Spec PA 101 Fundamentals of Accounting
Prepared by:
MARIBEL B. TUANTE
CHAPTER 1
Learning Objectives:
After studying this chapter, shou be able to:
1. Define accounting and explain its role in business.
2. Narrate briefly the development of accountancy in the Philippines and describe the attributes that
makes it a profession including the scope of its practice.
3. Explain the objectives as well as functions of accounting.
Do you agree with me that accounting is important in our lives, and it is essential in the world of business? It
is the system that measures business activities, processes that information into reports and communicates the
results to decision-makers. For this reason, accounting is called the language of business.
Accountants are the scorekeepers of business. Without accounting, a business couldn’t function optimally, it
would not know whether it’s making profit, and it would not know its financial situation.
Definitions of Accounting
Accounting 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.
Accounting is an information system that measures, processes and communicates financial information about
an economic entity.
Accounting is the process of identifying, measuring and communicating economic information to permit
informed judgements and decisions by users of the information. Definition by the American Accounting
Association (Year 1966):
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.
Definition by the American Institute of Certified Public Accountants (Year 1961):
Accounting is an art because it established rules and principles of accounting which are applied in an economic
entity's bookkeeping process.
Accounting is considered both an art and a science because it involves both creative and technical elements.
The art aspect comes from the interpretation and analysis of financial data, which requires a certain level of
creativity and subjectivity. The science aspect comes from the use of technical methods and procedures to
record, classify, and report financial data, which requires precision and accuracy. Together, these elements
make accounting a unique and complex field that requires both creative and technical skills.
Accountancy in the Philippines
Board of Accountancy - Subject to the approval of the Professional Regulation Commission, the Board of
Accountancy shall promulgate rules and regulations and set professional standards for the practice of
accountancy.
Board of Accountancy (BOA) is the professional board of Certified Public Accountants in the Philippines
under Professional Regulation Commission (PRC), a government agency administered to register and regulate
professionals in the Philippines.
Philippine Institute of Certified Public Accountants – In 1975 with the accreditation by the PRC of the
PICPA as the bona fide professional organization representing CPAs in the country, the Board has coordinated
with PICPA to further strengthen the profession. With PICPA, it has worked for the passage of the
Accountancy Act of 1967, the issuance of the Code of Professional Ethics in 1978, the issuance of guidelines
for the mandatory continuing professional education (CPE) program.
On November 18, 1981, The PICPA created the Accounting Standards Council (ASC) to establish and
improve standards that will be generally accepted in the Philippines. Accounting principles become generally
accepted if they have substantial authoritative support from the relevant parties interested in the financial
statements.
Per Section 9(A) of the Rules and Regulations Implementing Republic Act No. 9298 otherwise known as the
Philippine Accountancy Act of 2004, the Financial Reporting Standards Council (FRSC) shall be the new
accounting standard setting body thus, replacing the ASC.
SCOPE OF PRACTICE
(a) Practice of Public Accountancy - shall constitute a person, be it his/her individual capacity, or as a staff
member in an accounting or auditing firm, holding out himself/herself as one skilled in the knowledge, science
and practice of accounting, and as a qualified person to render professional services as a certified public
accountant; or offering or rendering, or both or more than one client on a fee basis or otherwise, services as
such as the audit or verification of financial transaction and accounting records; or the preparation, signing,
or certification for clients of reports of audit, balance sheet, and other financial, accounting and related
schedules, exhibits, statement of reports which are to be used for publication or for credit purposes, or to be
filed with a court or government agency, or to be used for any other purposes; or to design, installation, and
revision of accounting system; or the preparation of income tax returns when related to accounting procedures;
or when he/she represent clients before government agencies on tax and other matters relating to accounting
or render professional assistance in matters relating to accounting procedures and the recording and
presentation of financial facts or data.
(b) Practice in Commerce and Industry - shall constitute in a person involved in decision making requiring
professional knowledge in the science of accounting, or when such employment or position requires that the
holder thereof must be a certified public accountant.
(c) Practice in Education/Academe - shall constitute in a person in an educational institution which involve
teaching of accounting, auditing, management advisory services, fiancé, business law, taxation and other
technically related subject: Provided, that members of the Integrated Bar of the Philippines may be allowed
to teach business law and taxation subjects.
(d) Practice in Government - shall constitute in a person who holds, or is appointed to, a position in an
accounting professional group in government or in an government-owned and/or controlled corporation,
including those performing proprietary functions, where decision making requires professional knowledge in
the science of accounting, or where a civil service eligibility as a certified public accountant is a prerequisite.
Objectives of Accounting
(i) Providing Information to the Users for Rational Decision-making
The primary objective of accounting is to provide useful information for decision-making to stakeholders
such as owners, management, creditors, investors, etc. Various outcomes of business activities such as
costs, prices, sales volume, value under ownership, return of investment, etc. are measured in the
accounting process. All these accounting measurements are used by stakeholders (owners, investors,
creditors/bankers, etc.) in course of business operation. Hence, accounting is identified as ‘language of
business’.
(ii) Systematic Recording of Transactions
To ensure reliability and precision for the accounting measurements, it is necessary to keep a systematic
record of all financial transactions of a business enterprise which is ensured by bookkeeping. These
financial records are classified, summarized and reposted in the form of accounting measurements to
the users of accounting information i.e., stakeholder.
(iii) Ascertainment of Results of above Transactions
‘Profit/loss’ is a core accounting measurement. It is measured by preparing profit and loss account
for a particular period. Various other accounting measurements such as different types of revenue
expenses and revenue incomes are considered for preparing this profit and loss account. Difference
between these revenue incomes and revenue expenses is known as result of business transactions identified as
profit/loss. As this measure is used very frequently by stockholders for rational decision making, it has
become the objective of accounting. For example, Income Tax Act requires that every business should
have an accounting system that can measure taxable income of business and also explain nature and
source of every item reported in Income Tax Return.
(iv) Ascertain the Financial Position of Business
‘Financial position’ is another core accounting measurement. Financial position is identified by
preparing a statement of ownership i.e., Assets and Owings i.e., liabilities of the business as on a certain
date. This statement is popularly known as balance sheet. Various other accounting measurements such as
different types of assets and different types of liabilities as existed at a particular date are considered for
preparing the balance sheet. This statement may be used by various stakeholders for financing and
investment decision.
(v) To Know the Solvency Position
Balance sheet and profit and loss account prepared as above give useful information to stockholders
regarding concerns potential to meet its obligations in the short run as well as in the long run.
Functions of Accounting
The main functions of accounting are as follows:
(a) Measurement: Accounting measures past performance of the business entity and depicts its current
financial position
(b) Forecasting: Accounting helps in forecasting future performance and financial position of the enterprise
using past data.
(c) Decision-making: Accounting provides relevant information to the users of accounts to aid rational
decision making.
(d) Comparison & Evaluation: Accounting assesses performance achieved in relation to targets and discloses
information regarding accounting policies and contingent liabilities which play an important role in
predicting, comparing and evaluating the financial results.
(e) Control: Accounting also identifies weaknesses of the operational system and provides feedbacks
regarding effectiveness of measures adopted to check such weaknesses.
(f) Government Regulation and Taxation: Accounting provides necessary information to the government to
exercise control on the entity as well as in collection of tax revenues.
CHAPTER 2
Learning Objectives:
1.
2.
3.
4.
5.
Identify the branches of accounting.
Know the distinction between Book-keeping and Accounting.
Explain the Accounting Principles, Concepts and Conventions.
Expound on the going concern assumption.
Identify the users of accounting information and illustrate their information needs.
BRANCHES OF ACCOUNTING
As a result of economic, industrial, and technological developments, a number of specialized fields in
accounting have emerged.
1 Financial Accounting. Financial accounting involves recording and classifying business transactions, and
preparing and presenting financial statements to be used by internal and external users. In the preparation
of financial statements, strict compliance with generally accepted accounting principles or GAAP is
observed. Financial accounting is primarily concerned in processing historical data.
2 Managerial Accounting. Managerial or management accounting focuses on providing information for use
by internal user, the management. This branch deals with the needs of the management rather than strict
compliance with generally accepted accounting principles. Managerial accounting involves financial analysis,
budgeting and forecasting, cost analysis, evaluation of business decisions, and similar areas.
3 Cost Accounting. Sometimes considered as a subset of management accounting, cost accounting refers to
the recording, presentation, and analysis of manufacturing costs . Cost accounting is very useful
in manufacturing businesses since they have the most complicated costing process. Cost accountants also
analyze actual and standard costs to help managers determine future courses of action regarding the company's
operations.
4 Auditing
External auditing refers to the examination of financial statements by an independent party with the purpose
of expressing an opinion as to fairness of presentation and compliance with GAAP.
Internal auditing focuses on evaluating the adequacy of a company's internal control structure by testing
segregation of duties, policies and procedures, degrees of authorization, and other controls implemented by
management.
5 Tax Accounting. Tax accounting helps clients follow rules set by tax authorities. It includes tax planning
and preparation of tax returns. It also involves determination of income tax and other taxes, tax advisory
services such as ways to minimize taxes legally, evaluation of the consequences of tax decisions, and other
tax-related matters.
6 Government Accounting.T his branch of accounting is prevalent in Central Government (National
Government) and State. Government budget allocations and utilization. Keeping records ensures proper and
efficient utilization of the various budget allocations and safety of public funds.
7. BOOK-KEEPING As defined by Carter, ‘Book-keeping is a science and art of correctly recording in booksof accounts all those business transactions that result in transfer of money or money’s worth’.
Book-keeping is an activity concerned with recording and classifying financial data related to business
operation in order of its occurrence.
Book-keeping is a mechanical task which involves:
-Collection of basic financial information.
-Identification of events and transactions with financial character i.e., economic transactions.
-Measurement of economic transactions in terms of money.
-Recording financial effects of economic transactions in order of its occurrence.
-Classifying effects of economic transactions.
-Preparing organized statement known as trial balance
Book-Keeping
1. Output of book-keeping is an input for
accounting.
Accounting
1. Output of accounting permit informed
judgments and decisions by the user of
accounting information.
2. Purpose of book-keeping is to keep systematic 2. Purpose of accounting is to find results of
record of transactions and events of financial
operating activity of business and to report
character in order of its occurrence.
financial strength of business.
3. Book-keeping is a foundation of accounting.
3. Accounting is considered as a language of
business.
4. Book-keeping is carried out by junior staff.
4. Accounting is done by senior staff with skill of
analysis and interpretation.
5. Objects of book-keeping is to summarize the 5. Object of accounting is not only bookkeeping
cumulative effect of all economic transactions
but also analyzing and interpreting reported
of business for a given period by maintaining
financial information for informed decisions.
permanent record of each business transaction
with its evidence and financial effects on
accounting variable.
ACCOUNTING PRINCIPLES
GENERALLY ACCEPTED ACCOUNTING PRINCIPLES
A widely accepted set of rules, conventions, standards, and procedures for reporting financial
information, as established by the Financial Accounting Standards Board are called Generally Accepted
Accounting Principles (GAAP). These are the common set of accounting principles, standards and
procedures that companies use to compile their financial statements. GAAP are a combination of
standards (set by policy boards) and simply the commonly accepted ways of recording and reporting
accounting information.
GAAP is to be followed by companies so that investors have a optimum level of consistency in the
financial statements they use when analyzing companies for investment purposes. GAAP cover such
aspects like revenue recognition, balance sheet item classification and outstanding share measurements.
ACCOUNTING CONCEPTS AND CONVENTIONS
As seen earlier, the accounting information is published in the form of financial statements. The three basic
financial
statements are
(i) The Profit & Loss Account that shows net business result i.e. profit or loss for a certain periods
(ii) The Balance Sheet that exhibits the financial strength of the business as on a particular dates
(iii) The Cash Flow Statement that describes the movement of cash from one date to the other.
As these statements are meant to be used by different stakeholders, it is necessary that the information
contained therein is based on definite principles, concrete concepts and well accepted convention.
Accounting principles are basic guidelines that provide standards for scientific accounting practices and
procedures. They guide as to how the transactions are to be recorded and reported. They assure
uniformity and understandability. Accounting concepts lay down the foundation for accounting
principles. They are ideas essentially at mental level and are self-evident. These concepts ensure recording
of financial facts on sound bases and logical considerations. Accounting conventions are methods or
procedures that are widely accepted. When transactions are recorded or interpreted, they follow the
conventions. Many times, however, the terms-principles, concepts and conventions are used
interchangeably.
Professional Accounting Bodies have published statements of these concepts. Over years, many of these
concepts are being challenged as outlived. Yet, no major deviations have been made as yet. Path breaking
ideas have emerged and the accounting standards of modern days do require companies to record and
report transactions which may not be necessarily based on concepts that are in vogue for long. It is essential
to study accounting from the basic levels and understand these concepts in entirety.
A.
BASIC ASSUMPTIONS
(a) Business Entity Concept
This concept explains that the business is distinct from the proprietor. Thus, the transactions of business
only are to be recorded in the books of business. Simply put, the transactions of different entities
should not be accounted for together. Each entity should be evaluated separately.
(b) Going Concern Concept
This concept assumes that the business has a perpetual succession or continued existence. The financial
statements are normally prepared on the assumption that an enterprise is a going concern and will
continue in operation for the foreseeable future. Hence it is assumed that the enterprise has neither the
intention nor the need to liquidate or curtail materiality the scale of its operations.
(c) Money Measurement Concept
According to this concept only those transactions which are expressed in money terms are to be
recorded in accounting books. The Philippine peso is a reasonable unit of measure and that its
purchasing power is relatively stable.
(d) The Accounting Period Concept/Periodicity
An entity’s life can be meaningfully subdivided into equal time periods for reporting purposes. It will
be aimless to wait for the actual last day of operations to perfectly measure the entity’s net income.
This concept allows the users to obtain timely information to serve as a basis on making decisions
about the future activities. For the purpose of reporting to outsiders, one year is the usual accounting
period.
(e) The Accrual Concept
The accrual concept is based on recognition of both cash and credit transactions. In case of a
cash transaction, owner’s equity is instantly affected as cash either is received or paid. In a credit
transaction, however, a mere obligation towards or by the business is created. When credit
transactions exist (which is generally the case), revenues are not the same as cash receipts and
expenses are not same as cash paid during the period.
Today’s accounting systems based on accrual concept are called as Accrual system or mercantile
system of accounting.
B.
BASIC PRINCIPLES
(a) Realization Concept
This concept speaks about recording of only those transactions which are actually realized. For example
Sale or Profit on sales will be taken into account only when money is realized i.e. either cash is received
or legal ownership is transferred.
(b) Matching Concept
It is referred to as matching of expenses against incomes. It means that all incomes and expenses relating
to the financial period to which the accounts relate should be taken in to account without regard to
the date of receipts or payment.
(c) Adequate Disclosure Concept
As per this concept, all relevant and significant information must be disclosed. Accounting data should
properly be clarified, summarized, aggregated and explained for the purpose of presenting the
financial statements which are useful for the users of accounting information. Practically, this
principle emphasizes on the materiality, objectivity and consistency of accounting data which should
disclose the true and fair view of the state of affairs of a firm.
(d) Duality Concept
According to this concept every transaction has two aspects i.e. the benefit receiving aspect and
benefit giving aspect. These two aspects are to be recorded in the books of accounts.
(e) Verifiable Objective Evidence Concept/Verifiability
Under this principle, accounting data must be verified. In other words, documentary evidence of
transactions must be made which are capable of verification by an independent respect. In the
absence of such verification, the data which will be available will neither be reliable nor be
dependable, i.e., these should be biased data. Verifiability and objectivity express dependability,
reliability and trustworthiness that are very useful for the purpose of displaying the accounting data
and information to the users.
(f) Historical Cost Concept
Business transactions are always recorded at the actual cost at which they are actually undertaken.
The basic advantage is that it avoids an arbitrary value being attached to the transactions. Whenever
an asset is bought, it is recorded at its actual cost and the same is used as the basis for all subsequent
accounting purposes such as charging depreciation on the use of asset.
(g) Balance Sheet Equation Concept
Under this principle, all which has been received by us must be equal to that has been given by us
and needless to say that receipts are clarified as debits and giving is clarified as credits. The basic
equation, appears as :Debit = Credit
C.
MODIFYING PRINCIPLES
(a) The Concept of Materiality
The materiality could be related to information, amount, procedure and nature. Financial
information is only concerned with information that is significant enough to affect evaluations and
decisions. Materiality depends on the size and nature of the item or an aggregate of items is matrail,
the nature and size of the item are evaluated together.
(b) Consistency Concept
This Concept says that the accounting practices should not change or must remain unchanged over
a period of several years. The firms should use the same accounting method form period to period
to achieve comparability over time within a single enterprise. However changes are permitted if
justifiable and disclosed in the financial statements.
(c) Conservatism Concept
Conservatism concept states that when alternative valuations are possible, one should select the
alternative which fairly represents economic substance of transactions but when such choice is not
clear select the alternative that is least likely to overstate net assets and net income. It provides for all
known expenses and losses by best estimates if amount is not known with certainty, but does not
recognizes revenues and gains on the basis of anticipation.
(d) Timeliness Concept
Under this principle, every transaction must be recorded in proper time. Normally, when the
transaction is made, the same must be recorded in the proper books of accounts. In short, transaction
should be recorded date-wise in the books. Delay in recording such transaction may lead to
manipulation, misplacement of vouchers, misappropriation etc. of cash and goods. This principle is
followed particularly while verifying day to day cash balance. Principle of timeliness is also followed
by banks, i.e. every bank verifies the cash balance with their cash book and within the day, the same
must be completed.
(e) Industry Practice
As that are different types of industries, each industry has its own characteristics and features. There
may be seasonal industries also. Every industry follows the principles and assumption of accounting
to perform their own activities. Some of them follow the principles, concepts and conventions in a
modified way.
USERS AND THEIR ACCOUNTING NEEDS
Decision-makers need information. The more important the decision is, the greater is the need for reliable
information. Virtually all businesses and most individuals keep the accounting records to aid them in making
decisions. The users utilize financial statements in order to satisfy some of their different needs for
information. The users of financial statements and their information needs follow:
1. Investors need information to help them determine whether they should buy, hold or sell.
2. Employees are interested in information about the stability and profitability of the employers. They
are also interested in information which enables them to assess the ability of the enterprise to provide
remuneration, retirement benefits and employment opportunities.
3. Lenders are interested in information that enables them to determine whether their loans and the
related interest will be paid when due.
4. Suppliers and other trade creditors are interested in information that enables them to determine
whether among owing to them will be paid when due.
5. Customers have an interest in information about the continuance of an enterprise, especially when
they have long term involvement with, or are dependent on, the enterprise.
6. Government and their agencies are interested in the allocation of resources and, therefore, the
activities of the enterprise. They also require information in order to regulate the activities of the
enterprise, determine taxation policies and as the basis for national income and similar statistics.
7. Public. Enterprises affect members of the public in a variety of ways. For example, enterprises may
make a substantial contribution to the local economy in many ways including the number of people
they employ and their patronage of local suppliers. Financial statements may assist the public by
providing information about the trends and recent developments in the prosperity of the enterprise and
the range of its activities.
CHAPTER 3
Learning Objectives:
1.
2.
3.
4.
5.
6.
7.
Enable the students to understand the basic accounting terms.
Distinguish between capital and revenue transactions.
Define the elements of financial statements.
Identify the distinction basis of accounting.
Describe the account (the simple T-Account and its uses.
Understand what is meant by the double-entry systems
Explain how the double-entry system follows the rules of the accounting equation.
BASIC ACCOUNTING TERMS
In order to understand the subject matter clearly, one must grasp the following common expressions always
used in business accounting. The aim here is to enable the student to understand with these often-used concepts
before we embark on accounting procedures and rules. You may note that these terms can be applied to
any business activity with the same connotation.
(i)
Transaction: It means an event or a business activity which involves exchange of money or money’s
worth between parties. The event can be measured in terms of money and changes the financial position
of a person
e.g. purchase of goods would involve receiving material and making payment or creating an
obligation to pay to the supplier at a future date. Transaction could be a cash transaction or credit
transaction. When the parties settle the transaction immediately by making payment in cash or by
cheque, it is called a cash transaction. In credit transaction, the payment is settled at a future date as
per agreement between the parties.
(ii)
Goods/Services: These are tangible article or commodity in which a business deal. These articles
or commodities are either bought and sold or produced and sold. Services are intangible in nature which
are rendered with or without the object of earning profits.
(iii)
Profit: The excess of Revenue Income over expense is called profit. It could be calculated for each
transaction or for business as a whole.
(iv)
Loss: The excess of expense over income is called loss. It could be calculated for each transaction
or for business as a whole.
(v)
Asset: Asset is a present economic resource controlled by the entity as a result of past events. An economic
resource is a right that has the potential to produce economic benefits. There are three aspects: right, potential
to produce economic benefits, and control.
Assets can be Tangible and Intangible. Tangible Assets are the Capital assets which have some physical
existence. They can, therefore, be seen, touched and felt, e.g. Plant and Machinery, Furniture and
Fittings, Land and Buildings, Books, Computers, Vehicles, etc. The capital assets which have no
physical existence and whose value is limited by the rights and anticipated benefits that possession
confers upon the owner are known as lntangible Assets. They cannot be seen or felt although they help
to generate revenue in future, e.g. Goodwill, Patents, Trade-marks, Copyrights, Brand Equity, Designs,
Intellectual Property, etc.
Assets can also be classified into Current Assets and Non-Current Assets.
Current Assets – An asset shall be classified as Current when it satisfies any of the following:
(a) It is expected to be realized in, or is intended for sale or consumption in the Company’s normal
Operating Cycle,
(b) It is held primarily for the purpose of being traded,
(c) It is due to be realized within 12 months after the Reporting Date, or
(d) It is Cash or Cash Equivalent unless it is restricted from being exchanged or used to settle a Liability
for at least 12 months after the Reporting Date.
Non-Current Assets – All other Assets shall be classified as Non-Current Assets. e.g. Machinery held
for long
term etc.
(vi)
Liability: It is present obligation of an entity to transfer an economic resource as a result of past
events. It represents amount of money that the business owes to the other parties. E.g. when goods
are bought on credit, the firm will create an obligation to pay to the supplier the price of goods on an
agreed future date or when a loan is taken from bank, an obligation to pay interest and principal
amount is created.
For a liability to exist, three criteria must all be satisfied:
a. The entity has an obligation
b. The obligation is to transfer an economic resource
c. The obligation is a present obligation that exists as a result of past events
Depending upon the period of holding, these obligations could be further classified into Long Term
on non- current liabilities and Short Term or current liabilities.
Current Liabilities – A liability shall be classified as Current when it satisfies any of the following:
(a) It is expected to be settled in the Company’s normal Operating Cycle,
(b) It is held primarily for the purpose of being traded,
(c) It is due to be settled within 12 months after the Reporting Date, or
(d) The Company does not have an unconditional right to defer settlement of the liability for at least
12 months after the reporting date (Terms of a Liability that could, at the option of the counterparty,
result in its settlement by the issue of Equity Instruments do not affect its classification)
Non-Current Liabilities – All other Liabilities shall be classified as Non-Current Liabilities. E.g. Loan
taken for 5 years, Debentures issued etc.
(vii)
Equity: is the residual interest in the assets of the enterprise after deducting all its liabilities.
(viii)
Capital: It is amount invested in the business by its owners, original and additional investments. It may
be in the form of cash, goods, or any other asset which the proprietor or partners of business invest in the
business activity.
Drawings/Withdrawals: It represents an amount of cash, goods or any other assets which the owner
withdraws from business for his or her personal use. e.g. if the life insurance premium of proprietor or a
partner of business is paid from the business cash, it is called drawings.
(ix)
(x)
Debtor: Debtors are those persons from whom a business has to recover money on account of goods
sold or service rendered on credit.
(xi)
Creditor: A creditor is a person to whom the business owes money or money’s worth. e.g. money
payable to supplier of goods or provider of service. Creditors are generally classified as Current
Liabilities.
Capital Expenditure: This represents expenditure incurred for the purpose of acquiring a fixed asset
which is intended to be used over long term for earning profits there from. e. g. amount paid to buy a
computer for office use is a capital expenditure. At times expenditure may be incurred for enhancing
the production capacity of the machine. This also will be a capital expenditure. Capital expenditure
forms part of the Balance Sheet.
(xiii) Revenue expenditure: This represents expenditure incurred to earn revenue of the current period.
The benefits of revenue expenses get exhausted in the year of the incurrence. e.g. repairs, insurance, salary
& wages to employees, travel etc. The revenue expenditure results in reduction in profit or surplus. It
forms part of the Income statement.
(xii)
Standard contents of a set of financial statements:
(xiv) Balance Sheet: It is the statement of financial position of the business entity as of the report date.
It lists all assets, liabilities and owner’s equity. It is important to note that this statement exhibits the state
of affairs of the business as on a particular date only. It describes what the business owns and what the
business owes to outsiders (this denotes liabilities) and to the owners (this denotes capital). It is prepared
after incorporating the resulting profit/losses of Income statement.
CURRENT ASSETS
-Cash
- Cash Equivalents
- Notes Receivable
-Notes/Accounts Receivable
- Inventories
-Prepaid Expenses
CURRENT LIABILITIES
-Accounts/Notes payable
-Accrued liabilities
-Unearned revenue
-Current portion of long-term debt
NON-CURRENT ASSETS
- Property, Plant and Equipment (PPE)
- Accumulated depreciation
- Intangible assets
NON-CURRENT LIABLITIES
- Mortgage payable
- Bonds payable
(xv) Profit and Loss Account or Income Statement: This account shows the revenue earned by the business
and the expenses incurred by the business to earn that revenue. This is prepared usually for a
particular accounting period, which could be a month, quarter, a half year or a year. The net result of
the Profit and Loss Account will show profit earned or loss suffered by the business entity. This shows
the financial performance of the business entity.
INCOME - Service income, Sales
EXPENSES – Cost of sales, salaries and wages expenses, telecommunications, electricity, fuel and
water expenses, supplies expense, rent expense, insurance expense, depreciation expense, interest
expense
(xvi)
Statement of Cash Flows: Shows changes in the entity's cash flows during the reporting period.
Cash Flow Statement summarizes the amount of cash and cash equivalents entering and leaving a
company during a particular period of time
(xvii) Supplementary Notes: Includes explanations of various activities, additional detail on some
accounts, and other items as mandated by the applicable accounting framework, worldwide.
(xviii) Income Summary. It is a temporary account used at the end of the accounting period to close
income and expenses.
BASIS OF ACCOUNTING
ACCRUAL BASIS AND CASH BASIS OF ACCOUNTING
Accrual Basis of Accounting
Accrual Basis of Accounting is a method of recording transactions by which revenue, costs, assets and
liabilities are reflected in the accounts for the period in which they accrue. This basis includes consideration
relating to deferrals, allocations, depreciation and amortization. This basis is also referred to as mercantile
basis of accounting.
Cash Basis of Accounting
Cash Basis of Accounting is a method of recording transactions by which revenues, costs, assets and
liabilities are reflected in the accounts for the period in which actual receipts or actual payments are made.
Distinction between Accrual Basis of Accounting and Cash Basis of Accounting
THE CONCEPTS OF ‘ACCOUNT’
The account is the basic summary device of accounting. A separate account is maintained for each element that appears
in the balance sheet (assets, liabilities and equity) and in the income statement (income and expenses). Thus, an account
may be defined as a detailed record of the increases, decreases and balance of each element that appears in an entity’s
financial statements. Accounts are kept so that financial information can be analyzed, recorded, classified, summarized,
and reported.
Typically, an account is expressed as a statement in form of English letter ‘T’. It has two sides. The left
side is called as “Debit’ side and the right hand side is called as “Credit’ side. The debit is denoted as ‘Dr’
and the credit by ‘Cr’.
DOUBLE ENTRY SYSTEM OF BOOK KEEPING
•
•
•
This is the system of Keeping the Books of Accounts world-wide and now India is also following
the same
It is based on the principle that “every business transaction has two accounts in opposite directions
and if a complete record is to be made of each such transaction, it would be necessary to Debit one
account and Credit one Account.”
So “every Debit has a corresponding Credit and every Credit has corresponding Debit with
equal amount”
The concept of Debit and Credit
◆
In double entry book-keeping, debits and credits (abbreviated Dr and Cr, respectively) are entries
made in account ledgers to record changes in value due to business transactions.
◆
Debit is derived from the latin word “debitum”, which means ‘what we will receive’. It is the
destination, who enjoys the benefit.
◆
Credit is derived from the latin word “credre” which means ‘what we will have to pay’. It is the
source, who sacrifices for the benefit.
◆
The source account for the transaction is credited (an entry is made on the right side of the
account’s ledger) and the destination account is debited (an entry is made on the left).
◆
Each transaction’s debit entries must equal its credit entries.
The difference between the total debits and total credits in a single account is the account’s
balance. If debits exceed credits, the account has a debit balance; if credits exceed debits, the
account has a credit balance.
◆
The account type determines how increases or decreases in it are recorded. Increases in assets are recorded
as debits (on the left side of the account) while decreases in assets are recorded as credits (on the right side).
Conversely, increases in liabilities and owner’s equity are recorded by credits and decreases are entered as
debits.
The rules of debit and credit for income and expense accounts are based on the relationship of these accounts
to owner’s equity. Income increases owner’s equity and expense decreases owner’s equity. Hence, increases
in income are recorded as credits and decreases as debits. Increases in expenses are recorded as debits and
decreases as credits.
NORMAL BALANCE OF AN ACCOUNT
The normal balance of any account refers to the side of the account – debit or credit – where increases are
recorded. Asset, owner’s withdrawal and expense accounts normally have debit balances; liability, owner’s
equity and income accounts normally have credit balances.
Increase recorded by
Account Category
Debit
Assets
Credit

Liabilities
Normal balance
Debit
Credit





Owner’s equity
Owner’s Capital
Withdrawals



Income
Expense



EFFECTS OF TRANSACTIONS
1. Increase in Asset = Increase in Liability
2. Increase in Asset = Increase in Owner’s Equity
3. Increase in One Asset = Decrease in another Asset
4. Decrease in Asset = Decrease in Liability
5. Decrease in Asset = Decrease in Owner’s Equity
6. Increase in Liability = Decrease in Owner’s Equity
7. Increase in Owner’s Equity = Decrease in Liability
8. Increase in one Liability = Decrease in another Liability
9. Increase in one Owner’s Equity = Decrease in another Owner’s Equity
TYPES OF ACCOUNTS
1. Personal Accounts - As the name suggests these are accounts related to persons.
(a) These persons could be natural persons.
(b) The persons could also be artificial persons like companies, bodies corporate or association of
persons or partnerships.
2. Real Accounts - All assets of a firm, which are tangible or intangible, fall under the category “Real
Accounts“.
3. Nominal Accounts - Accounts which are related to expenses, losses, incomes or gains.