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Principles of

ACCOUNTING 1

(Adopted from Fundamentals of Accounting 1 by Leemon L. Araza)

TABLE OF CONTENTS

Session 1: Accounting Concepts and Its Consideration

Session 2: Basic Consideration on Financial Statements

Session 3: Preparation of Financial Statements

Session 4: Adjusting the Accounts

Session 5: Completing the Accounting Cycle

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Why

Do

We

Need

Accounting?

So why do we need accounting? Asking that question of an accountant is like asking a farmer why we need rain. We need accounting because it is the only way for business to grow and flourish. Accounting is the backbone of the business financial world. After all, accounting was created in response to the development of trade and commerce during the medieval times. Accounting is the conscious of the business world. When handled with care and with respect, it performs as expected. When abuse occurs, and the system is circumvented or overridden because of dishonesty and greed, it does not work correctly. Accounting is much like all other systems in place, they are only as good as the people using them.

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ACCOUNTING is a service activity. It’s function is to provide quantitative information, primarily financial in nature, about economic entities that is intended to be useful in making economic decisions. “ Language of business” Accounting as science and art  Accounting is a social science with a body of knowledge which has been systematically gathered, classified, and organized. It is influenced by, and interacts with, economic, social and political environments.

Fixed, inflexible, organized and systematic  Accounting is a practical art which requires the use of creative skill and judgment. Accounting as an information system

Opinionated, flexible and subjective  Accounting identifies and measures economic activities, processes information into financial reports and communicates these reports to decision makers. Economic Activities and their classification

 Production – the process of converting economic resources into

outputs of goods and services that are intended to have greater utility than the required inputs.

 Exchange – the process of trading resources or obligations for other

resources or obligation.

 Income distribution - the process of allocating rights to

the use of output among individuals and groups in society.

 Consumption – production process. the process of using the final output of the

 Investment – the process of using current inputs to increase

the stock of resources available for output as opposed to immediately consumable output.

 Savings – the process by which individuals and groups set aside

rights to present consumption in exchange for rights to future consumption.

BASIC PURPOSE OF ACCOUNTING: To provide quantitative information about economic entities intended to be useful in making economic decisions. TYPES OF INFORMATION PROVIDED BY ACCOUNTING

1. Quantitative information – expressed in numbers, quantities or units.
2. Qualitative information – expressed in words or descriptive form
3. Financial information – expressed in terms of money

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BRANCHES OF ACCOUNTING/AREA OF SPECIALIZATION

1. Financial Accounting. The recording of transactions, preparation of financial statements and communication of financial information to external user groups. Focuses on general purpose reports. 2. Auditing. The examination of financial statements by independent certified public accountant for the purpose of expressing an opinion on the fairness of presentation of financial statements. 3. Management Accounting. Incorporates cost accounting data and adapts them for specific decisions which management may be called upon to make. A management accounting system incorporates all types of financial and non-financial information from a wide range of sources. 4. Financial Management. Relatively new branch of accounting that has been grown rapidly over the last 35 years. Financial managers are responsible for setting financial objectives, making plans based on those objectives, obtaining the finance needed to achieve the plans, and generally safeguarding all the financial resources of the entity. 5. Taxation / Tax accounting. Involves the preparation of tax returns and rendering of tax advice, such as determination of tax consequences of certain proposed business endeavors. 6. Government Accounting. Accounting for the national government and its instrumentalities, focusing attention on the custody of public funds and the purpose or purposes to which such funds are committed. 7. Fiduciary Accounting. Handling of accounts managed by a person entrusted with the custody and management of property for the benefit of another. 8. Social Responsibility. Reporting of programs and projects that have to do with the upliftment of the welfare of the people of a community or of the nation. 9. Environmental Accounting. The area of accounting that focuses on programs, activities and projects that are focused care for Mother Earth. One example of this is carbon accounting such as “ Cap and Sch greenhouse gas emissions. eme ”, which is a process of encouraging reductions in 10. Price-level Accounting. Otherwise known as Accounting for Hyperinflationary Economies – simply defined, is accounting that recognizes in the financial statements changes in the purchasing power of money.

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USERS OF ACCOUNTING INFORMATION

 Internal Users are those who make decisions directly affecting the internal operations of the business. o Managers are directly involved in operation of the business. They need accounting data to improve the efficiency and effective of the organization. o Employees use financial data to assess whether they are receiving the right compensation and to check if they bargain for higher remuneration, retirement benefits and employment opportunities. o Officers, also called as the company executives who are interested to know if the company is doing well in its operation so they can plan for possible expansion or branching out to widen its geographical and demographic market. o Internal Auditors , there role is to protect and safeguard the resources of the company against fraud or irregularities.

the act of making money by making people believe something which is not true.  External users are individuals or enterprises that have financial interest in the business but they are not involved in the day activities of the organization. These are: o Investors (The providers of risk capital) are interested in information which enables them to assess the ability of the enterprise to pay dividends. They need information on whether they should buy, hold or sell their shares in. o Lenders are interested in information that enables them to determine whether their loans, and their interest attaching to them will be paid when due. o Suppliers and other trade creditors are interested in information that enables them to determine whether amount owing to them will be paid when due. o Customers are interested in the quality of goods and services that they are getting from the entity. o Government and their agencies require information in order to regulate the activities of the enterprise, determine taxation policies and as a basis for national income and similar activities,

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Revenue Recognition Principle. Revenue is to be recognized in the accounting period when goods are delivered or services are rendered or performed. Expense Recognition Principle. Expenses should be recognized in the accounting period in which goods and services are used up to produce revenue and not when the entity pays for those goods and services. Adequate Disclosure. Requires that all relevant information that would affect the user’s understanding and assessment of the accounting entity be disclosed in the financial statements. Materiality. Financial reporting is only concerned with information that is significant enough to affect evaluations and decisions. Materiality depends on the size and nature of the item judged in the particular circumstances of its omission. Consistency Principle. The firms should use the same accounting method from period to period to achieve comparability over time within a single enterprise. However, changes are permitted if justifiable and disclosed in the financial statements. UNDERLYING ASSUMPTIONS Accrual Basis Financial Statements are prepared on the accrual on the accrual basis of accounting and not as cash or its equivalent is received or paid. Under this assumption, the effects of transactions and other events are recognized when they occur and they are recorded in the accounting records and reported in the financial statements of the periods to why they relate.

In short, transactions are recognized when “ Revenue as they earned, even not yet received and; Expenses as they incurred, even not yet paid.

In cash basis accounting, however, does not record a transaction until cash is received or paid. Generally, cash receipts are treated as revenues and cash payments as expenses.

Going Concern Financial statements are normally prepared on the assumption that an enterprise is a going concern and will continue in operation for a foreseeable future. It is assumed therefore that the enterprise has neither the intention nor the need to liquidate its operations.

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BUSINESS ORGANIZATION

FORMS OF BUSINESS ORGANIZATIONS

 Sole Proprietorship. This business organization has a single owner called the proprietor who generally is also manager. It tends to be small service-type (e.g. physicians, lawyers and accountants) business and retail establishments. The owner receives all profits, absorbs all losses and is solely responsible for all debts of the business. From the accounting viewpoint, the sole proprietorship is distinct from its proprietor. Thus, the accounting records do not include proprietor’s personal financial records.  Partnership. A business owned and operated by 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. Each partner is personally liable for any debt incurred by the partnership, except limited partner.  Corporation. A business owned by its stockholders. It is an artificial being created by operation of law, having the rights of succession and the powers, attributes and properties expressly authorized by law or incident to its existence. The stockholders are not personally liable for the corporation’s debt. PURPOSE OF BUSINESS ORGANIZATIONS  Service companies perform services for a fee (e.g. law firms, accounting and law firms, stock brokerage, beauty salons and recruitment agencies)  Merchandising companies purchase goods that are ready for sale and then sell these to customers (e.g. car dealers, clothing stores and supermarkets)  Manufacturing companies buy raw materials, convert them into products and then sell the products to other companies or to final consumers (e.g. paper mills, steel mills, car manufacturers and drug manufacturers) MICRO, SMALL AND MEDIUM ENTERPRISES (MSME)  Micro Enterprises are those with assets, before financing of P 3 million or less and employ not more than nine (9) workers.  Small Enterprises are those with assets, before financing of above P 3 million to P 15 million and employ 10 to 99 workers.

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NAME: YR.&SEC.

COURSE: DATE

ACTIVITY NO. 1

Multiple Choice

1. Accounting is a service activity. Its function is to provide a. Quantitative information b. Qualitative information c. Quantitative and qualitative information d. None of the above
2. The basic purpose of accounting is a. To provide the information that the managers of an economic entity need to control its operations. b. To provide information that the creditors of an economic entity can use in deciding whether to make additional loans to the entity. c. To measure the periodic income of the economic entity. d. To provide quantitative financial information about a business enterprise that is useful in making rational economic decision.
3. Which of the following best describes the attributes of a a. Limited ability to raise capital; unlimited personal liability of partnership owners. b. Limited ability to raise capital; limited personal liability of owners. c. Ability to raise large capital; unlimited personal liability of owners. d. Ability to raise large amounts of capital; limited personal liability of owners.
4. Which of the following is true? a. Stockholders are personally liable for the liabilities of the corporation if the company us unable to pay. b. Normally, stockholders can only sell their ownership interests when the corporation terminates. c. Partners are personally liable for the liabilities of the partnership if the partnership is unable to pay. d. Partners can normally transfer their partnership interests with ease.
5. Which accounting process is the recognition or non-recognition of business activities as accountable events? a. b. IdentifyingCommunicating c. Recording d. Measuring
6. The concept of the accounting entity is applicable a. Only to the legal aspects of business organizations b. Only to the economic aspects of business organizations c. Only to business organizations d. Whenever accounting is involved

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7. The entity concept means that a. Because a firm is separate and distinct from its owners, those owners cannot have access to its assets unless the firm ceases to trade. b. Accounts must be prepared for every firm. c. The financial affairs of a firm and its owner are always kept separate for the purpose of preparing accounts. d. None of the above
8. Accountants do not recognize that the value of the peso changes over the time. This concept is called the a. Stable money unit concept b. Going concern concept c. Cost principle d. Entity concept
9. The principle of objectivity includes the concept of a. Summarization b. Verifiability c. Classification d. Conservatism
10. Which of the following is not a user of internal accounting information? a. Store Manager b. Chief executive officer c. Creditor d. Chief financial officer
11. An event that affects the financial position of an organization and requires recording is called: a. b. TransactionAccount c. Business documents d. Operating activities
12. All of the following are external users of accounting information except: a. Creditors, lenders and suppliers b. Present and potential investors c. Government regulatory bodies d. Managers and employees
13. It is the simplest of business organization a. Service Entity b. Merchandising Entity c. Partnership d. Sole Proprietorship
14. The following are examples of service business except: a. SM Supermarket b. Amana Hotel and Resorts c. Cebu Pacific d. Manila Water Inc.
15. The following are examples of manufacturing business, except: a. Toyota Motors, Inc.

Principles of

Accounting 1

SESSION 2

BASIC CONSIDERATION ON FINANCIAL STATEMENTS

Desired Learning Outcomes  Understand and explain the objective characteristics and of qualitativefinancial  statements.Distinguish the elements of financial recognition and statements, measurements. its  Learn Accounting and applyEquation, the principlethe rule ofof  debits andUnderstand^ credits.Accounting events and transactions, transactions types and effects of

FINANCIAL STATEMENTS

OBJECTIVES Provide information about the financial position, performance and changes in financial position of an entity that is useful to a wide range of users in making economic decisions. Financial statements prepared for this purpose:  Meet the common needs of most users  Also show the results of the steward ship* of management, or accountability of management for the resources entrusted to it.  Do not, however, provide all the information that users may need to make decisions since they largely portray the financial effects of past events and do not necessarily provide non- financial information. ***** e.g. in prev. times, it is the one employed by a large household or estate to manage domestic concerns such as supervision of servants, collection of rents and keeping of accounts. QUALITATIVE CHARACTERISTICS OF FINANCIAL STATEMENTS A. Fundamental qualitative characteristics a. Relevance b. Faithful Representation B. Enhancing Qualitative characteristics a. Comparability b. Verifiability c. Timeliness d. Understandability RELEVANCE Relevant financial information is capable of making a difference in the decision made by users, influences the economic decisions of users by helping them to evaluate, past, present, or future events or confirming, or correcting, their past evaluations. a. Predictive value. Financial information has predictive value if it can be used as input to processes employed by users to predict future outcomes. For e.g. information about financial position and past performance is frequently used in predicting wages payments, and the ability of the entity to meet maturing obligations. b. Confirmatory value (or feedback). Financial information has confirmatory value if it provides feedback about (confirms or changes) previous evaluation. Information with feedback value enables users to confirm or correct expectations.

RECOGNITION OF THE ELEMENTS OF FINANCIAL STATEMENTS

Recognition is the process of incorporating in the balance sheet or income statement an item that meets the definition of an element and satisfies the criteria for recognition. An item that meets the definition of an element should be recognized if:  It is probable that any future economic benefit associated with the item will flow to or from the enterprise; and  The item has a cost or value that can be measured with reliability. MEASUREMENT OF THE ELEMENTS OF FINANCIAL STATEMENTS Measurement is the process of determining the monetary amounts at which the elements of financial statements are to be recognized and carried in the balance sheet and income statement. This involves the selection of a particular basis of measurement. A number of these are used to different degrees and in varying combinations in financial statements. They include the following: 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 their acquisition. CURRENT COST. Assets are carried at the amount of cash or cash equivalents that would have to be paid if the same or an equivalent asset was acquired currently. “Liabilities are carried at the discounted amount of cash and cash equivalents that would be required to settle the obligation currently.” RELIAZABLE (SETTLEMENT) VALUE Reliazable value. Assets are carried at the amount of cash or cash equivalents that could currently be obtained by selling an asset in an orderly disposal. Settlement value. Liabilities are carried at the undiscounted amounts of cash or cash equivalents expected to be paid to satisfy the liabilities in the normal course of business. Present Value. Assets/liabilities are carried at present discounted value of the future net cash inflows/outflows that the item is expected to generate/settle in the normal course of business. GUIDELINES IN THE PRESENTATION OF FINANCIAL STATEMENTS Philippine Accounting Standard 1 (PAS) gives us the following guidelines in the presentation of financial statements.

(1) Each component of the financial statements shall be clearly identified and the following information shall be emphasized for a proper understanding of the information presented: i. The name of the reporting entity; ii. Whether the financial statements cover the individual entity or a group of entities. (2) The period covered by the financial statement shall be specified. Note: For Balance Sheet, use Equity and Statement of Cash flows, use As of (date). For Income Statement, Statement of Changes in Owner’s For the month/year ended (date). FINANCIAL POSITION The financial position of an enterprise is affected by the economic resources and its capacity it controls to adapt, its to financialchanges in structure the environment, it liquidity in which and it solvencyoperates., This is primarily provided in the Statement of Financial Position or Balance Sheet. It answers the following questions:  What assets does entity own?  What does it owe?  What are the residual equity interests in the entity’s net assets? Other important information provided by the statement of financial position is as follows:  Financial structure – is the source of financing for the assets of the enterprise. It indicates what amount of assets has been financed by creditors, which is borrowed capital, and what amount of assets has been financed by owners, which is invested capital. Significance: (1) Useful in predicting future borrowing needs and how future profits and cash flows will be distributed among those with an interest in the enterprise. (2) Useful in predicting how successful the enterprise is likely to be raising further finance.  Liquidity – refers to the availability of cash in the near future after taking account of financial commitments over this period. Significance: (1) Useful in predicting the ability of the enterprise to meet its short-term financial commitments as they fall due.  Solvency – refers to the availability of cash over the longer term to meet financial commitments as they fall due. Significance: