Reviewer for Midterms (Fundamentals of Accounting)
Organizations in the Field of Accounting:
● AICPA - American Institute of Certified Public Accountants
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Is a non-profit professional organization representing certified public
accountants (CPA) in the United States.
● AAA - American Accounting Association
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Is an organization that supports worldwide excellence in accounting education,
research, and practice.
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The primary professional association for accounting academics in the United States.
● FRSC - Financial Reporting Standards Council
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Was established by the Professional Regulatory Commission under the Implementing
Rules and Regulations of the Philippine Accountancy of Act of 2004 to assist
the Board of Accountancy in carrying out its power and function to promulgate
accounting standards in the Philippines.
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The authoritative body that establishes and promulgates GAAP and standards
in the Philippines
● IASB - International Accounting Standards Board
-
Its main objective is to create a semblance of uniformity in the accounting
practices among the different nations of the world.
Role of Accounting:
➢ It helps the owner/s or managers in making plans and decisions.
➢ It reports and analyzes business transactions through the financial statements.
➢ It communicates financial information to all interested parties.
Types of Accounting
❖ Financial Accounting
➢ Primarily concerned with the process of compiling information for financial
reports for external reporting.
❖ Management Accounting
➢ Documents, monitors and assists in the financial planning of an organization.
➢ Their documentation is typically meant for internal stakeholders rather than the
public.
❖ Tax Accounting
➢ Monitors businesses to stay in compliance with the Internal Revenue Code when
they file their tax documents each year.
❖ Cost Accounting
➢ Can be seen as a subcategory of managerial accounting
➢ The activities of cost accountants will affect both financial and managerial
accountants.
❖ Auditing
➢ External auditing is the action of a company providing financial documents to a
third party for financial feedback.
➢ Internal auditing determines the effectiveness of internal accounting processes.
❖ Accounting Information System
➢ Accounting information systems, or AIS, is the system by which a company collects,
stores and processes its financial and accounting data.
❖ Forensic Accounting
➢ Forensic accounting is used to investigate the financial records of individuals or
businesses.
➢ The goal of forensic accounting is to gather all available documentation and
accurately and comprehensively account for all transactions in financial statements.
❖ Public Accounting
➢ Public accounting refers to businesses that provide accounting advice to clients
based on their needs.
❖ Governmental Accounting
➢ Has standards that must comply with the Governmental Accounting Standards
Board (GASB), which is responsible for developing consistent accounting
procedures for local and state governments.
https://www.indeed.com/career-advice/career-development/types-of-accounting
Accounting as a Tool:
Primary Responsibilities of Management: POIFCA
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Planning and organizing the activities of the business enterprise
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Investing and financing activities
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Controlling and assessing the performance of the business enterprise
➢ These managers would depend on the useful financial information provided by the accounting
system.
Objectives of Business:
➔ Businesses are GENERALLY FORMED TO MAKE PROFIT
★ Profit-oriented Organizations
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(Business Enterprise)
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Main activities is to make profit
★ Non-profit Organizations
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Established NOT for profit
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It is to render services and meet the needs of the members of the
community.
➔ To provide jobs to the community
➔ To protect the environment
➔ To create new and better products for the consumers
➔ To render useful services at competitive prices
Types of Business
❖ Service Enterprise
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Type of business that provides various forms of services, not tangible products,
to its customers or clients.
❖ Merchandising Enterprise
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The type of business entity is in the “buy and sell” business.
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A trading or merchandising enterprise buys ready-to-use
products then sells these products at higher prices.
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Engaged in the buying of goods or merchandise which will be sold (in
its original form) at a higher price than the purchase cost
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It has more complicated transactions than service entities as it has
account titles peculiar to trading business.
★ Wholesaler
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Buys large quantities of finished goods directly from the manufacturers or
importers, and then resells the same to different merchandisers
★ Retailers
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Sell the goods directly to end-consumers
NORMAL OPERATING CYCLE
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Average length of time from the spending of cash to acquired goods, utilities, services and other
benefits, until cash is realized or received in the ordinary sale of goods
Inventory Systems Used for Merchandising Transactions
➔ Perpetual Inventory System
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Requires the maintenance of records called stock cards for each kind of good.
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The stock card normally shows the inflow, the outflow and the running balance of
inventory.
➔ Periodic Inventory System
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The inventory is determined by physical counting of goods on hand at the end of the
accounting period to determine quantities.
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The quantities for each kind of good are then multiplied by the corresponding unit
cost to get the inventory value.
Periodic Inventory System
● When goods for resale are purchased, Purchases is debited at the amount of the acquisition
cost (List price, net of trade discount, if there is any).
● Upon making a sale, income is recognized by crediting Sales based on the selling price of the
goods, net of trade discount.
● No separate entry is prepared to record the decrease in the inventory balance as a result of sale.
● There are no inventory ledger accounts that need to be updated as the buying and selling
transactions occur.
❖ Manufacturing Enterprise
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Involves the conversion of raw materials into finished products, which will be sold
at a higher price than the production cost.
Forms of Business Ownership:
❖ Single Proprietorship
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A business owned by one person, called entrepreneur or proprietor.
❖ Partnership
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Has two or more owners called partners.
❖ Corporation
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A business that has its ownership capitalization divided into hundreds or
thousands of transferable shares of stock.
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The corporation must have at least five owners or investors called stockholders
(corporators) or shareholders.
➢ CORPORATOR is a corporation organizer, member, or stockholder
➢ INCORPORATORS are those stockholders or members mentioned in the
Articles of Incorporation as originally forming and composing the
corporation, and who are signatories thereof.
➢ STOCKHOLDER is also known as a SHAREHOLDER of a company or an
individual that owns at least one share of an organization's capital stock.
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Stockholders are mostly the OWNER of the company and generally
acquire the company's accomplishment in the form of increased stock
valuation.
Characteristics
➔ Unlimited liability
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lf the business has unpaid debts which it can no longer pay
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The creditors can run after the owner and attach his properties to satisfy their claim.
➔ Limited liability
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The liability of the partner, shareholders or members is limited only up to the
extent of their paid up capital.
Profession:
➢ Career opportunities in the field of accounting may be divided into two broad disciplines PUBLIC and PRIVATE ACCOUNTING
★ Public Accounting
-
A certified public accountant (CPA) is a professional who is licensed to
perform an independent audit of business enterprises or to render other
forms of special accounting services to his clients.
● Certified Public Accountants (CPA) may offer the following services:
➔ Auditing
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It is the careful study of the client’s accounting information and gathering of
evidences both from within the business enterprise and from other sources
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Based on these gathered evidence, the CPA expresses a professional opinion
regarding the fairness and reliability of the financial statements.
➔ Tax Services
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The CPA may be hired by his client to perform the latter’s tax requirements
such as settlement of tax cases, tax planning, tax consulting, etc.
➔ Management Advisory Services
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The CPA may be consulted on a certain business problem and recommends
new policies and procedures that are needed as a solution.
➔ Other Services
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Preparation of financial forecasts or feasibility studies
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Assessment of the present cost accounting system
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Computation of the confidential payrolls and compensations
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Installation of the accounting information system
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In-house trainings and personal development
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Keeping the client’s stock and transfer records
★ Private Accounting
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An accountant who is in private accounting when he is employed by one
particular enterprise to perform accounting-related tasks.
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Controller is the chief accounting officer of a business enterprise
● Important areas of private accounting are:
➔ Financial Accounting
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The branch of accounting that is primarily concerned with the preparation and
presentation of general-purpose financial statements of a business enterprise
➔ Management Accounting
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Provides specific information needs of the internal data-users, principally the
management
➔ Internal Auditing
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Internal Auditors have the responsibilities of:
● Evaluating the efficiency of operations
● Determining whether the business’ policies are being followed in
all organizational levels of operations in order to achieve the
organization’s objectives.
Private Accounting involves the following disciplines; Financial Accounting. Cost Accounting.
Management Accounting.
Generally Accepted Accounting Principles:
➢ General-purpose reports must be prepared in accordance with certain generally
accepted “ground rules” and assumptions so that different users will be able to understand
and interpret their contents properly.
➢ Philippine Financial Reporting Standards (PFRS) and PFRS for Small and Medium-sized
Entities
➢ International Financial Reporting Standards – reporting standards carried out by the
IASB.
➢ Financial accountants are concerned with compliance and must abide by GAAP set for
U.S businesses and International Financial Reporting Standards.
Basic Accounting Concepts:
➢ Concepts provide the label for a class or category
➢ Principles provide abstract statements or characteristics
● Accrual Concept
RECOGNITION OF:
ACCRUAL BASIS
CASH BASIS
Income
When earned
When received
Expenses
When incurred
When paid
○ Accrual Basis
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The amount of profit (revenue) or loss (expense) is determined by deducting
the total expenses incurred (whether they are already paid for or not) during
the period from the total income earned (whether they are collected or not) for
the same time frame. [Profit/ Loss = Total Income Earned - Total Expense]
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A method of recording accounting transactions for revenue when earned and
expenses when incurred.
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Financial statements match income and expenses to the periods in which
they are incurred.
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Under this, the effects of the activities and events are measured, recognized
and reported in the period when they occur - not necessarily when cash or
its equivalent is received or paid out.
○ Cash Basis
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Financial statements only reflect income and expenses when they are
received or paid.
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Under this basis, activities and events are recognized and reported in the
period when cash is actually received or paid out.
● Business Entity Principle
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Assumes that the business and its owner are separate and distinct entities.
● Concept of Equality of the Value Received and Value Given Up
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For every value received,there is an equal value given up.
● Consistency Concept
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Choose an accounting method (accrual or cash) that the business would stick
with for all future financial records.
● Expense Recognition
➔ Direct association
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This involves the simultaneous recognition of the income and expenses
that resulted directly from the same transaction.
➔ Systematic and rational allocation
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The procedure recognizes expenses during periods when the economic
benefits are used, expired or are divided.
➔ Immediate Recognition
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Occurs from the moment an item to have no future economic usefulness
or when an item ceases to produce future economic benefits
● Going Concern Assumption
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Also known as continuity assumption.
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The primary financial statements of a business enterprise are prepared on the
assumption that the normal operations of the enterprise will continue
indefinitely or in the foreseeable future.
● Income Recognition
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The general rule is the income is recognized when the earning process is complete
or almost complete.
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Income is recognized in the period when there is a measurable increase in future
economic benefits, related to either an increase in an asset or decrease in a liability.
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Generally, income is recognized when services have been rendered (service
concern) or when goods have been delivered
(trading/merchandising/manufacturing).
● Matching Concept
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The assumption that the results of business operations could be measured if
there is a proper matching of income and expenses within a reporting period.
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The profit of an enterprise could be properly measured if there is a proper matching of
earned income and incurred expenses within the reporting period.
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Proper matching is attained only if there is proper measurement, recognition,
and reporting of both the earned income (revenues and gains) and the related
incurred expenses and losses.
● Monetary Concept
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The assumption that the business transactions can be objectively measured or
quantified in terms of “peso”
● Periodicity Concept
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The assumption that the operating life of the business may be divided into
time-periods.
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Assumes that the operating life of the business may be divided into time-periods so
that timely and regular financial reports will be available for the use of decision-makers.
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As a result of the end-of-the-period cut-offs, measurement and recognition
problems arise.
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The major problems revolve around the determination of the amounts that
pertain to an element’s year life.
● Quantifiability
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Quality of being measurable; Capable of being rated or estimated
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A characteristic of the accounting system which admits as inputs only those
transactions and events can be represented in numerical (primarily monetary)
terms.
Qualitative Characteristics of Financial Information:
★ FUNDAMENTAL
○ Relates to the content or substance of the Financial Information
○ Primary - Chief of Importance
○ Has only 2 parts: Relevance and Faithful Representation although there’s a lot in the
module
■ Relevance
● Financial information possesses the quality of relevance when its
knowledge can make a difference in whatever decisions the
data-users will make.
● Financial information is considered relevant (have connection) if it has:
○ Feedback Value
- Also known as a Confirmatory Value
-
Exists if the reported information could be used to
assess the outcome of the past activities and
transactions.
○ Predictive Value
- Exists if this could be used as a basis for forecasting
what may happen in the future.
■ Materiality
● Sub-concept of relevance
● An item of information is deemed material if it is important
enough to have an effect on the data-user’s decision-making
process.
● Depends on its relative (in relation) size, its nature, the precision with
which it can be estimated, and how large the business enterprise is.
○ Relative
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It may be important to one aspect, or irrelevant to
another.
-
It depends on the size of the business and many other
factors
■ Faithful Representation
● It is what the financial information presents.
● They are all properly accounted and represented
● Exists when financial information is not biased.
● NO BIAS does NOT mean there is NO ERRORin the financial
information
○ Bias
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It favors one person or business
Exists if the accountant did not use the measurement
method properly or if the reported information is
consistently too high or too low in order to
intentionally favor certain interest groups.
○ No error
- The financial information has been verified, has no
bias seen, and no mistakes seen on the accounts.
○ Neutrality
- It does not favor any person or business
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Exists when the recognition and measurement of the
reported financial information are not intended to
favor only a certain chosen group of decision-makers or
data-users.
★ ENHANCING
○ Manner of how you present
○ Pertains to presentation on form/manner of how Financial Information is
presented
■ Comparability
● Allows the data-users to assess the similarities and differences either for
the same enterprise over different time periods or among different
enterprises for the same period of time.
● Users must be able to compare the data from one period to
another, or from one enterprise to another.
○ Consistency
- Using the same procedures, systems, and methods
from one period to another.
■ Verifiability
● Exists if repeating the method by different independent accountants
will obtain basically the same results.
● If another accountant ends up with the same results, basically, by
repeating the same method, it is considered verifiable
+ Not after the absolute amount, just close to the
original amount
○ Reliability
- Financial information is considered reliable if it is
verifiable, neutral, and if it represents that which it
intends to represent.
■ Timeliness
● Having financial information available to decision makers to be
capable of influencing their decisions
● It will be provided on a timely basis
● Provided when users need it
■ Understandability
● Users must be able to easily understand the data
● Clearly presented and with additional information if needed
Accounting Constraints:
-
Hurdles encountered as we apply principles
★ Prudence
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Otherwise known as conservatism
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An accountant exercises prudence by choosing to apply the method that will tend to
make the profit smaller.
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Applying method that will make profit smaller, but NOT deliberately
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Less beneficial or have the least effect on equity of the company
★ Costs Vs. Benefits (or Trade-off )
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Financial information should be gathered or provided to the data-users only if
the benefits to be derived from it exceed the costs of collecting and providing such
information.
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Benefits must exceed the cost of obtaining the Financial Information
EQUATION AND RULE
Accounting Equations:
A. Fundamental Equation
Assets = Liabilities + Owner’s Equity + Income - Expenses - Withdrawals
Withdrawals = Ending owner's equity - net income - beginning owner's equity - additional
investments
B. Results of Operations
➢ The income statement is an expanded and detailed expression of the income
and expenses in order to arrive at the profit earned or loss incurred during a given
reporting period.
Net Income = Revenue – Cost of Goods Sold – Expenses
Net income = Ending equity - Beginning equity (from the balance sheet)
Total Expenses = Net Revenue - Net Income
C. Ending Balance of the Proprietor’s Equity
➢ The equity of the proprietor may be computed independently from the asset
and liability elements, if information about profit and withdrawals for personal use
is available.
Accounting Cycle/Process:
Phase 1: Recording and Classifying
Step 1 - Compile and arrange the source documents that support the business transactions.
Step 2 - Analyze the business transactions and determine their two-fold effects on the
accounting elements.
Step 3 - Journalize the business transactions in the books of original entry called
journals.
Step 4 - Post the journal entries to the books of the final entry called ledgers.
Step 5 - Prepare the unadjusted trial balance.
Phase 2: Summarizing and Reporting
Step 6 - Gather the data needed to adjust the accounts.
Step 7 - Prepare the worksheet.
Step 8 - Journalize and post the adjusting entries.
Step 9 - Prepare the financial statements and supplementary schedules.
Phase 3: Closing Process
Step 10 - Journalize and post the journal (closing) entries.
Step 11 - Rule and balance the ledger accounts.
Step 12 - Prepare the post-closing trial balance.
Step 13 - Journalize and post the reversing entries.
Classification of Business Transactions:
❖ Business Transactions
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Activities or events that occur during a period of time, if they affect the
business’ financial condition and are capable of being assigned monetary
values.
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They are the documents that are attached to the financial transactions.
➢ Internal business transactions
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Activities or events that occurred within the business enterprise with no
separate entity involved.
-
An employee receiving their salary or a department giving office supplies to
another department are examples of internal transactions.
➢ External business transactions
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Exchanges of economic consideration with another separate entity,
whether a natural or an artificial entity.
❖ Reciprocal transactions
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Every business transaction has two-fold effects.
-
There is reciprocity of value received and value parted with in every business
transaction.
❖ Non-reciprocal transactions
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Value is received yet no value is parted with.
❖ Monetary Transaction
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It is assumed that objective and reliable monetary values can be assigned to the
business transactions.
❖ Non-monetary transactions
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Are assigned equal-to-cash peso values or fair market peso values that are agreed
upon between parties involved.
❖ Source Documents
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It is necessary that the reported information can be easily traced back to the
supporting evidence.
JOURNAL
➢ Journalizing is crucial
➢ Incorrect journal entries have a domino effect in the accounting process that leads to incorrect
financial reports
A journal entry has the following parts:
a. The date when the transaction occurred
b. The effects of the transaction as reflected by the account titles debited and account titles
credited
c. The monetary values (debit values and credit values) assigned to each accounting element
that is affected by the transaction
d. A brief and clear explanation
e. The posting references showing the code of the designation ledger account
Kinds of Journal:
★ General Journal
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All types of business transactions can be recorded in here
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Usually used by small businesses with SMALL number of daily transactions
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Transactions are recorded in two or more items (debit and credit)
★ Special Journals
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May be used to be able to group specific types of transactions in one
book of original entry (e.g. cash receipts journal, cash payments journal)
-
Used by medium and large businesses with HUGE volume of transactions
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Transactions are recorded in the form of single item
❖ Simple Entry
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A journal entry with one debit and one credit
❖ Compound Entry
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A journal entry with two or more debits and/or credits.
-
When an entry involves two or more debit items, their account titles and amounts
must all be recorded ahead of the credit account titles and their amounts.
Advantages:
-
Since the transactions are recorded in the journals in chronological order, it then
becomes easier to locate a transaction.
-
The process of classifying and sorting of the financial data is facilitated (easy to use)
since both debit and credit account titles and amounts are clearly and systematically
reflected on the same page of the journal.
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The use of journals helps avoid omissions or duplications in the recording and posting
process.
-
The task of auditing the records becomes less difficult since the auditor could clearly see
how the accountant recorded each business transaction.
Double Entry Bookkeeping
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It is based on the fundamental accounting assumption that all business transactions
have two-fold effects – that for every value received, there is a corresponding equal value
given up.
-
A method of recording transactions where for every business transaction, an entry is
recorded in at least two accounts as a debit or credit.
Example:
Group of Accounts
Example of Mixed Accounts:
● Prepaid insurance to which a part has already expired but not yet recorded as expense
● Office supplies to which some have already been used but have not yet been recorded as
expense, and other prepaid expenses.
Rules of Debit and Credit:
Normal Balance:
● Assets, Withdrawals, and Expenses = DEBIT or DR
● Liabilities, Income, and Owner’s Equity = CREDIT or CR
T - Account
Debit
Asset
Credit
Liabilities + Owner’s Equity + Income - Expenses - Withdrawals
Journalizing Business Transactions:
Manner of recording in the general journal:
1. Write the page number on the upper right hand corner of the general journal.
2. Write the date (month and day) on the DATE column.
3. In the ACCOUNT TITLE/EXPLANATION column, enter the account/s to be debited.
The amounts will be entered on the DEBIT column.
4. Below the debit entry, enter the account/s to be credited.. The amounts will be entered on
the CREDIT column.
5. Below the credit entry, write a brief explanation of the transaction being recorded.
SAMPLE JOURNAL ENTRY:
Adjusting Entries
ADJUSTING ENTRIES
-
Entries that are used to update the books
Purpose:
● To conform with the principle of “Matching Costs against Revenue” (matching
concept) which will result in a more accurate measurement of the net income;
● To arrive at the correct valuation of assets and liabilities;
● To arrive at the correct determination of the owner’s equity.
ITEMS TO BE ADJUSTED
Transactions that affect the future periods
RECOGNIZED
UNRECOGNIZED
● Unearned Income
●
Accrued Revenues
● Prepaid Expenses
●
Accrued Expenses
● Depreciation
● Amortization
● Doubtful Accounts
● Ending Inventory
SUGGESTED STEPS IN MAKING ADJUSTING ENTRIES
1. Identify the type adjustment.
● Accrued income – income earned but not yet collected
● Accrued expense – expenses incurred but not yet paid
● Unearned income – income received in advance
● Prepaid Expense – expenses paid in advance
● Depreciation – allocation of cost over the life of the asset
● Doubtful accounts – provision for uncollectibility
● Merchandise inventory (for trading business) – unsold merchandise
2. Determine the method used, if any (by reference to the entry made during the original
transaction or the account in the trial balance).
● Unearned Income – Income Method or Liability Method
● Prepaid Expense – Asset Method or Expense Method
3. Prepare the pro-forma adjusting entry
4. Analyze the earned and unearned portion
5. Post the required portion
WORKSHEET
➢ Preparation of financial statements directly from the ledgers of the business is a complicated
and difficult task considering the number of accounts involved and the adjustments that need
to be taken up.
➢ Although the preparation of this may be forgone, its importance can not be ignored in the
accounting process.
CHARACTERISTICS:
The worksheet includes any columnar and systematic presentation of accounting data.
-
It provides a place where adjusting entries can be formally taken up.
-
It provides a balancing mechanism that helps to discover and correct errors.
-
It is a source of data that will facilitate the closing of the books of accounts.
FINANCIAL STATEMENTS
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The preparation of financial statements is the culmination (climax) of the accounting
process.
-
It is the “end product” of the entire accounting process.
-
These financial statements are made the basis of decisions by users of financial
information.
Complete Set of Financial Statements:
1. Statement of Financial Position or Balance Sheet (Assets, Liabilities, and Equity)
2. Statement of Earnings or Income Statement (Income and Expense)
3. Statement of Changes in the Owners’ Equity [Prepared after the income statement because of
the net income or net loss for the period; Prepared before balance sheet because of the amount of
owner's Equity at the end of the period]
4. Statement of Cash Flows (Operating, Investing, and Financing Activities)
5. Notes [Comprising of the summary of significant accounting policies and other explanatory notes]
-
The notes are used to explain the assumptions used to prepare the numbers in the financial
statements, as well as the accounting policies adopted by the company.
Objectives of Financial Statements:
★ General Purpose FS
-
External reports
-
It is intended to meet the diverse information needs of the wide-range of
data-users.
-
It is provided by financial accounting and prepared primarily for external users
★ Specific-Purpose FS
-
Internal reports
-
Prepared to meet the specific information needs of certain decision-makers
-
Provided by management accounting or other branches of accounting and is prepared
primarily for internal users
Reporting Periods:
● Calendar Year
-
12-month reporting period that begins on January 1 and ends on December 31
● Fiscal Year
-
12-month reporting period that ends on a date other than December 31
-
For example, a fiscal year beginning November 1 would end October 31 of the
following year.
● Natural Business Year
-
12-month period which ends in the month business activities are at their lowest
● Interim Year
-
A financial reporting period that is shorter than a full fiscal year.
RELATIONSHIP AMONG FINANCIAL STATEMENTS
ROLE OF MANAGEMENT IN THE PREPARATION OF FINANCIAL STATEMENTS
➢ The proprietor or manager has the primary responsibility for preparing and presenting
the financial statements of the business enterprise.
➢ He reviews these statements and gives the final approval before they are released to any
government agency, creditor, or other data-user.
Users of the Financial Statements:
➔ Management
-
All these financial statements and internal reports serve as management’s feedback
tools, and at the same time aid the managers in making decisions as to what future
actions to take.
➔ Investors
-
The financial information made available to the investors could help them decide
whether they should buy, hold or sell their investment in the business enterprise.
➔ Trade Creditors
-
A trade creditor wants to know whether his present or prospective customer is
capable of settling his financial obligations within a short period of time
➔ Banks and Other Lenders
-
A lender needs information that will help in assessing the safety of his investment,
or the risk involved in his lending exposure.
➔ Government and Its Agencies
-
The government wants to know how the business enterprise is contributing to the
needs of the community and to the economy as a whole.
➔ Employees and Labor Unions
-
This group needs to know how stable and profitable its employer is.
➔ Customers and Clients
-
The customers of the enterprise are interested to know whether their supplier is
capable of continuously supplying their needs for raw materials, spare parts,
services, and even technological information.
➔ General Public
-
The other external data-users need financial data related to the operations of a
business for varied reasons.
INTERNAL USERS
❖ Owners = To assess how their business is performing to know their level of stability
❖ Managers = To plan, monitor and make decisions against competitors and developing the
company
❖ Employees = To know how well the company is performing because it affects their income
EXTERNAL USERS
❖ Investors
❖ Lenders (Creditors)
❖ Suppliers = To assess if the company is suitable to receive financial credit based on their
reliability before offering goods or services on credit
❖ Customers
❖ Auditors = External auditors examine FS to form an audit opinion
❖ Tax Authorities = to determine whether the company declared correct amount of tax in its
tax returns
❖ Government = to ensure that the company disclosure of FS are within regulations
❖ Public = Journalists, analysts, academics, activists, and individuals that are interested in
economic development
Statement of Financial Position - BALANCE SHEET:
2 MAJOR PARTS OF THE BALANCE SHEET
Heading
● Legal name of the enterprise
Body
● Assets or economic resources owned by
the reporting business enterprise
● Title of the financial statement, which is
the balance sheet
● Liabilities or economic obligations of the
enterprise to other entities
● Particular date as of when the financial
condition of the business enterprise is
being reported
● Equity of the owner or owners over the
assets of the business enterprise
2 Forms of Statement of Financial Position
1. Account Form
-
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.
-
Presentation is in t-account form wherein assets are on the left side and
liabilities and equity are on the right side.
2. Report Form
-
ONE STRAIGHT COLUMN the assets, followed by the liabilities and owner’s
equity
-
Downward presentation of assets, liabilities and equity.
A.1 EXAMPLE
Assets
CLASSIFICATIONS OF ASSETS
1. Current Assets
-
Cash and other assets that are expected to be converted to cash or consumed
within one year from the accounting period or the normal operating cycle of the
business whichever is longer
2. Non-current Assets
-
Other assets of the business that are not classifiable as current such as fixed assets.
-
Company's long-term investments that are not easily converted to cash or are not
expected to become cash within an accounting year.
Characteristics of Assets
● An asset is acquired by the business enterprise as a result of a past activity or event.
● An asset is recognized in the balance sheet if, upon its acquisition, a reliable and objective
monetary value can be assigned to it.
● It is expected to generate, directly or indirectly, net cash inflows.
● The owner or user of an asset has the legal capacity to restrict or prevent other entities
from having access to its economic usefulness.
Accounting Elements of Assets
Current:
➢ Cash – money and other medium of exchange available for general disbursements
➢ Cash Equivalents - total value of cash on hand that includes items that are similar to cash.
They include bank certificates of deposit, banker's acceptances, Treasury bills, commercial
paper, and other money market instruments.
➢ Marketable Securities - any unrestricted financial instrument that can be bought or sold on a
public stock exchange or a public bond exchange.
➢ Trade and other receivable:
➔ Accounts Receivable – claims from customers arising from sale of goods and
services, on credit basis, in the ordinary course of the business
➔ Notes Receivable – claims from customers arising from the sale of goods and services,
on credit basis, or as a result of lending money, for which a promissory note was
received
➔ Loans Receivable – claims from borrowers as a result of lending money.
➔ Advances to employees
➔ Accrued Revenue Receivable – right to collect income that is already earned but not
yet collected.
➔ Merchandise Inventory – goods and products that are acquired by a merchandising
business for the primary purpose of reselling them to customers at higher prices
➔ Prepaid Expenses – right to receive benefit from expenses already paid for but are
expected to be consumed or used in the following periods
➢ Contra-Asset Accounts
➔ Allowance for bad debts - valuation account used to estimate the amount of a firm's
receivables that may ultimately be uncollectible.
➔ Accumulated depreciation - life-to-date depreciation that has been recognized that
reduces the book value of an asset.
Non-Current:
➢ Investments – placement of funds to generate income
➢ Investment in stock – ownership of shares of a corporation
➢ Investment in bonds – ownership of financial instruments evidencing an obligation of
another entity
➢ Property, Plant, and Equipment
➔ Land
➔ Building
➔ Office Equipment – mechanical equipment such as computers, printers, adding
machines used in the office.
➔ Office Furniture and Fixtures – tables, chairs, shelves, filing cabinets, etc. used in
the office
➔ Store Equipment – mechanical equipment such as computers, printers, point-of-sale
machines used in the store.
➔ Store Furniture and Fixtures – tables, chairs, shelves, filing cabinets, etc. used in the
store.
➔ Intangible Assets - an asset that is not physical in nature. Goodwill, brand recognition
and intellectual property, such as patents, trademarks, and copyrights, are all intangible
assets.
Liabilities
CLASSIFICATIONS OF LIABILITIES
1. Current Liabilities
-
Financial obligations of the business which are payable within one year from the
end of the accounting period.
2. Non-current Liabilities
-
Financial obligations of the business which are payable for more than one year from
the end of the accounting period.
-
Debentures, long-term loans, bonds payable, deferred tax liabilities, long-term lease
obligations, and pension benefit obligations.
Characteristics of Liabilities
● A specific financial activity or event that obligates the business enterprise has occurred.
● A liability is recognized if a reliable and objective monetary value can be assigned to it at
the time it is incurred.
● A liability requires a settlement sometime in the future – either on an agreed date, on
demand, or when a specified event occurs.
● The obligation to settle cannot be avoided.
Accounting Elements of Liabilities
Current:
➢ Trades and other payables
➔ Accounts Payable – obligations of the business enterprise to the suppliers as a result
of buying goods and services, on credit basis, in the ordinary course of business
➔ Notes Payable (short term) – obligations as a result of buying goods and/or services,
on credit basis, or as a result of borrowing money, for which a promissory note is given
by the business
➔ Loans Payable – obligations of the business enterprise to lenders as a result of
borrowing money.
➔ Utilities Payable - the amount owed to suppliers for electricity, gas, Internet
connections, telephones, and water.
➔ Unearned Revenues – obligations for revenues that are collected in the current
reporting period but are expected to be earned in the following periods
➔ Advances from Customers – obligations by a seller to deliver goods or render services
to the customers who paid in advance
➢ Accrued Liabilities
➔ Accrued Expenses Payable – obligations for expenses that are already incurred but
not yet paid
➔ Salaries Payable
➔ Tax Payable
➔ Interest Payable
Non-Current:
➢ Mortgage Payable – obligation of the business for long-term borrowing wherein a land or
building is used as collateral
➢ Bonds Payable
➢ Notes Payable (long term)
➢ Debentures - a marketable security that businesses can issue to obtain long-term financing
without needing to put up collateral or dilute their equity.
➢ Long-term loans
➢ 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.
➢ Long-term lease
➢ Pension benefit obligations - the present value of retirement benefits earned by employees.
➢ Deferred Revenue - a prepayment by its customers for goods or services that have yet to be
delivered.
Equity
Characteristics of Equity
● Original investment of the owner(s)
+ Additional investments
+ profit or (loss) during the reporting period
- personal withdrawals or profit distributions
= equity of the owner(s) as of the end of the reporting period
Accounting Elements of Equity
❖ Owner, Capital
-
Account title used to show the original and additional investments of the owner
of the business enterprise
Stockholders Equity Account
➢ Common Stock ➢ Preferred Stock ➢ Paid-in Capital in Excess of Par Value ➢ Paid-in Capital from Treasury Stock ➢ Retained Earnings ➢ Accumulated Other Comprehensive Income -
❖ Owner, Drawing (Owner, Personal)
-
Account title used to show the total withdrawals of the proprietor, whether in
the form of cash or non-cash assets, for personal or family use.
■ 3 Criteria of Recording Withdrawals
● Only the owner can withdraw
● It takes an asset
● It is for personal use or family use
Statement of Earnings - INCOME STATEMENT:
➢ Income statements also report earnings per share (or “EPS”).
-
This calculation tells you how much money shareholders would receive if the
company decided to distribute all of the net earnings for the period.
-
(Net income - dividends) / Ave. Outstanding Shares
2 MAJOR PARTS OF THE INCOME STATEMENT
Heading
Body
● Legal name of the enterprise
● Reports a detailed and systematic listing,
together with their cumulative balances,
● Title of the financial statement, which is
the income statement
of the operating and non-operating
income and expense elements of the
business
● The particular reporting period covered
by the income statement
Forms of Income Statement
1. Natural Form
-
Also called “Nature of Expense Method” or “Single-step income method”
-
Commonly used in Service business
-
A single-step of deducting expenses from the revenue
-
All costs and expenses are deducted from the income earned to arrive at net
income for the period.
2. Functional Form
-
Also called “Cost of Sales Method” or “Multiple-step income method”
-
Commonly used in Merchandising business and Manufacturing business
-
Presents expenses according to its function
-
A series of steps is performed
-
Net income is derived after several steps of computation.
B.1 EXAMPLE
Income
Characteristics
● Revenues – arise from those ordinary activities that are directly related to the normal
operations of the business enterprise, such as the selling of goods and products or rendering
of services to customers
● Gains – include income from activities or events that do not form part of the ordinary
operations of the business
● Losses – represent decreases in assets or increases in liabilities arising from those
activities or events that are outside the ordinary course of business operations
Accrual Basis
➢ Under the accrual basis accounting, revenues are reported in the income statement of the
period when they are earned.
➢ Revenue is considered earned in the period when the delivery of goods is made to the
customer, or in the period when the service is rendered to the client, in the ordinary course of
operations.
Accounting Elements of Income
● Sales Income, Sales Revenues, or Sales – used to record the gross selling price of the goods
and products sold
●
Service Fees/Service Income – generic term used to encompass all income earned for services
rendered to the customers
●
Professional Fees /Professional Income – used to record the gross billings of a doctor,
accountant, lawyer, architect, artist, engineer or other professionals, for services rendered
● Commission Revenues/Commission Income – consideration received by an agent or broker
for performing a task on behalf of the principal
● Rent Revenues/Rent Income – consideration received by the owner of a property for
allowing another entity to use his tangible property, such as land, building, machinery, or
equipment
● Interest Revenues/Interest Income – consideration received by the lender for allowing a
borrower to use his money
● Royalty Revenues/Royalty Income – consideration received by the owner of a brand,
patent, formula, secret, or any other exclusive right, for allowing another entity to use his
intangible asset
● Gain on sale of fixed assets & investments – If the selling price of a property is greater than
the book value of the said property, a gain would result
● Gain on sale of investments – If the selling price of the investment is greater than its carrying
amount, a gain would result.
Expenses
Accrual Basis
➢ Expenses and losses are recognized in the period when they are incurred.
➢ An expense that has a direct relationship with an income is reported in the same period when
the income is recognized.
➢ Expenses that have an indirect relationship with the income are systematically allocated over
the period or periods benefited by the expenses.
Accounting Elements of Expense
● Cost of Sales/Cost of Goods Sold – book value of the goods and products sold to the
customers in the ordinary course of business
● Freight In – cost of transporting the purchased goods to the business site
●
Salaries and Wages
● Permits and licenses – amount paid to the government for allowing the business enterprise
to operate
● Expired Insurance / Insurance expense
● Advertisement and Promotions
● Audit and Legal Fees Expense
● Supplies Used / Supplies expense
●
Communication Expenses – cost of sending email, telegrams, letters, and other forms of
communication
●
Utility Expenses – cost of electricity, water, telephone, and other utility services received
●
Representation and entertainment
● Membership and subscription Expenses
●
Bonus and Allowances
●
Transportation and Travel
● Bank Charges
●
Commission Expense – consideration paid by a principal for the performance of tasks
assigned to an agent
● Rent Expense – consideration paid by a lessee for using a property that belongs to another
entity called the lessor or landlord
●
Interest Expense – consideration paid by a borrower for using the money of a lender
● Royalty Expense – consideration paid by a franchisee for being allowed to use a brand,
patent, formula, or any exclusive right that belongs to another entity called the franchisor.
● Depreciation – Building/Machinery and Equipment/Furniture and Fixtures/Delivery
Equipment – portion of the cost of fixed assets that is considered as an expense of the current
reporting period
● Bad Debts/Doubtful Accounts – portion of the accounts and notes receivable that is
considered as a loss because it may not be collected any more
● Taxes and licenses – taxes paid to local and national governments.
●
Income Tax Expense – share of the government in the profit that the business enterprise
earned during the year
● Loss on sale of fixed asset
● Loss on sale of investment
Statement of Changes in Equity
➢ This explains why the balance of the owner’s equity increased or decreased during the
reporting period.
ELEMENTS:
❖ Owner’s beginning capital
❖ Additional investments
❖ Withdrawals for personal use
❖ Profit or loss
❖ Elements of gains and losses not reported in the income statement
❖ Owner’s ending capital
EXAMPLE
Statement of Cash Flows
➢ It has 3 parts or financial activities:
○ Operating
-
Collections from customers, cash from sale of goods, etc.
○ Investing
-
Proceeds from the sale of fixed assets, payments for the purchase of
fixed assets, etc.
○ Financing
-
Proceeds from borrowings, repayments of loans, etc.
METHODS OF PRESENTATION OF STATEMENT OF CASH FLOWS
1. Direct Method
-
Sources and uses of cash are itemized under each activity.
2. Indirect Method
-
Operating activity is presented starting from the net income earned during the
period adjusted by items not requiring cash and the effect in cash of the increase
and decrease of current assets and current liabilities while investing and financing
activities are itemized.
EXAMPLE (DIRECT METHOD)
LIMITATIONS OF FINANCIAL STATEMENTS
➔ The assets and liabilities are usually recognized in the financial statements at their
acquisition costs, known as historical costs.
◆ During periods of inflation, information about historical costs is NOT as useful as
information about current values.
➔ Under accrual basis accounting, as usually used by profit-oriented businesses, the use of
estimates cannot be avoided.
➔ The traditionally prepared balance sheet DOES NOT include some assets that have
financial value to the business enterprise.
➔ Another constraint that limits the usefulness of the balance sheet is that the time value
of money is NOT taken into consideration.
Dictionary:
Account
-
A sorting device used to record, classify, and summarize the increases and decreases in the
balance of each accounting element as a result of the completed transactions of the business
enterprise.
Accounting
-
It is involved whenever a natural or artificial person has a business.
-
Involves the systematic recognition, measurement, reporting, and interpretation of
data that are related to the financial activities of a natural or artificial person.
-
Processing information in such a way that it would be useful is the primary core of
accounting.
-
Often called the “language of business”
-
Accounting is the art of recording, classifying, and summarizing in a significant
manner and in terms of money, transactions and events which are in part, at least, of a
financial character, and interpreting the results thereof. (AICPA)
-
Accounting is the process of identifying, measuring and communicating economic
information to permit informed judgements and decisions by users of information.
(AAA)
-
Accounting is a service activity. Its function is to provide quantitative information,
primarily financial in nature, about economic entities, that is to be useful in making
economic decisions. (FRSC)
Assets
-
They include those economic resources, rights, and property – both tangible and
intangible – that are owned and/or controlled by either a natural or legal entity.
Balance Sheet
-
Statement of financial position
-
This shows the financial condition of a business enterprise, which is assumed to be a
going concern, as of a particular date
-
This statement will show the assets, liabilities, and owner’s equity of the business as of
a given date.
-
All accounts appearing in this statement are called real accounts in the sense that they
are more or less permanent in nature and their balances are carried forward from
period to period.
-
Represent those economic resources and/or controlled by the enterprise, and which are
expected to have future usefulness to the business.
-
Balance sheet accounts are the real accounts.
-
As of Month xx, xxxx
-
A debt security
-
Loan from an investor to a borrower such as a company or government.
Bonds
Bookkeeping
-
In the field of accounting, it involves those mechanical and repetitive recording and
classifying procedures related to the business activities of a natural or artificial person,
until the voluminous financial information is summarized and reported in the form of
financial statements.
-
Is only a part of the wider field of accounting.
Book of Accounts
-
Business enterprises should keep certain financial records, called books of accounts,
where business transactions are recorded, classified, and summarized.
-
The most commonly kept books of accounts are grouped into two: journals and the
ledgers.
Business Enterprise
-
Also called as “Profit-oriented Organizations”
-
Exists when a person or group of persons makes an investment or contributes its
resources in order to sell products or render services to others, for the ultimate purpose
of making profit.
Double-entry Accounting
-
Also called double-entry system
-
A system that requires two book entries — one debit and one credit — for every
transaction within a business.
-
Books are balanced when the sum of each debit and its corresponding credit equals
zero.
Equity
-
It represents the residual claim of the owner over the enterprise’s assets
-
The residual interest of the owner or owners over the assets of the enterprise, after
deducting its total liabilities.
Expense
-
Usually used in connection with the outflow of assets or inflow of liabilities that are
directly or indirectly related to the normal activities of the business enterprise
-
Loss in personal account or in business
Financial Statements
-
It does not report accurate and exact values - it is not an exact science, we use objective
estimates
-
Financial statements are the means by which the information accumulated and
processed in financial accounting is periodically communicated to the users.
-
It is the financial representation of the financial position and financial performance of
an entity.
Footing
-
The total or sum of the journal entries
-
Usually accompanied by the double rule sign
Generally Accepted Accounting Principles (GAAP)
-
The accounting principles and processes, standards of recognition, measurement
methods, and basic assumptions which have gained international acceptance in the
business world and the accountancy profession that are used in the preparation and
presentation of the basic financial statements.
Income
-
Usually used in connection with activities that result to the inflow of assets and/or
outflow of liabilities
Income Statement
-
Statement of earnings
-
This shows the results of the operations of a business enterprise for a certain period of
time or reporting period
-
This statement summarizes the different revenues and expenses of the business to arrive
at the net income.
-
All accounts appearing in this statement are called nominal accounts in the sense that
they are merely temporary accounts and are not carried forward from period to period.
-
All accounts in the income statement are temporary accounts.
-
For the Month/Year Ended Month xx, xxxx
-
All transactions must be recorded in the books as they occur regardless of when they
Incurred
are paid.
Interest
-
The cost of using money.
-
It is normally associated with an issuance of a promissory note.
-
A business enterprise that cannot meet its obligations as they FALL (MATURE).
-
Book of account where a business transaction is recorded for the first time
-
Also referred to as books of original entry
Insolvent
Journals
Journalizing
-
The process of analyzing and recording or entering a business transaction in a journal.
-
Also known as book of final entry
-
A systematic compilation of several accounts.
-
The ledger is used as a tool to classify the recorded transactions for the purpose of
Ledger
getting the final balance of each account.
Liabilities
-
They represent the present economic obligations of an entity that would require some
form of future settlement.
-
Include those economic obligations of the enterprise, and which require future
settlements that are expected to result in outflows of economic resources.
Liquidity
-
The ability of a business enterprise to pay its currently maturing financial obligations.
Mixed Account
-
An account that combines the features of real and a nominal account
-
A liability since it is money owed to creditors and is listed under current liabilities on
Payable
the balance sheet.
-
(Your debt) Debt to the customer; Debt of the owner to the bank institution or
another person
Permanent Account
-
Real Account
-
They are accounts that can be carried into another accounting period.
-
Assets, Liabilities, and Equity
-
The process of transferring the data from the journal to the ledger account.
-
An asset that represents money due to a company in the short term.
-
(Debt to you) Debt to the owner; Debt of the customer to the owner
Posting
Receivable
Reversing entries
-
Journal entries used to cancel or neutralize entries made in the previous accounting
period.
Statement of Changes in Owner’s Equity
-
Owner’s equity will increase as a result of additional investment of the owner and the
net income earned by the business.
-
Conversely, the owner’s equity will decrease as a result of the withdrawal of the owner
or the net loss incurred by the business.
-
This statement supports the balance sheet.
Statement of Cash Flows
-
This statement shows the sources and uses of cash.
-
Aside from the information related to the overall financial condition and results of
operations of the enterprise, a data-user needs certain information that he can use as a
basis for assessing the ability of the business enterprise to generate cash.
Solvency
-
The ability of a business enterprise to meet its long-term financial obligations.
Trial Balance
-
A built-in accounting device that is prepared as of a certain date usually at the end of a
month, to test the quality of the debit and credit balances of the ledger accounts after
completing the journal entries and ledger posting.
Temporary Account
-
Nominal Account
-
They are the accounts which are closed at the end of the accounting period.
-
Income and Expense
-
A bookkeeper or an accountant needs a tool or a device to facilitate the smooth
Worksheet
preparation of financial statements.
-
A worksheet is a tool or a device that facilitates the preparation of an entity's financial
statements.
-
It is used for the convenience of the preparer of the financial statements, worksheet is
only optional in the accounting process.
-
For the Month/Year Ended Monrh xx, xxxx