Chapter 1
Business- a legally-recognized organizational
entity existing within an economically free
country designed to sell goods and/or provide
services to consumers
Profit-oriented enterprise- aims to earn
income or profit through the provision of goods
and/or services to consumers

Non-profit-oriented enterprise- aims to
achieve socio-civic or charitable aims
Forms of Business Enterprises (according to
nature of operations)
1. Service business or service concernsimplest form of business and provides
services to clients or customers in
exchange for fees, rent, interest or
royalties
2. Merchandising business or trading
concern- purchase goods from suppliers
and, without altering the state of the
goods bought, sell the same at a higher
price than cost
3. Manufacturing business or
manufacturing concern- involves the
most complex activities and actually
produces the goods that it sells to
customers
LEGAL FORMS of Business/ Business
Ownership

Sole Proprietorship- most basic legal
form of business and has only one owner
Advantages:
1. Easier to form compared to
partnerships and corporations
2. Generally has uncomplicated
transactions and minimal regulatory
requirements
3. Decisions can be arrives at in less time
and implemented faster
4. Proprietor enjoys all the profits earned
by the business
Disadvantages:
1. Proprietor faces financing problems
because of the enterprise’s limited

ability to raise capital once volume of
business increases
2. Proprietor does not receive the benefit
of second opinion on decisions made
3. Proprietor bears the risks and losses
which may be incurred in the business
4. Proprietor has unlimited personal
liability for the debts incurred by the
business
Partnership- an association of two or
more persons who bind themselves to
contribute money, property, or industry to
a common fund with the intention of
dividing the profits among themselves
- Partnerships are governed by
the Civil Code of the Philippines
Advantages:
1. It is easier to organize compared to a
corporation
2. Burden of management is shared
among partners
3. More ideas are exchanged and
brainstormed which results in better
decision-making
4. Can raise more capital than sole
proprietorship
Disadvantages:
1. Depends on the capability of each
partner to invest resources into the
business
2. Plurality of owners may result to
disagreements regarding ideas and
management style, hampering
business operations
3. Life of partnership may be fragile –it
may be dissolved by agreement, by
withdrawal of one or more partners, or
by the death of or incapacity of partner
4. Partners have unlimited personal
liability for partnership debts
Corporation- the most complex form of
business organizations
- Shareholder- a person who invests in
a corporation
- Certificate of stock- evidence of the
number of shares purchased
- Governed by the Corporation Code of
the Philippines
- Management of operations of the
corporation is centralized in the
corporation’s board of directors
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Advantages:
1. Has the greatest capacity to raise
capital
2. Can raise capital by selling shares of
stock to the public as a whole
3. Shareholders may transfer their shares
without the need to obtain the consent
of other shareholders
4. Corporations may exist for period no
longer than 50 years, subject to
renewal
5. Limited liability of owners
(shareholders are liable to third parties
for the losses of the corporation only to
the limit of their fully-paid
investments)
6. If corporation goes bankrupt, lenders
cannot take personal assets of the
stockholders
Disadvantages:

1. The cost of forming and managing a
corporation is relatively high compared
to sole proprietorships and
partnerships
2. Subject to greater scrutiny, regulation,
control and supervision by the
government
3. Management is more complex
4. Has limited powers, as expressly
stated in the Corporation Code of the
Philippines and its own Articles of
Incorporation
5. Subject to higher income tax rate
Cooperatives- defined by International
Cooperative Alliance’s Statement on
Cooperative Identity as “autonomous
associations of persons united voluntarily
to meet their common economic, social,
and cultural needs and aspirations through
jointly owned and democratically
controlled enterprises”
Economic Decisions
Economic decisions- decisions which affect the
resources it controls and the obligations of the
business to other enterprises
Financial Information- a summary of all the
transactions of the business over a period of
time. Most important financial information comes
from accounting
Accounting- 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
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Is a service activity. Its function is to
provide quantitative information,
primarily financial in nature, about
economic entities, that is intended to
be useful in making economic
decisions
Service function to management. It
basically processes raw data and
converts them to meaningful
information that will be useful for
decision-making
Is the process of identifying, measuring
and communicating economic
information to permit informed
judgement and decision by users of
the information
Basic purpose of accounting: to supply
financial information to users of the information
to help them make informed judgements and
better decisions
Accounting is language of the business: used to
communicate financial information to interested
parties. Through this, different users of
information understand what is happening in the
business enterprise
Bookkeeping- procedural or mechanical aspect
of accounting and involves set-up, update and
maintenance of accounting records. It can be
done by properly trained non-accountants
Accounting- interpretation of information
recorded under bookkeeping. Practice of
accountancy can be done only by certified public
accountants
The Accountancy Profession
Accounting is a profession because it has the
attributes required of a profession.
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1. Mastery of particular intellectual
skill, acquired by training and
education. Accounting requires students
to finish degree in Bachelor of Science in
Accountancy and pass government
examination administered by Professional
Regulatory Board of Accountancy
2. Adherence by its members to a
common code of values and conduct
established by its administrating
body, including maintaining an
outlook which is essentially
objective. The Code of Ethics is
mandatory for all CPAs
3. Acceptance of duty to society as a
whole (usually in return for
restrictions in use of a title or in the
granting of qualification). Majority rely
on CPAs for sound financial accounting
and reporting, effective financial
management and competent advice on a
variety of business and taxation matters
The Accountancy Act of 2004
Republic Act No. 9298, the Philippine
Accountancy Act of 2004
Objectives:

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Standardization and regulation of
accounting education
Examination for registration of certified
public accountants
Supervision, control, and regulation of the
practice of accountancy in the Philippines
Article II creates Professional Regulatory
Board of Accountancy which enforces the
provisions of the Philippine Accountancy Act. It is
also granted the right to issue, suspend, revoke
or reinstate CPA certificates for the practice of the
profession

The Board is composed if a chairman and
6 members, all of whom are appointed by
the President of the Republic of the
Philippines
The CPA Board Exams
Any person applying for examination shall
establish the following requisites to the
satisfaction of the Board that he/she:
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Is a Filipino citizen
Is of good moral character
Is a holder of degree of Bachelor of
Science in Accountancy conferred by a
school, college, academy or institute duly
recognized and/or accredited by the CHED
or other authorized government offices
Has not been convicted of any criminal
offense involving moral turpitude
Licensure examination for CPAs shall cover , but
are not limited to, the following subjects:
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Management Services
Business Law and Taxation
Theory of Accounts
Auditing Theory
Auditing Problems
Practical Accounting Problems 1
Practical Accounting Problems 2
Economics
To be qualified as having passed the licensure
exam, candidate must obtain a general average
of 75% with no grades lower than 65% in any
given subject. If candidate obtains required rating
or above in at least a majority of subjects
provided for in this Act, they will receive a
conditional credit for the subjects passed Such
candidate will take an examination in the
remaining subjects within 2 years from preceding
examination and fails to obtain 75% and a rating
of at least 65% for the subjects re-examined, they
will be considered as having failed the entire
examination
Candidates who fail 2 complete examinations
shall be disqualified from taking another exam
unless they submit evidence to the satisfaction of
the Board that they enrolled an completed at
least 24 units of subject given in the licensure
examination
Sectors of Accounting Practice
1. Public practice- This sector includes
individual practitioners, small accounting
firms, medium sized and multinational
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accounting firms that render independent
professional accounting services to the
public. CPAs charge professional fees for
these services. Example of service are:
 Auditing- most common service
provided by CPAs and involves
independent examination of financial
statements for the purpose of
expressing an opinion on the fairness
of these statements
 Tax services- includes the preparation
of tax returns for various clients,
provision advice on tax matters and
representation of clients in tax cases
 Management and consulting
services- involves providing
advisory/consulting services on
matters of accounting, finance,
business policies, organization
procedures, budgeting, product costing
and the conduct of operations
2. Commerce and Industry
Accountants are employed in various
positions such as: vice-president for
finance, chief accountant, cost
accountant, internal auditor or budget
officer. The highest accounting officer of a
business organization is known as the
controller. Accountants in commerce and
industry assist management in planning
and controlling a company’s operations
3. Education
This area employs accountants as
professors, reviewers or researchers. They
take steps to clarify and address emerging
accounting issues encountered by
accountants in other sectors. They share
results of discussion and research with
colleagues in other sectors. Educators also
prepare aspiring CPAs for the Licensure
Examinations
4. Government
Accountants may be hired as staff,
auditor, budget officer or consultant in
government units like the Commission on
Audit, Bureau of Internal Revenue,
Department of Finance, Department of
Budget and Management, and the
Securities and Exchange Commission
Accounting –Then and Now
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Comes from Middle East Region, where as
early as 8500 BC, tradesmen use clay
objects to represent commodities
Ancient civilizations of Babylon, Greece
and Egypt also used clay tablets and later
papyri to record document wage
payments, material requisitions and costs
of labor
In 13th to 15th centuries, more systematic
record-keeping methods were developed
with the growth of trade and commerce
Florentine, Venetian and Genoan
merchants used these methods to keep
track of their business
Double-entry records first appeared in
Genoa in 1340 AD
Luca Pacioli and the Summa
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1494, Friar Luca Pacioli wrote a book
containing discussions on the doubleentry bookkeeping system entitled Summa
de Arithmetica, Geometria, Proportioni et
Proportionalita (Everything about
Arithmetic, Geometry, Proportions and
Proportionality), summary of the existing
mathematical knowledge at the time
Considered as Father of Double-Entry
Bookkeeping
The Industrial Revolution

Cost accounting- specialized field of
accounting which deal with the allocation
of costs to products was developed during
this period
Fields of Accounting
1. Financial accounting-focuses on
preparation of general-purpose financial
statements with the aim of meeting most
of the needs of the external users
2. Management accounting- concerned
with financial reporting for internal users
(management) and users have control
over the accounting system and can
specify precisely the type of reports
needed for use in decision-making
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3. Cost accounting- measures a business’
costs to help management in controlling
expenses
4. Tax accounting- has two aims:
compliance with tax laws and minimizing
the company’s tax bill through legal
means
5. Government accounting- encompasses
the process of analyzing, classifying,
summarizing and communicating all
transactions involving receipt and
disposition of government funds and
property and interpreting the results
thereof. Focus is the proper custody,
disposition and accounting for public funds
3.
4.
Chapter 2
Generally Accepted Accounting Principles
GAAP- comprises the accounting principles and
processes, standards and underlying assumptions
that are used in preparing financial statements
Financial Reporting Standards Council
(FRSC)- official accounting standard setting body
in the Philippines. The primary task of FRSC is to
improve and establish accounting standards that
will be generally accepted in the Philippines
Philippine Financial Reporting Standards
(PFRS)- The FRSC issued this and this
constitutes the generally accepted accounting
standards observed in the Philippines
-PFRS includes:
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Philippine Accounting Standards
PFRS
Philippine Interpretations developed by
Philippine Interpretations Committee
5.
6.
Basic Accounting Concepts
1. Business entity principle: business is
considered distinct and separate from the
owner(s) of the business
 Accounting entity- an organization
accounted for as a separate economic
unit
2. Dual-effect of business transactions:
whenever a business transaction takes
place, it is assumed that the value receive
7.
is equal to the value given up (for every
value received, there is an equal value
given up) Debit-Credit
Matching principle: profit or loss is
computed by deducting the expenses
incurred from the income earned during
an accounting period. Income recorded
and reported in one accounting period
should be matched against the expenses
that directly or indirectly contributed to
the generation of the income
Accrual basis: income is recognized
when it is earned, regardless of when cash
is received. Expenses are recognized when
incurred, regardless of when cash is paid
 If services have already been rendered
to a customer, income is recognized
even if cash has not been received
from the customer
 If cash is received from customer
before a service is rendered or goods
are delivered, income is not yet earned
because there is no service or delivery
of goods yet. The cash received would
be earned only upon rendering of
service or delivery of the goods
 If services have already been received
by the business from its suppliers,
expenses are recognized even if these
services have not yet been paid for by
the businessz
 If cash has already been paid by the
business to its suppliers, an expense is
not recorded until it is incurred
Cash basis of Accounting: income is
recognized when cash is received, and
expenses are recognized when cash is
paid (extra concept sometimes used by
other businesses)
Stable monetary unit: it is concerned
with information which can be quantified
and expressed in terms of money. For
business transactions to be included in the
accounting records and financial
statements of the enterprise, it must be
expressed in terms of a uniform means of
measurement
Periodicity (Time Period Concept):
operating life of an enterprise may be
conveniently divided into time periods of
equal length called accounting periods.
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Normal accounting period is equal to 12
months or 1 year
8. Going Concern (Continuity
Assumption): enterprise is a going
concern and will continue operation for the
foreseeable future. It is assumed that the
enterprise has neither the intention nor
the need to liquidate or curtail materially
the scale of its operations
Accounting Framework
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The Framework for the Preparation and
Presentation of Financial Statements sets
out the concepts that underlie the
preparation and presentation of financial
statements for external users
The Framework is not part of the PFRS and
in case of conflict, the requirements of the
PFRS shall prevail over those of the
Framework
Purposes of the Framework
a) Assist the FRSC in developing accounting
standards that represent the GAAP in the
Philippines
b) Assist the FRSC in its review and adoption
of existing International Financial
Reporting Standards
c) Assist prepares of financial statements in
applying FRSC Philippine Financial
Reporting Standards and in dealing with
topics that have yet to from the subject of
an FRSC statement
d) Assist the auditors in forming an opinion
as to whether financial statements
conform with the Philippine GAAP
e) Assist users of financial statements in
interpreting the information contained in
financial statements prepared in
conformity with Philippine GAAP
f) Provide those who are interested in the
work of the FRSC with information about
its approach to the formulation of
Philippine Financial Reporting Standards
Scope of the Framework
a. Objective of financial statements
b. Underlying assumptions in the preparation
of financial statements
c. Qualitative characteristics that determine
the usefulness of information in financial
statements
d. Definition, recognition and measurement
of the elements of the financial
statements
e. Concepts of capital and capital
maintenance
Financial Statements
Financial statement- the means by which the
information accumulated in and processed by
financial accounting is communicated to users on
a periodic basis and is the end-product of the
financial accounting process
Parts:
1. Statement of financial position or
balance sheet
2. Statement of comprehensive income
(income statement)
3. Statement of changes in equity
4. Statement of cash flows
5. Notes to the financial statements
Users of Financial Statements
1. Investors- providers of risk capital and
are concerned with the risk inherent in
and return provided by their investments.
They need information to help them
determine whether to buy, sell or hold
their investments. Info enables them to
assess enterprise’s ability to pay dividends
2. Employees- interested in information
about the stability and profitability of their
employers. Info enables them to assess
the enterprise’s ability to provide
remuneration, retirement benefits and
employment opportunities
3. Lenders- determine whether their loans
and the interest attaching to them will be
paid when due
4. Suppliers and other trade creditorsdetermine whether the amounts owing to
them will be paid when due
5. Customers- information about the
continuance of an enterprise
6. Government and their agenciesinterested in the allocation of resources
and, therefore, the activities of the
enterprise. They also require information
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to regulate the activities of enterprise,
determine taxation policies and as the
basis for national income and similar
statistics
7. The public- enterprises affect the
members of the public in a variety of ways
 Financial statements are primarily used for
the use of investors and creditors
Information Provided by Financial
Statements

Information about the financial position,
financial performance and cash flows of an
entity
1. Financial Position
- Condition of a business, in monetary
terms, as of a given date or point in
time and is primarily provided in a
statement of financial position or
balance sheet. Financial position is
affected by the economic resources
controlled, financial structure,,
liquidity, solvency, and capacity to
adapt to changes in the environment
in which an enterprise operates
Liquidity- availability of cash in the near future
to cover currently maturing liabilities or
obligations
Solvency- availability of cash over the long term
to meet obligations when they fall due
Capacity for adaptation- ability of the
enterprise to use its available cash for
unexpected requirements and investment
opportunities or simply called as emergency
money
2. Performance or profitability
- Refers to whether a company is able to
generate profit or incur a loss during a
particular accounting period and is
used for statement of comprehensive
income. 2 parts: profit/loss portion and
other comprehensive income portion
Income statement- useful tool for evaluating
management’s stewardship of the resources of
the enterprise and for assessing the inflow and
outflow of cash
3. Changes in financial position
- Information concerning changes about
a company’s financial position is useful
in order to assess its investing,
financing and operating activities
during the reporting period. This
information provides users with a basis
to assess the enterprise’s ability to
generate cash and cash equivalents
and the needs of the enterprise to
utilize those cash flows
Statement of changes in equity- shows
balance of the owner’s investment in the
business at the beginning of the accounting
period, additional investments made by the
owner, withdrawals by the owner for personal
use, the profit or loss for the period, and the
balance of the owner’s investment at the end of
the accounting period
Statement of cash flows- summarizes cash
activity for the period, classified according to the
nature of activity
4. Other supplementary information
- Additional information that is relevant
to the need of financial statement
users. May include:
 disclosures about the risk and
uncertainties concerning the
enterprise and any resources and
obligations not recognized in the
statement of financial position
 information about geographical and
industry segments
 effects on the enterprise of changing
prices
General-Purpose Financial Statements

financial statements that meet most of
the needs of other users
Special-purpose financial statementscovered by management accounting and
auditing courses
Frequency of Preparation of Financial
Statements
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Usually prepared annually
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Interim financial statements- shorter
period financial statements (monthly,
quarterly or semi-annually)
Responsibility for Financial Statements
Management is responsible for:
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Preparation and presentation of the
financial statements of the enterprises
Selecting and applying the accounting
policies and principles which are
appropriate for the company
Underlying Assumptions in the Preparation
of Financial Statements
Underlying assumptions-concepts which are
assumed to have been applied in preparing
financial statements
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Accrual basis
Going concern
Elements of Financial Statements
A. Elements pertaining to financial
position
1. Assets- resource owned and/or
controlled by the enterprise and
expected to provide future economic
benefits to the enterprise. It is
acquired by an enterprise as a result of
a past transaction or event. The
enterprise should have the capacity to
restrict or prevent other entities from
enjoying the economic benefits arising
from the use of the resource or item
 Cash- items considered as medium
of exchange in business
transactions
 Accounts receivable- valid claims
from customers or clients arising
from the provision of services or
delivery of goods in the ordinary
course of business where the price
for these services or goods have
not yet been paid
 Supplies on hand- supplies
purchased by an enterprise which
are unused as of the reporting date
 Merchandise inventory- goods
which have been bought from
suppliers for resale to customers at
a higher price than cost
 Property , plant and
equipment- long-lived assets
which have been acquired for use
in operation
2. Liabilities- present obligation of the
enterprise arising from past events,
which are to be settled in the future. It
is required to be settled in the future
 Accounts payable- amounts due
to suppliers for goods purchased or
services received on account
 Salaries payable- due to
employees which are unpaid as of
the reporting date
 Utilities payable- due to utility
companies for electricity, heat,
light and water charges
 Advances from customersamounts received from customers
in advance for delivery of goods or
provision of services
 Loans payable- obligations of an
enterprise to lenders
3. Equity- claim; residual interest in the
assets of the enterprise after
deducting all its liabilities and arise
from the original investment by an
owner into the business and increased
by additional investments by the
owners and by profit earned during a
period
B. Elements pertaining to performance
or profitability
1. Income- increase in economic benefits
during the accounting period in the
form of inflows or enhancements of
assets or decreases of liabilities that
result in the increase of equity other
than those a relating to contributions
from equity participants
 Revenue- course of the ordinary
activities of an enterprise (sales,
fees, dividends, royalties and rent)
 Gain- other items that meet the
definition of income and may or
may not arise in the course of the
ordinary activities of an enterprise
2. Expenses- decrease in economic
benefits during the accounting period
in the form of outflows or depletions of
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assets or incidences of liabilities that
result in decreases in equity other than
those relating to distributions to equit
participants
 Losses- other items that meet the
definition of expenses and may or
may not arise in the course of the
ordinary activities of the enterprise
Recognition of the Elements of the Financial
Statements
Recognition- process of incorporating in the
statement of financial position or statement of
comprehensive income an item that meets the
definition of an element and satisfies the criteria
for recognition
financial statements are to be
recognized and carried in the financial
statements
Measurement Bases
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Criteria:
1. It is probable that any future economic
benefit associated with the item will flow
to or from the enterprise
2. The item has cost or value that can be
measured with reliability
Qualitative Characteristics of Financial
Statements (Accounting concepts)
Examples:
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Asset is recognized when it is probable
that the future economic benefits will and
asset has a cost or value that can be
measured reliably
Liability recognized when it is probable
that an outflow of resources embodying
economic benefits will result from
settlement of a present obligation and it
can be measured reliably
Income is recognized when increase in
future economic benefits related to an
increase in an asset or a decrease of a
liability has arisen that can be measures
reliably
Expenses is recognized when a decrease
in future economic benefits related to a
decrease in asset or an increase of a
liability has arisen that can be measure
reliably
Measurement of the Elements of the
Financial Statements
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Historical cost: assets are recorded at
the amount of cash or cash equivalents
paid or the fair value of the consideration
given to acquire them at the time of their
acquisition
Current cost: assets are carried at the
amount of cash or cash equivalent they
would have to be paid if the same or an
equivalent asset was acquired currently
Realizable (settlement) value: assets
are carried at the amount of cash or cash
equivalent that could currently be
obtained by selling the asset in an orderly
disposal
Present value: assets are carried at the
present discounted value of the future net
cash inflows that the item is expected to
generate in the normal course of business
Process of determining the monetary
amounts at which the elements of the
Qualitative characteristics- attributes that make
the information provided in financial statements
useful to users
4 principal qualitative characteristics
1. Relevance- when it influences the
economic decisions of users by helping
them evaluate past, present or future
events or confirming or correcting past
evaluations
a) Predictive role- if it is used to make
predictions of future cash inflows or
income in future periods
b) Confirmatory role- if it is used o
confirm or correct the earlier
expectations of a financial statement
user
c) Materiality- if its omission or
misstatement could influence the
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economic decisions of users taken on
the basis of financial statements
2. Reliability- info should be free from
material error and bias and can be
depended upon by users to respect
faithfully that which it either purports to
represent or could reasonably be expected
to represent
a) Faithful representation- information
must represent faithfully the
transactions and other events it either
purports to represent or could
reasonably be expected to represent.
The actual effects of transactions
should be properly accounted for and
reflected in the financial statements
b) Substance over form- transactions
and other accountable events are
accounted for and presented in
accordance with their substance and
economic reality and not merely their
legal form
c) Neutrality- financial statements must
be free from bias
d) Prudence (Conservatism)- inclusion
of a degree of caution in the exercise
of judgement needed in making the
estimates required under conditions of
uncertainty, such that asset or income
are not overstated and liabilities and
expenses are not understated
e) Completeness- info must be
complete within the bounds of
materiality and cost
3. Understandability- words and other
accounting terminology being used are
those expected to be known and
understood by users of the financial
statements
4. Comparability
a) Intra-comparability- users must be
able to compare the financial
statements of an enterprise across
accounting periods
b) Inter-comparability- users must be
able to compare financial statements
of different enterprises in order to
evaluate their relative financial
position
Constraints on Relevant and Reliable
Information
1. Timeliness- if there is undue delay in the
reporting of information it may lose its
relevance
2. Cost-benefit- cost of providing financial
information should not exceed the benefits
of having these information available for
decision-makers
3. Balance between Qualitative
characteristics- relevance and reliability
are not present simultaneously as desired
Chapter 3
Business transaction- exchange of values
involving two parties or within the enterprise
External transactions- sale of goods to
customers or the provision of services to clients
Internal transactions- manufacture of goods
for sale and incurrence of losses by the company
resulting from fire and flood
Source Documents
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Original record of a business
transaction (date and nature of
transaction amount and parties
involves)
Examples:
1. Sales invoice- issued to evidence a sale
for cash
2. Delivery receipt- evidence the
acceptance/receipt of the goods delivered
to the customer
3. Official receipt- issued to evidence the
receipt of cash from customers
4. Vendor’s invoice- issued to the
enterprise by the enterprise’s suppliers
5. Purchase requisition forms- evidences
an employee’s request for the purchase of
needed goods or suppliers
6. IOUs- note acknowledging indebtedness
to the enterprise
7. Promissory notes- unconditional
promise in writing made by one person to
another
8. Bank statements- summary of all
financial transactions occurring over a
certain period on a bank account
9. Minutes of meetings- record of a
meeting
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10. Business letters- business
correspondences
11. Job time tickets- time spent working at a
particular customer order
12. Certificates of stock-ownership of
shares in a corporation
13. Time records/timesheets- time-in and
time-out of employees
14. Check voucher- authorization of cash
disbursement transactions
15. Journal voucher- documents used for
transactions and journal entries for which
there is no other source document
Basic Accounting Equation
Assets= Liabilities + Equity
Net Assets-focuses on equity or the claim of
owners to the assets of the business
Equity= Assets – Liabilities
Possible effects of business transactions:
a) Increase in assets= increase in liabilities
b) Increase in assets = increase in equity
c) Increase in one asset= decrease in
another asset
d) Decrease in assets= decrease in liabilities
e) Decrease in assets= decrease in equity
f) Increase in liabilities= decrease in equity
g) Increase in equity = decrease in liabilities
h) Increase in one liability= decrease in
another liability
i) Increase in one equity= decrease in one
equity
Expanded Accounting Equation
Assets= Liabilities + Equity + Income – Expenses
Parts of:




Financial Position: assets, liabilities and
equity
Comprehensive Income: Income and
expenses
Changes in Equity: capital, additional
investments and withdrawals
Cash flows: any activity that results in
inflow or outflow of money or resources
Common Examples of Account Titles Used
1. Asset Accounts
 Cash- medium of exchange for
business transactions
 Held for trading securitiestemporary investments of excess cash
which are primarily held for short-term
gain
 Loans and receivables- trade
receivables and non-trade receivables
and are claim against others which
arise in the ordinary course of doing
business
 Trade notes receivable- written
promise from the customer to pay a
fixed amount of money on a certain
future date
 Non-trade receivables- all other
claims which are not trade
 Inventories- assets which are held for
sale/ in the process of production/ in
the form of materials and supplies
 Prepaid expenses-expenses paid for
by the business in advance. (e.g.
prepaid insurance and prepaid rent)
 Long-term investments- asset held
by an enterprise for the accretion of
wealth through capital distribution for
capital appreciation or for other
benefits to the investing enterprise
 Property, plant and equipmenttangible assets used in the production
or supply of goods or services
 Intangible assets- identifiable, nonmonetary assets without physical
substance
2. Liability Accounts
 Accounts payable- opposite of
accounts receivable
 Notes payable- enterprise is the one
who promises to pay
 Accrued liabilities- amounts owed to
others for unpaid expenses
 Unearned revenues- enterprise
receives payments before providing
its customers with goods or services
 Mortgage payable- used for
recording long-term debts of an
enterprise
 Bonds payable- large sums of money
are often required by a business for
working capital and expansion
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purposes and is often obtained by
floating bonds
3. Equity Accounts
 Equity- used to record the original and
additional investments of the owner of
the business entity
 Withdrawals- when proprietor
withdraws cash or other assets for
non-business use
 Income summary- temporary
account used to summarize all income
and expenses for a given period
4. Income Accounts
 Service income or fees incomerevenues earned by performing
services for customers
 Sales- revenues earned as a result of
sale of merchandise
5. Expense Accounts
 Cost of sales- cost incurred to
purchase or to produce the products
sold to customers during the period
 Salaries and wage expensepayments as a result of an employeremployee relationship
 Utilities expense- expenses related
to use of communication facilities, the
consumption of water and electricity
 Rent expense- expense for leased
office space, equipment or other
assets rented from others
 Supplies expense- account used for
recording the usage of supplies in the
normal course of business
 Insurance expense- portion of
premiums paid on insurance coverage
which has expired
 Depreciation expense- the portion
of the cost of a tangible asset
allocated or charged as expense
during as accounting period
 Bad debts expense- amount of
receivables estimated to be
uncollectible and charged as expense
during an accounting period
 Interest expense- expense related to
borrowed funds
Double-Entry Accounting System
1. For every debit entry, there must be a
corresponding credit entry and accounting
equation must always be maintained
2. Each transaction affects at least two
accounts
3. Total debit for a transaction must equal
total credits
4. An account is debited when an amount is
entered on the left side of the account and
credited when amount is entered on the
right side
5. The account type determines how
increases or decreases in it are recorded
Account Balances
-
Difference between the total debits
and the total credits of each account
Debit balance- if total debits are greater than
the total credits
Credit balance- if the total credits are greater
than the total debits
Normal balance- usual balance of an account
assuming proper accounting has been made
Chapter 4
Steps in Accounting Cycle:
1. Analyzing business transactions through
source documents
2. Journalizing, or the recording of
transactions in a journal
3. Posting or transferring of the entries from
the journal to the ledger
4. Preparing the trial balance
5. Preparing the 10-column worksheet and
making the necessary adjusting journal
entries
6. Preparing the financial statements based
on adjusted account balances
7. Recording adjusting entries to the journal
and posting the same to the ledger
8. Recording and posting of closing entries
9. Ruling and balancing real and nominal
accounts
10. Preparing post-closing trial balance
11. Preparing reversing entries
Journal- book where transactions are initially
recorded in a systematic and chronological order;
also called the book of original entry
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Simple journal entry- one account debited and
one account credited
Open account- when in trial balance, there is a
balance either on the debit or credit side
Compound journal entry- more than one
account is involved in a single entry
Closed account- if the debit equals credit
Memorandum entry- an entry which has no
debit or credit, which shows only the date and a
brief explanation or reminder
Chart of accounts- list of all accounts of the
business and their respective account numbers.
Use of this would reduce confusion as to the
choice of account titles and permits uniformity in
recording routine transactions
Ledger- group of accounts and known as the
book of final entry
Trial balance- list of all accounts and their
balances and indicated whether total debit equals
total credit. It does not guarantee that all
transactions have been recorded. It is commonly
taken every month-end
Reasons Why Trial Balance may not be
Balance:
1. Error in footing the debit and credit
columns
2. Error in transferring from the ledger to the
trial balance
3. Error in posting (e.g. posting debit to
credit side of account)
4. Error in journalizing
5. Error of omission
Working-Back Method
1. Check if amount is doubled on debit or
credit side
2. Transplacement error- e.g. 1M -> 100,000
3. Transposition error- when position of
numbers are mixed (e.g. 535,700 ->
553,700)
Footing- adding all the debits and credits
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