - focuses on general purpose reports known as financial statements which are
intended for internal and external users. Emphasizes reporting to creditors and investors.
Managerial accounting - accumulation and preparation of financial reports for internal users only.
Emphasizes developing accounting information for use within an entity.
Generally Accepted accounting principles (GAAP) - encompass the conventions, rules and procedures
necessary to define what is accepted accounting practice.
- GAAP are conventional. The principles become generally accepted by agreement. The principles
have developed on the basis of experience, reason, custom, usage, and practical necessity.
Represents the rules, procedures, practice and standards followed in the preparation and
presentation of financial statements. Like laws that must be followed in financial reporting.
Financial reporting standards council (FRSC) - Accounting standard setting body created by the PRC to
assist the BOA in carrying out its powers and functions provided under R.A. No. 9298.
Function: to establish and improve accounting standards that will be generally accepted in the
Philippines.
Constitute the highest hierarchy of GAAP in PH
Statements are known as Philippine Accounting standards (PAS) or Philippine financial reporting
standards (PFRS).
PFRS corresponds to IFRS and IAS and the interpretations of IFRIC
FRSC members - 15, chairman should have been a senior accounting practitioner. 3 years term.
Philippine Interpretation Committee (PIC) - To prepare interpretations (intentive to give authoritative
guidance) of PFRS for approval by FRSC. To provide timely guidance on financial reporting issues not
specifically addressed in current PFRS
International Accounting Standards committee ( IASC) - objective of achieving uniformity in accounting
principles used by businesses around the world. Approved statements are called International
accounting standards (IAS)
IASC is now International accounting standards board (IASB) - statements made are called
International Financial reporting standards (IFRS)
IFRS - is a global phenomenon intended to bring about greater transparency and a higher degree of
comparability in financial reporting.
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Conceptual framework (Objective of financial reporting)
Thursday, November 4, 2021
4:51 PM
Conceptual framework - is a summary of terms and concepts that underlie the preparation and
presentation of financial statements.
- Describes the concepts for general purpose of financial reporting.
- Underlying theory for the development of accounting standards and revision of previously issued
one.
- An attempt to provide an overall theoretical foundation for accounting.
Provides foundation for standards:
Contribute to transparency - enhancing international comparability and quality
Strengthen Accountability - reducing information gap between providers of capital and the
people to whom they have entrusted their money.
Contribute to economic efficiency - helping investors to identify opportunities and risks across the
world.
Purposes of the conceptual framework
- To assist IASB in developing IFRS based on consistent concepts
- To assist preparers of financial statements when no standard applies to a transaction
- To assist preparers to develop accounting policy when a standard allows a choice of an accounting
policy
- To assist all parties to understand and interpret IFRS
Authoritative status
- If there is a standard or an interpretation that specifically applies to a transaction, the standard
overrides the conceptual framework. In the absence of a standard management considers the
applicability of conceptual framework.
- Conceptual framework is not IFRS
- IFRS over Conceptual framework.
USERS OF FINANCIAL INFORMATION under the conceptual framework
Primary users - include the existing and potential investors, lenders, and other creditors.
- The parties to whom general purpose financial reports are primarily directed (see book for more
details pg. 23)
Other users - include the employees, customers, government and its agencies, and the public
- Parties that may find the general purpose financial reports useful but the reports are not directed
to them primarily. (see book, pg. 24)
Revised Conceptual Framework
1. Objective of financial reporting - to provide financial information for decision making. Why,
purpose or goal of accounting.
Financial reporting - provision of financial information about an entity to external users.
Financial highlights, summary of important financial figures, analysis of financial statements
and significant ratios. Also include nonfinancial information such as description of major
products and a listing of corporate directors and officers.
Objectives: to provide information useful in making decisions about providing
resources to entity, useful in assessing the cash flow prospects of the entity, entity
resources, claims, and changes in resources and claims.
Limitations: do not and cannot provide all the information that users need, not
designed to show the value of the entity but reports provide information to help the
primary users estimate the value of the entity, intended to provide common
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2.
3.
4.
5.
6.
7.
8.
primary users estimate the value of the entity, intended to provide common
information and not specialized information, based on estimate and judgment rather
than exact depiction.
Provides information not only about the entity performance but also management
performance or management stewardship.
Annual financial statements - principal way of providing financial information to external
users.
Qualitative characteristics of useful financial information
Financial statements and reporting entity
Elements of financial statements
Recognition and derecognition
Measurement
Presentation and disclosure
Concepts of Capital and capital maintenance
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Conceptual Framework (Qualitative Characteristics)
Thursday, November 4, 2021
5:55 PM
Qualitative characteristics - are the qualities of attributes that make financial accounting information
useful to the users.
Deciding which information should be included - the objective is to ensure that the information is
useful to the users in making economic decisions.
Two classifications
1. Fundamental qualitative characteristics - relate to the content or substance of financial
information
a. Relevance - the capacity of the information to influence a decision. Capacity to make a
difference in a decision made by users. Information that does not bear an economic decision
is useless. (pg. 36)
i. Predictive value - can help users increase the likelihood of correctly predicting or
forecasting outcome of events.
ii. Confirmatory value - provides feedback about previous evaluations. Enables users to
confirm or correct earlier expectation.
Predictive and confirmatory value of an information is interrelated.
Materiality (doctrine of convenience) related to relevance - strict adherence to GAAP
is not required when the items are not significant enough to affect the evaluation,
decision and fairness of the financial statements.
- Quantitative threshold
- The relevance of information is affected by its nature and materiality.
- Subq-uality of relevance based on nature and magnitude of the item to which
the information relates.
- Materiality is a relativity.
- Materiality of an item depends on relative size rather that absolute size. What is
material for one entity may be immaterial for another.
- Dependent on good judgment, professional expertise and common sense.
- An item is material if knowledge of it would affect or influence the decision of
the primary user of the financial statements.
- Information is material if omitting, misstating or obscuring it could reasonably
be expected to influence the economic decisions that primary users of general
purpose financial statements make on the basis of those statements which
provide financial information about a specific reporting entity.
- Materiality of information is relevant only to primary users and not to other
users.
- Primary users because these groups are the users to whom general purpose
financial statements are primarily directed.
Obscuring Information - presentation of financial information not readily understood
or not clearly expressed.
- May be characterized by deliberate vagueness, ambiguity and abstruseness.
(p40)
b. Faithful Representation - financial reports represent economic phenomena or transactions
in words and numbers.
- The descriptions and figures match what really existed or happened.
Concept of substance over form - if information is to represent faithfully the
transactions it purports to represent, it is necessary that the transactions are
accounted for in accordance with their economic substance and reality and not
merely their legal form.
- if there is a conflict between substance and form, the economic substance of
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- if there is a conflict between substance and form, the economic substance of
the transaction shall prevail over the legal form.
- Faithful representation inherently represents the substance of an economic
phenomenon or transaction rather than merely representing its legal form.
i. Completeness - requires that relevant information should be presented in a way that
facilitates understanding and avoids erroneous implication.
- Result of the Adequate disclosure standard or principal of adequate disclosure
- Means that all significant and relevant information leading to the
preparation of financial statements shall be clearly reported.
- Disclosure of any financial facts significant enough to influence the
judgment of informed users.
- Financial statements shall include notes to financial statements. The
purpose of the notes is to provide necessary disclosures required by PFRS
Notes to financial statements provide narrative description or
disaggregation of the items presented in the financial statements
and information about items that do not qualify for recognition.
ii. Neutrality - financial statements should not be prepared so as to favor one party to
the detriment of another party.
- Information in financial statements must be free from bias.
- Principle of fairness
- To be neutral is to be fair
Concept of Prudence - is the exercise of care and caution when dealing with the
uncertainties in the measurement process such that assets or income are not
overstated and liabilities or expenses are not understated.
- Neutrality is supported by the exercise of prudence
Concept of Conservatism - when alternative exist, the alternative which has the
least effect on equity shall be chosen.
- Managers, investors, and accountants generally preferred that possible
errors in measurement be in the direction of understatement rather than
overstatement of net income and net assets.
- In case of doubt, record any loss and do not record any gain.
- If there is a choice between two acceptable asset values, the lower figure
is selected.
Contingent loss - recognized as a provision if the loss is probable
and the amount can be reliably measure.
Contingent gain - not recognized but disclosed only.
- Conservatism is not a license to deliberately understate net income and
net assets.
Expressions of conservatism
- Anticipate no profit and provide for probable and measurable
loss
- In the matter of income recognition, the accountant takes the
position that no matter how sure the businessman might be
in capturing the bird in the bush, the accountant, must see it
in the hand.
- Don't count your chicks until the eggs hatch.
iii. Free from error - there are no errors or omissions in the description of the
phenomenon or transactions.
- Does not mean perfectly accurate in all aspects.
- For example, estimation of a value cannot be determined to be accurate or
inaccurate. However, a representation of that estimate can be faithful if the
amount is described clearly and accurately as an estimate. Moreover, The
nature and limitations of the estimating process are explained. No errors have
been made in applying an appropriate process for developing the estimate.
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been made in applying an appropriate process for developing the estimate.
Information must be both relevant and faithfully represented for it to be useful.
2. Enhancing Qualitative characteristics - intended to increase the usefulness of the financial
information that is relevant and faithfully represented. Relate to the presentation or form of
financial information.
a. Understandability - requires that financial information must be comprehensible or
intelligible if it is to be useful
- Information should be presented in a form and expressed in terminology that a user
understands.
- Classifying, characterizing and presenting information clearly and concisely.
- Information in financial statements are readily understandable by users.
- Financial statements cannot realistically be understandable to everyone.
- Financial reports are prepared for users who have a reasonable knowledge of business
and economic activities and who review and analyze the information diligently.
- A relevant and faithfully represented information may prove useless if it is not
understood by users.
b. Comparability - the ability to bring together for the purpose of noting points of likeness and
difference.
- There are two kinds of comparability:
Comparability within an entity (horizontal comparability or
intracomparability) - is the quality information that allows comparison within a
single entity through time or from one accounting period to the next.
Comparability across entities (intercomparability or dimensional
comparability) - quality of information that allows comparisons between two or
more entities engaged in the same industry.
- Financial statements of different entities are compared in order to
evaluate their relative financial position, financial performance and cash
flows.
- Users' decisions involve choosing between alternatives
- Relevant and faithfully represented information is most useful if it can be compared
with similar information about the same entity for the previous period and with
similar information reported by other entities.
- Uniform application of accounting method between and across entities in the same
industry.
Principle of Consistency - use of the same method for the same item, either from
period to period within an entity or in a single period across entities.
- Is not the same with comparability. Comparability is the goal and consistency
helps to achieve that goal.
- Uniform application of accounting method from period to period within an
entity.
- Does not mean that no change in accounting method can be made. If the
change will result to more useful and meaningful information, then such change
should be made. But there should be full disclosure of the change and the peso
effect thereof.
- It is inappropriate to leave accounting policies unchanged when better and
acceptable alternatives exist.
c. Verifiability - different knowledgeable and independent observers could reach consensus
that a particular depiction is a faithful representation.
- Verifiability implies consensus
- Information is supported by evidence so that an accountant that would look into the
same evidence would arrive at the same decision or conclusion.
- Verifiable financial information provides results that would be substantially duplicated
by measurers using the same measurement method.
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by measurers using the same measurement method.
d. Timeliness - having information available to decision makers in time to influence their
decisions.
- Financial information must be available or communicated early enough when a
decision is to be made.
- Relevant and faithfully represented financial information furnished after a decision is
made is useless or of no value.
- Relevant information may lose relevance if there is undue delay in the reporting.
- Without knowledge of the past, the basis of prediction will usually be lacking and
without interest in the future, knowledge of the past is sterile
- What happened in the past would become the basis of what would happen in the
future.
Cost constraint - consideration of the cost incurred in generating financial information against the
benefit to be obtained from having the information.
- Reporting financial information imposes cost and it is important that such cost is justified by
the benefit derived from the financial information.
- The benefit derived from the information should exceed the cost incurred in obtaining the
information.
- Evaluation of cost constraint is a judgmental process.
- Assessing whether the cost of reporting outweighs or falls short of the benefit is difficult to
measure an becomes a matter of professional judgment.
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Conceptual frameworks (Financial statements and reporting
entity underlying assumptions)
Thursday, November 4, 2021
7:43 PM
Financial statements - provide information about economic resources of the reporting entity, claims
against the entity and changes in the economic resources and claims.
- Provide financial information about an entity's assets, liabilities, equity, income and expenses
(ALEIE) useful to users in assessing future cash flows of the entity and assessing management
stewardship of the entity's economic resources.
Parent - entity that exercise control over the subsidiaries.
Revised conceptual framework
1. Consolidated financial statements - financial statements prepared when the reporting entity
comprises both the parent and its subsidiaries.
- Provide information about ALEIE of both the parent and its subsidiaries as a single reporting
entity.
- Net cash inflows to the parent include distributions to the parent from its subsidiaries.
- Not designed to provide separate information about the ALEIE of a particular subsidiary.
2. Unconsolidated financial statements - prepared when the entity is the parent alone.
- Designed to provide information about the parent's ALEIE and not about those of the
subsidiaries.
- A claim against the parent typically does not give the holder of that claim against
subsidiaries.
- Unconsolidated financial statements cannot serve as substitute for consolidated financial
statements.
- Typically not sufficient to meet the requirement need of primary users
3. Combined financial statements - when the reporting entity comprises two or more entities that
are not linked by a parent and subsidiary relationship.
Reporting entity - an entity that is require or chooses to prepare financial statements.
- Can be a single entity or a portion of an entity, or can comprise more than one entity.
- Not necessarily a legal entity
Considered as reporting entity:
- Individual corporation, partnership or proprietorship
- The parent alone
- The parent and its subsidiaries as a single reporting entity
- Two or more entities without parent and subsidiary relationship as a single reporting
entity
- A reportable business segment of an entity.
Reporting period - is the period when financial statements are prepared for general purpose
financial reporting.
Interim basis - financial statements are prepared for example on three months, six months,
or nine months. Not required but optional
- Financial statements must be prepared on an annual basis or a period of twelve months.
- Financial statements provide information about ALE at the end of the reporting period and
IE during the reporting period. It also provides comparative information for at least one
preceding reporting period. May also include information about transactions and other
events occurred after the end of reporting period.
Accounting assumptions or Accounting postulates - basic notions or fundamental premises in which the
accounting process is based.
- Foundation of accounting in order to avoid misunderstanding but rather enhance the
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- Foundation of accounting in order to avoid misunderstanding but rather enhance the
understanding and usefulness of the financial statements.
- The conceptual framework for financial reporting mentions only one assumption, namely going
concern.
Going concern or continuity assumption - the accounting entity is viewed as continuing in
operation indefinitely in the absence of evidence to the contrary.
- Financial statements are prepared normally on the assumption that the entity shall
continue in operation for the foreseeable future.
- Assets are normally recorded at original acquisition cost. As a rule, market values are
ignored.
- This postulate is the very foundation of the cost principle
- Implicit in accounting are the basic assumptions of accounting entity, time period and monetary
unit.
Accounting entity assumption - The entity is separate from the owners, managers, and
employees who constitute the entity.
Accounting entity - the specific business enterprise, which may be a proprietorship,
partnership or corporations.
- The transactions of the entity should not be merged with the transactions of the
owners.
Time period assumption - requires that the indefinite life of an entity is subdivided into
accounting periods which are usually of equal length for the purpose of preparing reports on
financial positions, financial performance, and cash flows.
Accounting period or fiscal period - one year or a period of twelve months. May be:
Calendar year - a twelve-month period that ends on December 31
Natural business year - a twelve month period that ends on any month when
the business is at the lowest or experiencing slack season.
- One year period is traditionally the accounting period because usually it is after one
year that government reports are required.
Monetary unit assumption
Quantifiability aspect - means that the ALEIE should be stated in terms of a unit of
measure which is the peso in the Philippines.
Stability of the peso aspect or postulate - means that the purchasing power of the
peso is stable or constant and that its instability is insignificant and therefore may be
ignored.
- Amplification of the going concern.
- The accounting function is to account for peso only and not for changes in purchasing
power.
- Assumption that the peso is a stable measure over time is not necessarily valid, when
there is a significant gap between historical cost and current replacement cost, the
entity may choose the revaluation model as an accounting policy.
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Conceptual framework (Elements of financial statements)
Thursday, November 4, 2021
8:34 PM
Elements of financial statements - refer to the quantitative information reported in the statement of
financial position and income statement.
- Building blocks from which financial statements are constructed.
- The elements directly related to the measurement of financial position are asset, liability, and
equity.
- The elements directly related to the measurement of financial performance are income and
expense.
- The conceptual framework identifies no elements that are unique to the statement of changes in
equity because such statements comprises items that appear in the statement of financial position
and the income statement.
- Equity is the residual interest in the assets of the entity after deducting all the liabilities.
New definition of Asset - defined as a present economic resource controlled by the entity as a result of
past events.
- An asset is an economic resource and that the potential economic benefits no longer needed to be
expected to flow to the entity.
Economic resource - a right that has the potential to produce economic benefits
- It does not need to be certain or even likely that the right will produce economic benefits.
- It is only necessary that the right already exist.
- A right can meet the definition of an economic resource even if the probability that it will
produce economic benefit is low.
- The economic resource is the present right that contains the potential and not the future
economic benefits that the right may produce.
Examples of rights that have the potential to produce economic benefits (p74):
- Rights that correspond to an obligation of another entity
- Rights that do not correspond to an obligation of another entity
- Rights established by contract or legislation
- An entity controls an asset if it has the present ability to direct the use of the asset and obtain the
economic benefits that flow from it.
- Control also includes the ability to prevent others from using such asset and therefor
preventing others from obtaining the economic benefits from the asset.
- Control may arise if an entity enforces legal rights.
- If there are no legal rights, control can still exist if an entity has other means of ensuring that
no other party can benefit from an asset.
New definition of Liability - present obligation of an entity to transfer economic resource as a result of
past events.
- The entity has an obligation
- The obligation is to transfer an economic resource
- The obligation is a present obligation that exists as a result of past event.
- An obligation is a duty or responsibility that an entity has no practical ability to avoid
Legal obligation - enforceable by court as a result of a binding contract or statutory
requirement.
Constructive obligation - arises from normal business practice, custom and a desire to
maintain good business relations or act in an equitable manner.
Income
- Defined as increases in assets or decreases in liabilities that results in increase in equity, other
than those relating to contributions from equity holders.
- Encompasses both revenues and gains.
Revenue - arises in the course of the ordinary regular activities and is referred to by variety
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Revenue - arises in the course of the ordinary regular activities and is referred to by variety
of different names including sales, fees, interests, dividends, royalties, and rent.
- Regularity
Gains - represents other items that meet the definition of income and do not arise in the
course of the regular activities.
- Gains from disposal of noncurrent asset, unrealized gain on trading investment and
gain from expropriation.
Expense
- Decreases in assets or increases in liabilities that result in decreases in equity, other than those
relating to distributions to equity holders.
- Encompasses losses as well as those expenses that arise in the course of the ordinary regular
activities.
Expenses on regular activities
- Cost of goods sold, wages and depreciation.
Losses
- Resulting from disasters. Fire, flood, storm surge, tsunami and hurricane, disposal of
noncurrent assets.
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Conceptual framework - Recognition and measurement
Sunday, November 7, 2021
1:30 PM
Recognition - process of capturing for inclusion in the financial statements an item that meets the
definition of an asset, liability, equity, income, or expense.
- Links the elements to the statement of financial position and statement of financial performance.
- The recognition of an item in one statement requires the recognition of the same item in another
statement.
- Only items that meet the definition of an asset, a liability or equity are recognized in the
statement of financial position
- Only items that meet the definition of income or expense are recognized in the statement of
financial performance.
- An asset or liability and any corresponding income or expense can exist even if the probability of
inflow and outflow of the economic benefit is low.
Carrying amount - amount at which an asset, a liability or equity is recognized in the statement of
financial position.
Sale income recognition principle
- Income shall be recognized when earned.
- With respect to sale of goods in the ordinary course of the business, the point of sale is
unquestionably the point of income recognition.
○ Legal title to the goods were passed to the buyer at the point of sale.
Expense recognition principle
- Expenses shall be recognized when incurred
- Application of the matching principle
- The generation of revenue is not without any cost. There has got to be some cost in earning
a revenue.
- Requires that the costs and expenses incurred in earning a revenue shall be reported in the
same period.
Three applications of matching principle:
a. Cause and effect association
- The expense is recognized when the revenue is already recognized on the basis of a
presumed direct association of the expense with specific revenue.
- The strict matching concept
- Example: cost of merchandise inventory, doubtful accounts, warranty expense, sales
commissions.
b. Systematic and rational allocation
- Some costs are expensed by simply allocating them over the periods benefited.
- The cost incurred will benefit future periods and there is an absence of a direct or
clear association of the expense with specific revenue.
- When economic benefits are expected to arise over several accounting periods and
the association with income can only be broadly or indirectly determined, expenses
are recognized on the basis of systematic and allocation procedures
- Examples: Depreciation, amortization, allocation of prepayments.
c. Immediate recognition
- The cost incurred is expensed outright because of uncertainty of future economic
benefits or difficulty of reliably associating certain costs with future revenue.
- Expenses is recognized immediately when an expenditure produces no future
economic benefit or when cost incurred does not qualify or ceases to qualify for
recognition as an asset.
- Examples: officers salaries, most administrative expenses, advertising and most selling
expenses, amount to settle lawsuit, worthless intangibles, loss from disposal of
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expenses, amount to settle lawsuit, worthless intangibles, loss from disposal of
building, loss from sale of investments and casualty loss.
Derecognition
- The removal of all or part of a recognized asset or liability from the statement of financial position.
- Occurs when an items no longer meets the definition of an asset or a liability.
Derecognition of an asset
- Occurs when the entity loses control of all or part of the asset
Derecognition of a liability
- Occurs when the entity no longer has a present obligation for all or part of the liability.
Measurement
- Quantifying in monetary terms the elements in the financial statements.
Two categories of measurement:
a. Historical Cost - entry price or entry value to acquire an asset or to incur a liability
- The measurement basis most commonly adopted in preparing financial statements
Of an asset
- Cost incurred in acquiring or creating the asset comprising the consideration paid plus
transaction cost.
Updated because of:
- Depreciation and amortization
- Payment received as a result of disposing part or all of the asset
- Impairment
- Amortized cost measurement of financial asset.
Of a liability
- Consideration received to incur the liability minus transaction cost.
Updated because of:
- Payment made or satisfying an obligation to deliver goods
- Increase in value of the obligation to transfer economic resources such that the
liability became onerous
- Accrual of interest to reflect any financing component of the liability
- Amortized cost measurement of financial liability
b. Current value
i. Fair value - exit price or exit value
- Can be observed using the market price of the asset or liability in an active
market
- If fair value cannot be directly measured, an entity can use present value of cash
flows.
Fair value of an asset
- The price that would be received to sell an asset in an orderly transaction
between market participants at measurement date.
Of a liability
- Price that would paid to transfer a liability in a orderly transaction between
market participants at the measurement date.
ii. Value in use for asset - exit price or exit value
- Present value of cash flows that an entity expects to derive from the continuing
use of an asset and from the ultimate disposal.
- Does not include transaction cost on acquiring the asset but includes transaction
cost on the disposal of the asset
iii. Fulfillment value for liability - exit price or exit value
- Is the present value of cash that an entity expects to transfer in paying or
settling a liability.
- Does not include transaction cost on incurring a liability but on fulfillment of
liability.
iv. Current cost
Replacement cost of an asset
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Replacement cost of an asset
- Is the cost of an equivalent asset at the measurement date comprising the
consideration paid and transaction cost
Of a liability
- Is the consideration that would be received less any transaction cost at
measurement date.
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Conceptual framework - Presentation and disclosure of capital
Sunday, November 7, 2021
2:17 PM
Presentation and disclosure of capital
- Can be an effective communication tool about the information in financial statements
- A reporting entity communicates information about ALEIE by presenting and disclosing
information in the financial statements
- Effective communication of information in FS:
- makes the information relevant contributes to faithful representation
- It also enhances the understandability and comparability of information in FS
- Supported by not duplicating information in different parts of the FS
Duplication - usually unnecessary and can make financial statements less
understandable
- Can be achieved by classification and aggregation of ALEIE
Classification
- Sorting of ALEIE on the basis of shared or similar characteristics
Aggregation
- Adding together the ALEIE that have similar or shared characteristics and are included in the
same classification.
- Useful by summarizing a large volume of detail but may conceal some of the detail.
Two approaches in determining the financial performance of an entity
Transaction approach
- Traditional preparation of an income statement.
Capital maintenance approach
- Net income occurs only after the capital used from the beginning of the period is
maintained.
- Net income is the amount an entity can distribute to its owners and be as well-off at the end
of the year as at the beginning
Return of Capital
- Erosion of the capital invested in the entity
Return on capital
- Amount in excess of the initial investment earned by shareholders
Financial capital concept - Net assets approach
- Capital is synonymous with net assets or equity of the entity.
- Is the monetary amount of the net assets contributed by shareholders and the
amount of the increase in net assets resulting from earning retained by the entity.
- Traditional concept based on historical cost and adopted by most entities
- Net income occurs when the nominal amount of the net assets at the end of the year
exceeds the nominal amount of the net assets at the beginning of the period, after
excluding distributions to and contributions by owners during the period.
- The amount of net assets is the excess of total assets over total liabilities.
Physical Capital concept
- Is the quantitative measure of the physical productive capacity to produce goods and
services.
- May be based on unit of output per day or physical capacity of productive assets to
produce goods and services.
- Requires that productive assets be measured at current cost.
Productive assets includes inventories and PPE
- Should be adopted if the main concern of users is the operating capability of the
entity.
- Net income occurs when the physical productive capital of the entity at the end of the
year exceeds the physical productive capital at the beginning of the period, also after
excluding distributions to and contributions from owners during the period.
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Accounting Process
Sunday, November 7, 2021
2:54 PM
Accounting process - uniform procedures done to accomplish the accounting process are referred to as
the accounting cycle.
can be classified into two parts:
Recording Phase - includes analyzing the transaction, journalizing and posting
Summarizing phase - includes the unadjusted trial balance process to reversing entries.
Double - entry system
- Transaction has a dual effect
- Every transaction effects at least two accounts
- For every debit, there is a corresponding credit
- The total amount of the accounts debited must equal the total amount of the accounts credited
The post-closing trial balance, reversing entries, and worksheet are optional.
Steps in Accounting Cycle
1. Analyzing the business documents or transactions.
- The accountant determines the impact of the transactions on the financial positions as
represented by the basic equation "Assets = Liabilities + Equity"
- Identifying what should be recorded and what shouldn't
- Business documents - forms containing evidence to support a business transaction
- Provides the data concerning the parties involved in the transaction
2. Journalizing
- Process of recording the transactions on journal
Journal - a chronological record of transactions
- Book of original entry
General journal - the most fundamental journal, often simply called as journal
General journal entry - consists of the transaction date, the accounts and amounts to be
debited, the accounts and amounts to be credited, and a brief explanation of transactions.
Simple journal entry - consists of one debit and one credit
Compound journal entry - consist of two or more debits or two or more credits.
3. Posting
- Transactions as classified and recorded in journal are transferred to the appropriate
accounts in the general ledger and subsidiary ledger, if appropriate.
- Transferring information from journal to ledger
General ledger - often called simply as ledger, is a group of accounts
- Book of final entry
- Accounts under ledger are classified into two general groups:
○ Balance sheet or real accounts (ALE)
○ Income statement or nominal accounts (IE)
Account - the accounting device used in summarizing the effects of transaction on each
asset, liability, equity, revenue, and expense.
- A form of record that summarizes the increase or decreases of any specific accounting
value.
Chart of accounts - listing of all the entity's general ledger accounts in a systematic form
- List of all account titles used by the company with their corresponding account
numbers.
- Account titles are arranged in financial statement order.
- Order of accounts: ALERE or ALEIE
- The accounts are numbered for purpose of indexing and cross-referencing.
4. Preparing the unadjusted trial balance
Trial balance - a list of general ledger accounts with their respective debit or credit balance
- Schedule of all balances to prove the equality of the debit and credit.
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- Schedule of all balances to prove the equality of the debit and credit.
- A control device that helps eliminate accounting errors
- When total debits do not equal total credits, the trial balance is out of balance. This
alerts the accountant that errors have been made.
- If the total debits equal total credits, the trial balance is said to be balance however,
this does not signify the absence of errors.
- Does not indicate the failure to record a transaction or the recording of transaction in
wrong accounts.
- A list of accounts found in the ledger together with the account's total balance
Unadjusted trial balance - account balances do not yet reflect adjustments
5. Preparing the adjusting entries and worksheet
Worksheet - common tool used by accountants to assemble in one sheet all the information
needed to prepare the financial statements.
Adjusting entries - are made at the end of every accounting period in order to split mixed
accounts or to bring the accounts up to date.
- Allocates revenue and expenses between the current and future period
- Affects both a real account and a nominal account
- Necessary for a fair and accurate measurement of performance and financial position
on the accrual basis
Cash basis - revenue is recorded when cash is received and expenses are
recorded when paid in cash
Accrual basis - recognition of revenue when earned and recognition of expenses
when incurred
- GAAP requires the use of accrual accounting
Items that require adjusting entries
a. Ending Inventory
Inventory - end
xx
Income summary or cost of sales
xx
b. Doubtful accounts
Doubtful accounts
xx
Allowance for bad debts
xx
c. Depreciation
Depreciation
xx
Accumulated depreciation
xx
Deferrals
d. Prepaid expenses (Prepayments) - paid but not yet incurred. (Deferred expense)
Two methods of Recording prepaid expenses
Asset method - the original payments is debited to an asset
- Represents the expired or used portion of the prepayment
Journal entry upon payment
Prepaid expense
xxxx
Cash
xxxx
Adjusting entry
Expense
xxxx
Prepaid expense
xxxx
Expense method - An alternative method in recording prepayments wherein it
was initially recorded as an expense instead of an asset
- Represents the unexpired or unused portion of the prepayment
Journal entry upon payment
Expense
xxxx
Cash
xxxx
Paid expense
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Adjusting journal entry
Prepaid expense
xxxx
Expense
xxxx
To record unexpired expense
e. Deferred Income (unearned income) - income already received but not yet earned
(Deferred revenue)
Two methods of recording deferred or unearned Income
Liability method - A liability account is credited for the receipt of income
- In the adjusting entry, the amount is the earned portion of the amount
initially received.
Journal entry upon receipt of cash
Cash
xxxx
Unearned Income
xxxx
Received cash for service to be rendered
Adjusting entries
Unearned Income
xxxx
Income
xxxx
To record earned portion of the liability
Income method - An alternative method in recording deferrals is to initially
record them as an income instead of liability
- In the adjusting entry, the amount is the unearned portion of the amount
initially received
Journal entry upon receipt of cash
Cash
xxxx
Income
xxxx
Received cash for service to be rendered
Adjusting entry
Income
xxxx
Unearned Income
xxxx
To record income not yet earned
Accruals
f. Accrued expenses - expenses already incurred but not yet paid
Expenses
xx
Expenses Payable xx
g. Accrued Income - income already earned but not yet received
Income Receivable
xx
Income
xx
6. Preparing the financial statements
7. Preparing the closing entries
- Made for the purpose of closing all nominal and temporary accounts (Income and expenses)
- Use to update the capital account
- To close an account means to reduce its balance to zero
Nominal accounts - measure activities that have occurred during a given period of
time
- At the end of accounting period, nominal accounts have served their purpose.
- Balances must be reduced to zero so that the new nominal accounts can be
used to measure activities in the next accounting period.
- Temporary equity accounts (revenue, expenses, drawing)
- Balances may be transferred directly to an equity account during closing
- Most accountants transfer nominal accounts to a clearing account known as
income summary
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income summary
Income summary - summarizes the net income or net loss for the period and its
balance is ultimately closed to capital in the case of a proprietorship or retained
earnings in the case of corporation
- Temporary account used to close the nominal accounts
- Steps in closing the accounts - service
i. Close the Income accounts
ii. Close the expense accounts
iii. Close the income summary to capital
iv. Close the drawing account
- Closing entries for Merchandising
i. Close beginning inventory and nominal accounts with debit balances (expenses, sales
returns, sales discount, purchases, freight-in)
ii. Set up ending inventory and close nominal accounts with credit balances (Sales,
purchase returns, Purchase discount, Revenues)
iii. Close income summary to capital
iv. Close drawing account to capital
8. Preparing a post-closing trial balance
Post-closing trial balance - a listing of general ledger accounts and their balances after the
closing entries have been made.
- Consists entirely of real or permanent accounts (assets, liabilities, ending capital)
- Will test the equality of accounts
9. Preparing the reversing entries
Reversing entries
- Made at the beginning of the new accounting period in order to transfer all accrued
and prepaid items established by adjusting entries to the nominal accounts that are to
be used in recording transactions during the new period.
- The sole purpose is to simplify the recording of certain kinds of recurring transactions.
- Made to simplify the accounting process.
- A journal entry that is just the opposite of the adjusting entry made at the end of the
preceding accounting period.
- Adjusting journal entry is simply reversed at the beginning of the next accounting
period.
- The adjustments normally requiring reversal are:
1) Accrued expenses
2) Prepaid expenses (if expense method were used in recording expense)
3) Accrued Income
4) Deferred Income (If the income method is used in recording income)
Common errors in accounting process
Transposition - The figures are interchanged. For example: P1,234 is written as P4,123
Transplacement - Error in placing Decimal point. For example, P12,000 is written as P1,200.
Error of omission - A transaction is not recorded. For example: A sale of P10,000 is not journalized
T-account
- An informal tool used to analyze the effect of a transaction in ALEIE
- Three elements of an account: Account title, Debit, Credit
Worksheet
- Multicolumn sheet of paper that an accountant uses in compiling and summarizing the
information necessary for the preparation of the financial statements.
- Not a formal statement
- Only a tool of an accountant for the preparation of FS
- The accountant prepares a worksheet at that stage of the accounting cycle when it is time to make
adjustments and prepare financial statements
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adjustments and prepare financial statements
- Balancing figure in the worksheet is the net income or net loss
Net loss
- If the total of debits exceeds the total of the credits in income statement columns
- If the total credits exceed the total of the debits in the financial position column
Net income
- If the total of the credits exceeds the total of the debits in the income statement
columns
- If the total of the debits exceeds the total of the credits in the statement of financial
position
Principle of Debit and Credit
Debit - left side of an account, does not necessarily mean an increase
Credits - right side of an account, does not necessarily mean a decrease
Balance of the account - when both sides on account are each totaled and the smaller sum is
deducted from the larger sum, the difference is called balance of the account
Normal balance - the balance ordinarily found in an account, may be either debit or credit
depending on the type of account
Normal debit balance - increased when debited and decreased when credited
Normal Credit balance - increased when credited and decreased when debited
Account Normal Balance Balance Increased by
Balance decreased by
Asset
Debit
Debit
Credit
Liability
Credit
Credit
Debit
Equity
Credit
Credit
Debit
Revenue Credit
Credit
Debit
Expense Debit
Debit
Credit
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Financial statements
Thursday, November 11, 2021
1:47 PM
Financial statements - the means by which the information accumulated and processed in financial
accounting is periodically communicated to the users.
- End product or main output of the financial accounting process
- A structured financial representation of the financial position and financial performance of an
entity
- Objective: 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.
- Also shows the results of the management stewardship of the resources entrusted to it.
- Provide information about assets, liabilities, equity, income and expense including gains and
losses, contributions by and distribution to owners in their capacity as owners, cash flows.
General purpose financial statement
○ Statements that have been prepared for use by those who are not in a position to require an
entity to prepare reports tailored to their particular information needs.
○ Are directed to all common users and not to specific users.
Complete set of financial statement
1. Statement of financial position
2. Income statement
3. Statement of comprehensive income
4. Statement of changes in equity
5. Statement of cash flows.
6. Notes, comprising a summary of significant accounting policies and other explanatory information
- The management of an entity has the primary responsibility for the preparation and presentation
of the financial statements of the entity.
- Management is accountable for the safekeeping of the entity's resources and for their proper,
efficient and profitable use.
General features in the preparation and presentation of financial statements
1. Fair presentation and compliance with PFRS
- Fair representation of the effects of transaction and other events in accordance with the
definitions and recognition criteria for ALEIE laid down in the conceptual framework.
2. Going concern
- The accounting entity is viewed as continuing in operation indefinitely in the absence of
evidence to the contrary
3. Accrual basis
- Income is recognized when earned regardless of when received and expense is recognized
when incurred regardless of when paid.
4. Materiality and aggregation
- Specific requirements of PFRS need not to be met if the resulting information is not
material
5. Offsetting
- Assets, liabilities, income and expenses, when material, shall not be offset against each
other.
6. Frequency of reporting
- An entity shall present a complete set of financial statement annually
7. Comparative information
- The financial statements of the current period shall be presented with comparative figures
of the financial statements of the preceding year.
- Comparative information shall also include narrative and descriptive information when it is
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- Comparative information shall also include narrative and descriptive information when it is
relevant to an understanding of the current period's financial statement.
8. Consistency of presentation
- The presentation and classification of financial statement items shall be uniform from one
accounting period to the next.
Third statement of financial position
Required when an entity:
a. Applies an accounting policy retrospectively
b. Makes retrospective restatement of items in financial statements
c. Reclassifies items in the financial statements
Under these circumstances, the entity shall present three statements of financial position as at:
a. The end of the current period
b. The end of the previous period
c. The beginning of the previous comparative period.
Financial statements should displayed the following information for it to be understandable:
a. The name of reporting entity
b. Whether the financial statements cover the individual entity or a group of entities
c. The date of the reporting period or the period covered by the financial statements
d. The presentation currency
e. The level of precision used in the amount in the financial statements.
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Income statement
Thursday, December 2, 2021
10:27 AM
Income statement - shows the result of operations for a given period. It consists of the revenue, cost
and expenses.
Forms of Income statement
1. Natural form (nature of expense method or single-step income statement)
- presents expenses according to nature.
- Used in service business.
- A single step of deducting expenses from revenue is performed to arrive at the net
income or net loss.
2. Functional form (cost of sales method or multiple-step income statement)
- presents expense according to function (cost of sales, selling expense, administrative
expense)
- Used in merchandising business
- A series of steps is performed to arrive at the net income or net loss
Single-step income statement
Accounts that composed the single step income statement
○ Service Income - includes revenues earned or generated by the business in
performing services for a customer or client
○ Salaries or wages expense - includes all payments made to employees or workers for
rendering services to the company
○ Utilities expense - an expense related to the use of electricity, fuel, water, and
telecommunication facilities
○ Supplies expense - covers office supplies used by the business in the conduct of its
daily operations.
○ Insurance expense - is the expired portion of premiums paid on insurance coverage
such as premiums paid for health or life insurance, motor vehicles or other properties
○ Depreciation expense - is the annual portion of the cost of a tangible asset such as
buildings, machineries, and equipment charged as expense for the year.
○ Uncollectible accounts expense/Doubtful accounts expense/Bad debts expense means the amount of receivables charged as expense for the period because they are
estimated to be doubtful of collection.
○ Interest expense - is the amount of money charged to the borrower for the use of
borrowed funds.
Multiple-step income statement
Components of the multiple-step income statement
○ Net sales - The first line after the heading of the income statement is the net sales. To
show the details of its computation, it is supported by a note to financial statement
○ Cost of Sales - represents the cost of merchandise inventory sold by the business to its
customers. This comprises the company's biggest expenses and is deducted from net
sales to arrive at the gross profit.
○ Other income - is income derived from sources other than the company's main line of
business. Ex. Interest income, dividends income, commissions income, rent income,
and gain on sale of assets. Also supported by a note to financial statement.
○ Distribution expenses/Selling expenses - those incurred in directly selling the
merchandise.
Includes:
- salaries of sales personnel
- expenses incurred in promoting advertising the product
- commissions on sales
- store supplies used
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store supplies used
utilities used in store
depreciation expense of assets used in the store
and the cost of transporting merchandise to the customer's place of
business under the account title freight-out or delivery expense.
○ General/Administrative expense - expenses necessary in the management of the
office.
Includes:
- Salaries of office personnel
- Office supplies used
- Utilities used in the office
- Depreciation of office assets
- Provisions for bad debts and uncollectible accounts
Note: If the business has a small office, does not maintain a store, and sales are also
made in the office, operating expenses need not be categorized under selling and
administrative expenses.
○ Other expenses - expenses not connected to the operating activities of the business.
An example of this is loss on sale of assets and discount lost.
○ Finance cost - the interest expense paid for the use of borrowed funds.
-
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Statement of comprehensive income
Friday, November 12, 2021
7:53 PM
Comprehensive income - is the change in equity during a period resulting from transactions and other
events, other than changes resulting from transactions with owners in their capacity as owner.
Includes the following:
1. Components of profit or loss
2. Components of other comprehensive income
Profit or loss - total of income less expenses, excluding the components of other comprehensive
income.
- Bottom line in the traditional income statement.
- Other term may be used such as net income or net loss
Other comprehensive income - comprises items of income and expense including reclassification
adjustments that are not recognized in profit or loss as required or permitted by PFRS.
Components of OCI that will be reclassified subsequently to profit or loss includes:
○ Gain or loss from translating financial statements of a foreign operations
○ Unrealized gain or loss on derivative contracts designated as cash flow hedge
○ Unrealized gain or loss or debt investment measured at fair value through OCI
Components of OCI that will be reclassified subsequently to retained earnings include:
○ Unrealized gain or loss on equity investment
○ Change in revaluation surplus
○ Re-measurements of defined benefit plan
○ Change in fair value attributable to credit risk of financial liability designated at fair value
through profit or loss.
Line items in the statement of comprehensive income
1. Revenue
2. Gain or loss from derecognition of financial asset measured at amortized cost as required by PFRS
9
3. Finance cost
4. Share of income or loss of associate and joint venture accounted for using the equity method
5. Income tax expense
6. A single amount for discontinued operation
7. Profit or loss for the period
8. Total other comprehensive income
9. Comprehensive income for the period.
PAS 1, paragraph 85 - provides that an entity shall present additional line item, headings and subtotals
in the statement of comprehensive income or separate income statement when such presentation is
relevant to an understanding of the financial performance.
Two forms of presenting the income statement
1. Functional presentation
- Traditional and common form
- Also known as cost of goods sold method
- Classifies expenses according to their function as part of cost of goods sold (cost of sales),
distribution costs (selling expenses) and administrative activities (administrative expenses)
- Used in merchandising business.
- Multiple step income statement - a series of steps is performed to arrive at the net income
or net loss.
2. Natural presentation
- Nature of expense method, it presents expenses according to nature
- Single-step income statement - a single step of deducting expenses from revenue is
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- Single-step income statement - a single step of deducting expenses from revenue is
performed to arrive at the net income or net loss.
- Used in service method
- Expenses are aggregated according to their nature and not allocated among the various
functions within the entity.
Equity - residual interest in the assets of an entity after deducting all of the liabilities
- Equivalent of net assets, meaning total assets minus total liabilities
Statement of changes in equity
- Is a basic statement that shows the movements in the elements or components of the
shareholders equity
Components
a. Comprehensive income for the period
b. For each component equity, the effects of changes in accounting policies and corrections of
errors.
c. For each component of equity, a reconciliation between the carrying amount at the
beginning and end of the period, separately disclosing changes from:
- Profit or loss
- Each item of OCI
- Transactions with owners in their capacity as owners showing separately
contributions and distributions to owners.
Statement of retained earning
- Shows the changes affecting directly the retained earnings and relates the income statement to
the statement of financial position
- No longer require but is a part of the statement of changes in equity
- The important data affecting this that should be completely disclosed are:
a. Profit or loss for the period
b. Prior period errors
c. Dividends declared and paid to shareholders
d. Effects of change in accounting policy
e. Appropriation of retained earnings
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Statement of financial position
Thursday, November 11, 2021
8:44 PM
Statement of financial position - is a formal statement showing the three elements comprising financial
position, namely assets, liabilities, and equity.
- Investors, creditors, and other statement users analyze this to evaluate such factors as liquidity,
solvency, and the need of the entity for additional financing.
Liquidity - the ability of the entity to meet currently maturing obligations
Solvency - the availability of cash over the longer term to meet maturing obligations
- Useful in predicting the ability of the entity to comply with future financial statements and
to pay dividends to shareholders.
Current Assets
- The asset is cash or a cash equivalent unless the asset is restricted from being exchanged or used
to settle a liability for at least twelve months after the reporting period.
- The entity holds the asset primarily for the purpose of trading
- The entity expects to realize the asset within twelve months after the reporting period
- The entity expects to realize the asset or intends to sell or consume it within the entity's normal
operating cycle.
- Usually listed in the statement of financial position in the order of liquidity
The line items under current assets are:
a. Cash and cash equivalents
b. Financial assets at fair value profit as loss such as trading securities and other investments in
quoted equity instruments
c. Trade and other receivables
d. Inventories
e. Prepaid expenses
Non-Current Assets
- An entity shall classify other assets not classified as current as noncurrent
Current Liabilities
- The entity expects to settle the liability within the entity's normal operating cycle.
- The entity holds the liability for the purpose of trading.
- The liability is due to be settled within twelve months after the reporting period
- The entity does not have an unconditional right to defer settlement of the liability for at least
twelve months after the reporting period.
The line items for current liabilities are:
a. Trade and other payables
b. Current provisions
c. Short-term borrowing
d. Current portion of long-term debt
e. Current tax liability
Noncurrent liabilities
- All liabilities not classified as current liabilities are classified as noncurrent liabilities
Example:
a. Noncurrent portion of long-term debt
b. Finance lease liability
c. Deferred tax liability
d. Long-term obligations to entity officers
e. Long-term deferred revenue.
Treatment of currently maturing long-term debt
A liability which is due to be settled within twelve months after the reporting period is classified as
current, even if:
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current, even if:
a. The original term was for a period longer than twelve months
b. An agreement to refinance or to reschedule payment on a long-term basis is completed
after the reporting period and before the financial statements are authorized for issue.
However, if the refinancing on a long-term basis is completed on or before the end of the
reporting period, the refinancing is an adjusting event and therefore the obligation is classified as
noncurrent.
Treatment of a currently maturing obligation if there is a discretion to refinance:
- If the entity has the discretion to refinance or roll over an obligation for at least twelve months
after the reporting period under an existing loan facility, the obligation is classified as noncurrent
even if it would otherwise be due within a shorter period
Reason: such obligation is considered to form part of the entity's long-term refinancing
because the entity has the unconditional right under the existing loan agreement to defer
payment for at least twelve months after the end of the reporting period.
- Note that the refinancing or rolling over must be at the discretion of the entity, otherwise it will be
classified as a current liability.
Covenants
- Are often attached to borrowing agreements which represents undertaking by the borrower.
- Restrictions on the borrower as to undertaking further borrowings, paying dividends, maintaining
specified level of working capital and so forth
- If certain conditions relating to the borrower's financial situation are breached, the liability
becomes payable on demand.
Breach of covenants
- PAS 1, paragraph 74, provides that The liability is classified as current even if the lender has
agreed, after the reporting period and before the statements are authorized for issue, not to
demand as a consequence of the breach.
- The liability is classified as current because at reporting date the borrower does not have an
unconditional right to defer payment for at least twelve months after the reporting period.
- Paragraph 75: the liability is classified as noncurrent if the lender has agreed on or before the end
of reporting period to provide a grace period ending at least twelve months after the end of the
reporting period.
Equity
- The residual interest in the assets of the entity after deducting all the liabilities.
- Net assets = total assets minus liabilities
- Term used in reporting the equity of an entity depending on the form of the business
organization:
a. Owner's equity in proprietorship
b. Partner's equity in a partnership
c. Shareholder's equity in a corporation
- The term equity may simple be used for all business organizations.
Line items on Statement of Financial position
1. Cash and Cash equivalents
2. Financial assets (other than 1,3, and 6)
3. Trade and other receivables
4. Inventories
5. Property, plant and equipment
6. Investment in associates accounted for by the equity method
7. Intangible assets
8. Investment property
9. Biological assets
10. Total of assets classified as held for sale and assets included in disposal group classified as held for
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10. Total of assets classified as held for sale and assets included in disposal group classified as held for
sale
11. Trade and other payables
12. Current tax liability
13. Deferred tax asset and deferred tax liability
14. Provisions
15. Financial Liabilities (other than 11 and 14)
16. Liabilities included in disposal group classified as held for sale
17. Noncontrolling asset
18. Share capital and reserves.
- Additional line items, headings, and subtotals shall be presented on the face of the statement of
financial position when such presentation is relevant to the understanding of the financial position
of an entity
Presentations of assets and liabilities
- Common practice in the Philippines: present the current assets before the noncurrent assets,
current liabilities before noncurrent liabilities, and equity after liabilities
- Format in other jurisdiction, like the united kingdom:
Noncurrent assets
Current Assets
Equity
Noncurrent Liabilities
Current Liabilities
Two forms of Statement of Financial Position
1. Account form - which follows the accounting equation where assets are listed on the left-hand
column of the report with the liabilities and owner's equity listed on the right-hand column
2. Report Form - which shows in one straight column the assets, followed by liabilities and owner's
equity
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Statement of Cash Flows
Thursday, December 2, 2021
11:21 AM
Statement of cash flows
- Summarizes the cash receipts and cash disbursements for the accounting period.
- Primary purpose is to provide relevant information about cash receipts and cash payments of an
entity during a period.
- It summarizes the cash activities of the business by classifying cash inflows and cash outflows into
operating, investing, and financing activities.
○ Cash inflows - receipts
○ Cash outflows - payments
- It shows the net increase or decrease of cash in a given period and the cash balance at the end of
the period.
Components of the statement of cash flows classified according to activities
Operating activities - cash inflows and cash outflows arising from the normal operations of
the business
- Derived primarily from the principal revenue producing activities of the entity
- Cash flows arising from the purchase and sale of dealing or trading securities are
classified as operating activities
- Cash advances and loans made by a financial institution are usually classified as
operating act. Since they relate to the main revenue producing activity of that entity.
Cash Inflows (Receipts)
○ Collections from customers for the performance pf services or sales of goods
○ Royalties, fees, commissions received
○ Interest, dividends, and other income received
Cash Outflows (payments)
○ Payment to suppliers for services and goods acquired
○ Employee's salaries
○ Government licenses and taxes
○ Interest expense
○ Other operating expense
Investing Activities - the cash inflows and cash outflows from the purchase and sale of
property and equipment, investment in debt or trading securities, lending money and
collection of the principal amount of the money loaned
- Cash flows derived from the acquisition and disposal of long-term assets and other
investments not included in cash equivalents.
- Involves nonoperating assets
Payments
○ To acquire PPE, Intangibles and other long-term assets
○ To acquire equity or debt instruments of other entities and interest in joint
venture
○ Cash advances and loans to other parties other than advances and loans made
by financial institution
○ Payments for future contract, forward contract, option contract and swap
contract
Receipts
○ Receipts from sales of PPE, intangibles and long-term assets
○ Sales of equity or debt instruments of other entities and interest in joint venture
○ Receipts from payments of advances and loans made to other parties
Financing Activities - the cash inflows and cash outflows from the owners and creditors of
the business
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the business
- Cash flows derived from equity capital and borrowings of the entity
- Result from transactions between the entity and its owners (equity financing) and
between the entity and its creditors (debt financing)
- Includes cash flows from transactions involving "nontrade liabilities" and "equity"
Cash Inflows (receipt of cash)
○ Original and additional investments by owner
○ Receipts from issuing ordinary and preference share or other equity instruments
○ Receipts from issuing debentures, loans, notes, bonds, mortgages, and other
short or long term borrowings
Cash outflows (payments of cash)
○ Cash withdrawal of owner
○ Payment for the principal balance of loan
○ Payments to owners to acquire or redeem the entity's shares, for example,
payment for treasury shares
○ Payment for amounts borrowed
○ Payments by a lessee for the reduction of the outstanding liability relating to a
finance lease
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Notes to Financial Statements
Thursday, November 11, 2021
10:24 PM
Notes to financial statements - provide narrative description or disaggregation of items presented in the
financial statements and information about items that do not qualify for recognition.
- Used to report information that does not fit into the body of statements in order to enhance the
understandability of the statements.
- Each item on the face of the financial statements shall be cross-referenced to any related
information in the notes
- Purpose: to provide the necessary disclosures required by PFRS.
- It shall provide:
a. The basis of preparation of the financial statements and the specific accounting policies
used.
b. Disclose the information required by the PFRS that is not presented elsewhere in the
financial statements.
c. Provide additional information that is not presented on the face of the financial statements
but that is necessary for a fair presentation.
Order of presenting the notes based on PAS 1, paragraph 114
1. Statement of compliance with PFRS
2. Summary of significant accounting policies used
- The measurement basis used in preparing the financial statements such as historical cost,
current cost, realizable value and present value.
3. Supporting information or computation for line items presented in the financial statements
4. Other disclosures, such as contingent liabilities, unrecognized contractual commitments and
nonfinancial disclosure
PAS 1, Paragraph 6 - an entity whose financial statements comply with PFRS shall make an explicit and
unreserved statement of such compliance in the notes.
PAS 1, Paragraph 122 - an entity shall disclose in the summary of significant accounting policies the
judgement that management has made in the process of applying accounting policies and that has a
significant effect on the amounts recognized in the financial statements.
PAS 1, paragraph 125 - an entity shall disclose information about the assumptions it makes about the
future and other major sources of uncertainty at the end of the reporting period that have a significant
risk of resulting in a material adjustment to the carrying amount of assets and liabilities within the new
financial year.
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Related party disclosure
Thursday, November 11, 2021
10:48 PM
Related Party - parties are considered related if one party has the ability to control the other party, the
ability to exercise significant influence over the other party, joint control over another entity.
Related party transaction - is a transfer of resources or obligations between related parties, regardless
of whether a price is charged.
Significant Influence - is the power to participate in the financial and operating policy decisions of an
entity but not control of the policies.
- May be gained by share ownership of 20% or more
- Beyond the mere 20% threshold of ownership, significant influence may be evidenced by the
following:
a. Representation in the board of directors
b. Participation in policy making process
c. Material intercompany transactions
d. Interchange of managerial personnel
e. Dependence on technical information
Examples of related parties
○ Affiliates - the parent, the subsidiary and fellow subsidiaries. Entities that directly or
indirectly through one or more intermediaries, control or are controlled by or under
common control with the reporting entity.
○ Associates - entities for which the investments are accounted for by the equity method. An
associate includes the subsidiaries of the associate. If the investment shares is 20% to 50%,
the equity method is used in accounting for the investment.
○ Venturer - in a joint venture. A joint venture includes the subsidiaries of the associate.
○ Key management personnel - those persons having authority and responsibility for planning,
directing and controlling the activities of the entity, directly or indirectly including any
executive director or nonexecutive director.
○ Close family members of an individual - family members who may be expected to influence
or be influenced by that individual in their dealings with the entity. Includes spouse and
children, children of the individual's spouse, dependents of the individual or the individual's
spouse
○ Individuals - owning directly or indirectly an interest in the voting power of the reporting
entity that gives them significant influence over the entity, and close family members of
such individuals.
○ Post-employment benefit plans for the benefit of employees of an entity, or of any entity
that is a related party to the entity.
PAS 24, Paragraph 12 - requires disclosure of related party relationship where control exists irrespective
of whether there have been transactions between the related parties.
Paragraph 17 - if there have been transactions between related parties, an entity shall disclose the
nature of the related party relationship as well as information about the transactions.
PAS 24, paragraph 16 - an entity is required to disclose key management personnel compensation in
total and for each of the following categories:
1. Short-term employee benefits
2. Post-employment benefits
3. Other long-term benefits
4. Termination benefits
5. Share based payment transactions
Examples of unrelated parties (PAS 24)
1. Two entities simply because they have a director or key management personnel in common
2. Providers of finance, trade unions, public utilities and government agencies in the course of their
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2. Providers of finance, trade unions, public utilities and government agencies in the course of their
normal dealings with an entity by virtue only of those dealings
3. A single customer, supplier, franchisor or general agent with whom an entity transacts a
significant volume of business merely by virtue of the resulting economic dependence.
4. Two ventures simply because they share joint control over a joint venture.
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Events after the reporting period
Friday, November 12, 2021
7:27 PM
- Those events both favorable and unfavorable that occur between the end of the reporting period
and the date when the financial statements are authorized for issue.
- Also known as subsequent events which may require either adjustment or disclosure.
Types of events after the reporting period
1. Adjusting events - those that provide evidence of conditions that exist at the end of the reporting
period
Examples:
a. Settlement after the reporting period of a court case
b. Bankruptcy of a customer which occur after the reporting period
c. Sale inventories after the reporting period
d. The determination of the cost of assets or the proceeds from assets sold
e. The determination of the profit sharing or bonus payment
f. The discovery of fraud or errors that show the financial statements were incorrect
2. Non-adjusting events - Those that are indicative of conditions that arise after the end of the
reporting period.
Examples: (for more, see p.187)
a. Business combination
b. Plan to discontinue operation
c. Major purchase and disposal of asset or expropriation of major asset by government
d. Destruction of a major production plant by a fire after the reporting period
The financial statements are authorized for issue when the board of directors reviews the financial
statements and authorizes them for issue.
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Merchandising
Saturday, November 13, 2021
8:26 AM
Merchandising - earns income by buying and selling of finished goods
- Business engaged is called Trading or Merchandising business
- Purchase goods from manufacturer or other merchandisers
- There are two activities involved namely, buying and selling
Manufacturing - buys raw materials and processes them to become finished goods for sale
Types of merchandising
Wholesaler - one who buys in bulk or volume directly from a manufacturer and sells the goods to a
retailer
Retailer - one who sells products to end users
Two point of views in merchandising:
Buyers point of view
Sellers point of view
Inventory system in Merchandising
Periodic system - good for selling goods with different low-priced items
Acquisition of inventory - Purchases, purchase discount, purchase returns and allowances
Cost of transporting goods shouldered by buyer - Freight-in
Sale of inventory - sales, sales discounts, sales returns and allowances
Cost of transporting goods shoulder by seller - Freight out or delivery expense
Perpetual System - for business selling high price items
Cost of each item - costs of goods sold
- The running balance of inventory on hand and cost of sales are shown continuously
- The balance of the ending inventory should be the same with the actual physical count
unless:
- Theft, obsolescene, or spoilage of goods
Purchase price
List price
Periodic system
Discount - a reduction from a certain price or amount.
Two kinds of discount
Trade discount - a deduction from the list price or catalogue price granted to
customers to encourage purchase of goods or merchandise in big quantities or
volume.
- Not recorded in the buyer's or seller's book
- The trade discount was not shown in the books and the purchase price will be
recorded. The list price will not reflect in the books
- Can be deducted immediately to list price
Cash discount - a deduction from the selling or purchase price granted to customers
to encourage prompt payments of accounts.
- Recorded and shown in the buyer's and seller's books
- Recorded as purchase discount and seller discount
- Gross method
- Deducted when buyer's paid within the term for discount.
- n/30 - n/60 - no discount - purchase price less returns and allowances is payable
within 30 or 60 days
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within 30 or 60 days
- 2/10 EOM (end of the month) -2% cash discount is granted if paid 10 days after
the end of the month.
- EOM - no discount - purchase price less returns and allowances are paid by the
end of the month
- Counting of days start after - Purchased date: July 1 - counting of 10 days term
will start at July 2
Buyer's point of view
Buyer - the one who purchased goods
Merchandise inventory - goods or commodities purchased by the company for sale
normally at a profit.
Documents to be prepared by the buyer:
Purchase order - a document sent by the buyer to the seller ordering certain goods
- Date, quantity, description of goods, and the total amount of the order
- Authorizes the seller to deliver goods to the buyer under the agreed
specification, terms, and conditions
Receiving Report - a form prepared by the buyer's receiving personnel stating the
quantity and condition of the goods delivered by the seller
Debit memorandum - a written notice from the buyer informing the seller that the
buyer will debit the account or decrease the amount (accounts payable) to the seller
for returned goods or allowances requested due to defect or wrong specifications.
Journal entries
1. Purchased merchandise for cash
Purchases
xxxx
Cash
xxxx
2. Purchased Merchandise on account
Purchases
xxxx
Accounts Payable
xxxx
3. Returned defective merchandise brought on account
Allowances Granted by seller for the account purchases
Issued a debit memo to the seller for merchandise returned
Accounts Payable
xxxx
Purchase returns and allowances
xxxx
4. Received cash refund for returned merchandises
Cash
xxxx
Purchase returns and allowances
xxxx
5. Transportation charges incurred in buying merchandise
Freight-in
xxxx
Cash or accounts payable
xxxx
6. Paid account within the discount period arising from the purchase of merchandise
Accounts payable
xxxx
Purchase discount
xxxx
Cash
xxxx
7. Paid account after the discount period
Accounts payable
xxxx
Cash
xxxx
Account titles
Purchases - the account used to record the cost of the goods or merchandise bought for
purposes of resale
- Normal balance: Debit
Purchase Returns and Allowances - the account used to record returns acknowledged or
allowances granted by the supplier to the buyer from the purchase of goods
- Normal balance: Credit
Purchase Discount - a reduction from the purchase price of the merchandise or goods
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Purchase Discount - a reduction from the purchase price of the merchandise or goods
bought granted by the supplier to the buyer or customer from paying within the discounted
period.
- Normal balance: Credit
Freight-in - the cost of transporting the merchandise or goods from the seller's place to the
buyer's place of business. Also called Transportation-in
- Normal Balance - Debit
Computation format - discount always comes first before decreasing partial payment
Purchases
Less: Down payment
Account purchases
Less: Purchase returns and allowances
Net purchases
Less: Purchase discount
Balance
Less: Partial payment
Payment w/in discount period
To be asked: for 2/10 EOM is discount still applicable if paid before 10 days after the end fo the
month?
Seller's point of view
Seller - one who offers his/her merchandise for sale in exchange for monetary payment
- In a sale's transaction, documents are ordinarily issued by the seller to evidence the
sale of goods.
Sale's invoice - Evidences the transfer of ownership of the goods from the seller to the
buyer
- Contains the name and address of the buyer, the description of the cost of goods sold,
the credit terms, the unit price, quantities, total amount, and date of sale.
Official receipt - a written acknowledgement of money received by the seller evidencing
payment of the buyer for goods purchased and received
Credit memorandum - a written notice from the seller signifying acknowledgement or
acceptance of the goods returned by the buyer.
- Notifies the buyer of a corresponding reduction in the amount owed by the buyer
because of goods returned or allowances granted due to defect or wrong
specifications.
Journal entries
1. Sold merchandise for cash
Cash
xxxx
Sales
xxxx
2. Sold merchandise on account
Accounts receivable
xxxx
Sales
xxxx
3. Received defective merchandise sold on account
Allowances granted to buyer for the account sales
Issued a credit memo to the buyer for merch returned
Sales returns and allowances
xxxx
Account receivables
xxxx
4. Paid cash refund for returned merchandise
Sales returns and Allowances
xxxx
Cash
xxxx
5. Transportation charges incurred in selling merchandise
Freight-out or delivery expense
xxxx
Cash or accounts payable
xxxx
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Cash or accounts payable
xxxx
Note: Freight-out is used if delivery of goods is outside the area of the seller's place of
business
Delivery expense is debited if delivery of goods is within the area of the seller's
place of business
6. Collected account within the discount period arising from the sale of merchandise
Cash
xxxx
Sales Discount
xxxx
Accounts Receivable
xxxx
7. Collected account after the discount period
Cash
xxxx
Accounts receivable
xxxx
Account titles
Sales - the proceeds from the sales price of goods sold credited to the revenue account in
the accounting period when the sales were made
- Normal Balance: Credit
Sales return and allowances - the account used to record returns acknowledged or
allowances granted by the supplier to the buyer from the sale of goods.
- Normal Balance: Debit
Sales discount - a reduction from the sales price of the merchandise or goods sold granted
by the seller to the buyer or customer for paying within the discount period
- Normal Balance: Debit
Freight-out or delivery expense - the cost of transporting the merchandise or goods from
the seller's place to the buyer's place of business
- Normal Balance: debit
Note: Accounts payable - only in Buyer's POV
Accounts receivable - only in Seller's POV
COD - Cash on Delivery/Collect on Delivery
- The buyer will pay the full amount upon delivery of the merchandise
Computation
Sales
Less: Down Payment
Account sales
Less: Sales returns and allowances
Net sales
Less: Sales discount
Balance
Less: Partial Payment
Payment w/in discount period
Perpetual System
- An acquisition of merchandise is debited to merchandise inventory
- Sale of the merchandise is recorded as a credit to merchandise inventory with a corresponding
debit to cost of goods sold account.
- Continuous record of the inventory systems
Journal entries buyer's POV
1. Purchased merchandise for cash/on account
Merchandise inventory
xxxx
Cash/Accounts Payable
xxxx
2. Incurred transportation charges in the purchase of merchandise
Merchandise Inventory
xxxx
Cash/Accounts payable
xxxx
FAR Page 45
Cash/Accounts payable
xxxx
3. Returned defective merchandise bought on account
Granted allowances to the buyer for the account purchase
Issued a debit memo to the seller for merchandise returns
Accounts Payable
xxxx
Merchandise Inventory
xxxx
4. Paid account within the discount period arising from the purchase of merchandise
Accounts Payable
xxxx
Merchandise Inventory
xxxx
Cash
xxxx
5. Paid account after the discount period arising from the purchase of merchandise
Accounts Payable
xxxx
Cash
xxxx
Question: Freight charges are recorded as Merchandise inventory under the perpetual system but
it can't be sell unlike the actual merchandise supply, what was the justification for this principle?
Journal Entries Seller's POV
1. Sold merchandise for cash/on account
Cash/Accounts Receivable
xxxx
Sales
xxxx
Cost of Sales
xxxx
Merchandise Inventory
xxxx
Note:
- The total amount of cash/accounts receivable and sales on the first entry is the
total sales price of the goods sold
- The amount of cost of sales and merchandise inventory on the second entry is
the cost of merchandise sold
- The second entry removes the sold goods from the merchandise inventory
account and transfers it to the costs of goods sold.
2. Received defective merchandise sold on account
Granted allowances to the buyer for the account sales
Issued a credit memo to the buyer for merchandise returns
Sales returns and allowances
xxxx
Accounts Receivable
xxxx
Merchandise Inventory
xxxx
Cost of sales
xxxx
Note:
- Sales returns and allowances and accounts receivables - total sales price of the
goods returned
- Merchandise inventory and cost of sales - cost of merchandise returned.
- The second entry transfers back to the merchandise inventory account the cost
of returned goods while removing it from the cost of goods sold.
3. Collected account within the discount period
Cash
xxxx
Sales Discount
xxxx
Accounts receivable
xxxx
4. Collected accounts after the discount period
Cash
xxxx
Accounts receivable
xxxx
COST OF SALES/GOODS SOLD FORMULA
Merchandise Inventory, Beginning
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Merchandise Inventory, Beginning
Add: Net cost of purchases
Purchases
Less: Purchase Returns and Allowances
Purchase discount
Net Purchases
Add: Freight In
Goods available for sale
Less: Merchandise Inventory, End
Cost of sales
FAR Page 47
Freight
Friday, November 26, 2021
3:43 PM
Terms of shipment
- Cost of transporting goods from the seller's place to the buyer's place is shouldered by either
party depending on arrangement
- Merchandise can be transported either by a trucking service, a shipping line, or an airline
- FOB: Free on Board
Fob shipping point
- The buyer should be the one to pay for the cost of transporting the goods from the seller's
place to the buyer's place
- Once the merchandise leaves the seller's place for shipping, ownership of the goods is
transferred to the buyer
FOB destination
- The seller should be the one to pay for the cost of transporting the goods.
- Ownership of the merchandise is transferred to the buyer only when the merchandise
reaches the buyer's place of business
Freight prepaid
- Means the seller initially paid for the freight of the merchandise upon shipment
Freight Collect
- Means the Freight company collects the cost of transportation from the buyer
Terms of freight
Who should pay for the freight charges? Who paid?
FOB shipping point, freight collect
Buyer
Buyer
FOB shipping point, Freight prepaid Buyer
Seller
FOB destination, Freight collect
Seller
Buyer
FOB destination, Freight Prepaid
Seller
Seller
FOB shipping point, freight collect
- The goods are free on board up to shipping point and the freight company collects payment
for the freight charges from the buyer
Buyer's POV
Freight-in
xxxx
Cash
xxxx
Seller's POV - non recordable
FOB shipping point, Freight prepaid (Freight-In)
- The goods are free on board up to the shipping point, and the seller paid for the freight
charges at the time of shipping
Buyer's POV
Freight-In
xxxx
Accounts payable
xxxx
Seller's POV
Accounts Receivable
xxxx
Cash
xxxx
FOB destination, Freight Collect (Freight-out)
- The goods are free on board up to the destinations and the freight company collects
payment for the freight charges from the buyer
Buyer's POV
Accounts Payable
xxxx
Cash
xxxx
FAR Page 48
Cash
xxxx
Seller's POV
Freight-out
xxxx
Accounts Receivable
xxxx
FOB destination, Freight Prepaid
- The goods are free on board up to the destinations and the seller paid for the freight
charges at the time of shipment
Buyer's POV - non recordable
Seller's POV
Freight-out
xxxx
Cash
xxxx
FAR Page 49
VAT
Friday, November 26, 2021
7:27 PM
VAT - Value added tax
- A tax imposed upon purchase and sale of goods
- Included in the amount payable to seller but should not be recorded as an addition to the
purchases accounts of buyers
Input tax - VAT paid on the purchase of goods
- Normal Balance: Debit
- Added to the amount collectible from customer but should not be recorded as an addition to the
sales account of the seller
Output tax - VAT collected on the sale of goods
- Normal balance: Credit
VAT payable
- Difference when the output tax is greater than the input tax
- Current liability
- Computation
Total output taxes
Less: Total Input taxes
VAT payable
Creditable Input tax
- VAT creditable to be carried over and applied to future tax outputs
- Input tax is greater than the output tax
- A tax credit to be applied to the subsequent month
- Under other current asset
Value added tax normal percentage for computation
- 12% unless otherwise stated
JOURNAL ENTRIES IN RECORDING VAT
1. Sale of Merchandise
Cash/Accounts receivable
xxxx
Sales
xxxx
Output Tax
xxxx
2. Received merchandise returns
Allowances granted to buyer for wrong specification or defective goods
Issued credit memo to buyer for merchandise returns
Sales Returns and allowances
xxxx
Output tax
xxxx
Accounts receivable
xxxx
3. Collection of account within discount period
Cash
xxxx
Sales Discount
xxxx
Output Tax
xxxx
Accounts Receivable
xxxx
4. Purchase of merchandise
Purchases
xxxx
Input tax
xxxx
Cash/Accounts payable
xxxx
5. Returned defective merchandise
Allowances granted by seller for wrong specification or defective goods
Issued debit memo to buyer for merchandise returns
Cash/Accounts Payable
xxxx
FAR Page 50
Cash/Accounts Payable
xxxx
Purchase returns and allowances
xxxx
Input TAX
xxxx
6. Payment of account within discount period
Accounts payable
xxxx
Purchase discount
xxxx
Income TAX
xxxx
Cash
xxxx
7. To record VAT payable or creditable input tax
A. If output tax is greater than input tax
Output tax
xxxx
Input TAX
xxxx
VAT Payable
xxxx
B. If input tax is greater than output tax
Output TAX
xxxx
Creditable input TAX
xxxx
Input tax
xxxx
8. Payment of VAT
VAT Payable
xxxx
Cash
xxxx
FAR Page 51
Subsidiary ledgers and special journals
Tuesday, November 30, 2021
12:57 PM
Subsidiary ledger - necessary if business has hundreds of customers and creditors to keep up all types of
receivables and payables
- Shows the details supporting the controlling accounts balances
Accounts receivable ledger - A list of all customer accounts arranged in alphabetical order in a
separate ledger.
Accounts payable ledger - A list of all creditors arranged in alphabetical order on a separate ledger
Controlling accounts - Accounts receivable and accounts payable.
Special Journals - columnar books of original entry for recording similar transactions.
- The design and use depend on the needs of a specific business entity.
Transaction
Special Journal
Selling of merchandise on credit Sales journal
Buying of merchandise on credit Purchases journal
Cash collections
Cash receipts journal
Cash payments
Cash disbursements journal
Sales journal
- Records all sales transaction on account or with promissory note.
- Doesn't record cash sales and sales of assets on account.
- For sales transaction with promissory note, transaction is initially recorded in the sales
journal then in the general journal
Cash Receipts Journal
- All transactions involving inflows of cash or receipts of cash is recorded here.
- Whenever there is an increase in cash, the transaction is always recorded in the cash
receipts journal.
Purchases Journal
- Records all purchase transactions on account or with promissory note.
- For purchases transaction with promissory note, transaction is initially recorded in the
purchase journal then in the general journal
Cash Payments journal or Cash Disbursement Journal
- All transactions involving outflow of cash or payment of cash are recorded here
- Whenever there is a decrease in cash, the transaction is always recorded here.
General Journal
- Transactions that cannot be recorded in the special journals are recorded in the general journal.
○ Provision for doubtful accounts
○ Write-offs of doubtful accounts
○ Depreciation
○ Non-cash investment
○ Withdrawal of owner
○ Issuance of a note in lieu of an account.
FAR Page 52