Module 1

SUBJECT Fundamentals of Accounting for non-accountants

CHAPTER/UNIT Chapter 1/Part 1
LESSON TITLE Accounting and Business
LESSON OBJECTIVES At the end of this module, you are expected to:
a. Define accounting;
b. Explain the importance of accounting in business as well as the
keeping of records;
c. Discuss Generally Accepted Accounting Principles (GAAP) and
enumerate its basic assumptions; and
d. Classify account titles by its elements and lists the financial
statements.

OVERVIEW/INTRODUCTION The study of accounting has a universal existence. Accounting is not only
for business alone. Whatever one’s occupation or profession is the need
for financial information is inevitable. We cannot earn a living, spend
money, takes credit line or loan, pay taxes without having the financial
information. And making sound decision depends on good information.
The purpose of this module will show you that accounting is a system
that provides useful financial information.

ACTIVITY 1.Flow Chart Analysis (ACCOUNTING PROCESS IN ACTION)

2. Interactive discussion/Recitation

ANALYSIS 1. What is accounting? Why is it important in the business?

2. Why do you need to keep financial records in business? Who are the
users of this accounting record?

3. What is Generally Accepted Accounting Principles? What are its

criteria to be acceptable?

4. What are the basic accounting concepts or assumptions used in the

preparation of Financial Statements?
 5. What are the financial statements required to be prepared by the
business entities? Why do we need to know the account titles by its
elements? What is the relationship of account title with financial
statements?

ABSTRACTION WHAT IS ACCOUNTING?

Accounting consists of three basic activities—it identifies, records, and
communicates the economic events of an organization to interested
users.

The accounting process starts with the company by,

1.identifying the economic events relevant to its business;

2. record those events in order to provide a history of its financial

activities.
Recording consists of keeping a systematic, chronological diary of
events measured in pesos and centavos. It also classifies and
summarizes the economic events.

3. communicates the collected information to interested users by

means of accounting reports commonly known as financial statements.

In order for the reported financial statements to be meaningful,

recording is done in a standardized way. It accumulates information
from similar transactions, accumulates all transactions over a certain
period of time, and reports the data as one amount in the company’s
financial statements.

A vital element in communicating economic events is the accountant’s

ability to analyze and interpret the reported information. Analysis
involves use of ratios, percentages, graphs, and charts to highlight
significant financial trends and relationships. Interpretation involves
explaining the uses, meaning, and limitations of reported data.

Accountants help the proprietor or owner know how much profit that
his business is making. Accountant also provides management with
information essential to the efficient conduct and evaluations of its
business activities. It gathers financial data and identifies which data are
relevant to the decisions to be made, processes and analyses these data
before transforming into reports that can be used in making better or
sound decisions.

WHO ARE THE USERS OF ACCOUNTING DATA?

The information that a user of financial information needs depends
upon the kinds of decisions the user makes. There are two broad groups
of users of financial information: internal users and external users.

INTERNAL USERS
Internal users of accounting information are managers who plan,
organize, and run the business. These include marketing managers,
production supervisors, finance directors, and company officers. In
running a business, internal users must answer many important
questions, as shown in below Illustration:

To answer these and other questions, internal users need detailed

information on a timely basis. Managerial accounting provides internal
reports to help users make decisions about their companies. Examples
are financial comparisons of operating alternatives, projections of
income from new sales campaigns, and forecasts of cash needs for the
next year.

EXTERNAL USERS
External users are individuals and organizations outside a company who
want financial information about the company. The two most common
types of external users are investors and creditors. Investors (owners)
use accounting information to make decisions to buy, hold, or sell
ownership shares of a company. Creditors (such as suppliers and
bankers) use accounting information to evaluate the risks of granting
credit or lending money. Below illustration shows some questions that
investors and creditors may ask.

Financial accounting answers these questions. It provides economic and

financial information for investors, creditors, and other external users.
The information needs of external users vary considerably. Taxing
authorities, such as the Bureau of Internal Revenue, want to know
whether the company complies with tax laws. Regulatory agency, such
as the Securities and Exchange Commission, wants to know whether the
company is operating within prescribed rules. Customers are interested
in whether a company like General Motors will continue to honor
product warranties and support its product lines. Labor unions such as
the San Miguel Packaging Products Employees Union want to know
whether the owners have the ability to pay increased wages and
benefits.

GENERALLY ACCEPTED ACCOUNTING PRINCIPLES (GAAP)

The accounting profession has developed standards that are generally
accepted and universally practiced. This common set of standards is
called generally accepted accounting principles (GAAP). These standards
indicate how to report economic events.

CRITERIA FOR A PRINCIPLE TO BECOME GENERALLY ACCEPTABLE

The preparation of financial statements is governed and guided by
Generally Accepted Accounting Principles (GAAP). GAAP are a uniform
set of accounting rules, procedures, practices, and standards that are
followed in preparing the financial statements.

GAAP serve as the “ground rules” that guide accounting practitioners in

recording (identifying, analysing and measuring) and reporting financial
information of a business entity.

The general acceptance of the an accounting principle usually depends

on how well it meets the following requirements:
1. Principle of Relevance – that the resulting information is
meaningful and useful to those who need to know something
about the status of a certain organization.
2. Principle of Objectivity – that the resulting information is not
influence by the personal bias or judgment of those who furnish
it. Objectivity connotes reliability and trustworthiness. It further
connotes verifiability, which means that there is some way of
finding out whether the information is true and correct.
3. Principle of Feasibility – that it can be implemented without
undue complexity or cost. These criteria are conflicting with one
another and to resolve, the one which may be at least objective
and least feasible is favoured.

The practice of accounting profession is continually evolving and

developing to meet the changing needs of time and therefore, there is
no comprehensive list of Generally Accepted Accounting Principles. As
time changes, new accounting principles emerges as business
organizations enter into a new form.

Here in the Philippines, the development of GAAP is formalized through

the creation of the Accounting Standards Council, now Philippine
Financial Reporting Standards Council (PFRSC), a standard setting body
with its pronouncements contained previously in the Statement of
Financial Accounting Standards (SFAS), now Philippine Accounting
Standards (PAS) used as the primary source of GAAP.

The following are some of the Generally Accepted Accounting Principles

that are followed and are still applicable for use:
Cost Principle – this principle requires that assets should be recorded at
original or acquisition cost.
Example, if we buy land today with a cost of 1 Million and after a year
the current value of the land is approximately 3 Million. The record will
show the cost of 1 Million because cost is definite and verifiable. This
draws controversy but despite this cost continues to be used in the
accountant’s reports because of its reliability. However, the Philippine
Financial Reporting Standards (PFRS) sacrifices reliability and
verifiability in favour of fair value measurement.

Objectivity Principle – this principle requires that accounting records

should be based on reliable and verifiable data as evidence of
transactions.

Materiality Principle – this principle dictates practicability to rule over

theory in determining the valuation of an item. To determine whether
the item is material or not, it is a matter of professional judgment on the
part of the accountant.

Matching Principle – this is the combined concept of Revenue

Recognition and Expense Recognition Principles. Revenue should be
recognized when earned and corresponding expense should be
recognized when incurred during the same period as revenue is earned.

Consistency Principle – this principles requires that accounting methods

and procedures should be applied on a uniform basis from period to
period to achieve comparability in the financial statements. However,
per PAS No. 1, Presentation of Financial Statements, it allows changes if
justifiable and disclosed in the financial statements, that is, when there
is a significant change in the nature of the business operation or when a
new PAS or interpretation so requires.

Adequate Disclosure Principle – this principle requires that financial

statements should be free from any material misstatement; that if there
is any, proper disclosure should be made.
For example, the building owned by the business was gutted by fire. It
should be disclosed why there was a sudden decrease in asset- building
in its Statement of Financial Position as of that date.

BASIC ACCOUNTING CONCEPTS OR ASSUMPTIONS

The preparation of financial statements is guided by concepts or
assumptions. Accounting concepts or assumptions are the very
foundations of Generally Accepted Accounting Principles. Without these
accounting assumptions, there could be no uniformity in the practice of
accounting which can only result to having misleading and meaningless
financial statements. They are as follows:
Accounting Entity - the business is considered as an entity that is
separate and distinct from the owner.

Other concepts and assumptions are Going-concern, Time-period

Assumption, Unit of Measure and Accrual Basis Assumptions are
discussed in detail in CFAS subject.

WHAT ARE FINANCIAL STATEMENTS?

Financial Statements are structured representation of financial position
and financial performance of an entity at a certain point in time. The
objective of financial statements is to provide information about the
financial position, financial performance and cash flows of an entity that
is useful to a wide range of users in making sound economic decisions.
Financial statements also show the results of the management’s
stewardship of the resources entrusted to it.

Financial statement is the output or the end product of the accounting

process. These refer to the accountant’s reports based on the data
gathered, accumulated and processed in financial accounting that are
periodically communicated to the variety of users particularly the
owners, creditors and investors.

The financial statements that are prepared on a basis that is designed to

provide useful information to a wide range of users (e.g., investors and
creditors) are called general-purpose financial statements.

Financial statements that are prepared covering less than a year period
is called interim financial statements.

The following are the six (6) basic financial statements as per revised
PAS No. 1:
1. A Statement of financial position as at the end of the period;
(Balance Sheet)
2. A Statement of comprehensive income for the period; (Income
Statement)
3. A Statement of changes in equity for the period;
4. A Statement of cash flows for the period;
5. Notes, comprising a summary of significant accounting policies
and other explanatory information; and
6. A Statement of financial position as at the beginning of the
earliest comparative period when an entity applies an
accounting policy retrospectively or makes a retrospective
restatement of items in its financial statements or when it
reclassifies items in its financial statements.

What comprises the Statement of Financial Position?

Statement of Financial Position (Balance Sheet) – is a financial

statement which shows the financial position of an enterprise as of a
particular date. It measures and evaluates in terms of the enterprise’
liquidity, solvency, financial structure and capacity for adaptation.

Liquidity – is the stability of the enterprise to meet currently maturing

obligations.
Solvency – is the ability of cash over the longer term to meet maturing
obligations.
Financial Structure – is the source of financing for assets of the
enterprise. It indicates how much is borrowed capital and how much is
equity capital.
Capacity for Adaptation – is the financial flexibility of the enterprise to
use the available cash for unexpected requirements and investments
opportunities.

The Statement of Financial Position, previously known as the “Balance

Sheet” shows the Assets, Liabilities and Owner’s Equity which are called
“Accounting Values”. The SFP is also known as the Permanent or Real
Accounts.

Assets – in layman’s language, are the things of value or rights that are
owned and used by the business in the conduct of its operation such as
cash, land, building, inventories, furniture and fixtures, machineries and
equipment, prepaid expenses, etc. It also includes accounts collectible
by the business which we termed as “Receivable”. This tells us how
much the business owns.

Liabilities – in layman’s language, are the debts or financial obligations

of the business that are payable in cash or in some kind of assets such as
Accounts Payable, Notes Payable, Salaries Payable, Mortgage Payable,
etc. This tells us how much the business owes.

Owner’s Equity – in layman’s language, refers to money or value of

property put by the proprietor in to the business to start with which
refers to “initial investment”.
Owner’s equity will be increased by profits or additional investment and
decreased by withdrawal, expenses and losses.
Owner’s Equity is the residual interest in assets after deducting all the
liabilities. It is expressed in the accounting equation as:
Assets less Liabilities equals Owner’s Equity ( A –L = OE )

Thus if:
the business owns (assets) P100,000
less what the business owes (liabilities) 70,000
equals what is left for the business (owner’s equity) P 30,000

Owner’s Equity therefore, tells us how much is left for the business.
(PICTURE example –in pdf file)

What comprises the Statement of Comprehensive Income?

Statement of Comprehensive Income, previously known as “Income

Statement” is a financial statements that shows the “results of
operations” of the business for a given period of time. It consists of
three (3) sections, the Revenue or Income, Expenses and Profit or Loss.
The period covered by the statement may be:

“For the month ended ______________”

“For the quarter ended _____________”
“For the six months period ended __________”
“For the year ended _____________”

Revenue or Income – denote money to or proceeds from services

rendered by servicing company or income from use by other entities of
the resources of the enterprise such as Rent Income, Royalties, etc.
Servicing companies like Auto Repair Shop, Laundry Shop, Barber Shop,
Beauty Parlor, etc. and Professional Income such as Auditing Fees, Legal
Fees, Retainers Fees and others.

Expenses – denote the benefit received by the business from its use
which had helped in carrying out its operation, like salaries expense,
rent expense, repairs and maintenance, taxes and licenses, etc.

Profit (loss) – the excess of revenues over expenses is called “profit”,

while the excess of expenses over revenues is “loss”.

Basically, the Statement of Comprehensive Income features the

following:
 Revenue or Income Pxx
- Expenses xx
= Profit Pxx

(PICTURE example –in pdf file)

What is a Statement of Owner’s Equity?

A Statement of Changes in Owner’s Equity is a financial statement that

summarizes the changes in equity for a given period of time. The
beginning equity of the owner is increased by the additional investment
and profit. And correspondingly, it is decreased by withdrawal and loss.

(PICTURE example-in pdf file )

The Statement of Changes in Owner’s Equity answers the question:

What cause the increase in Owner’s Equity of S. Santos from P850,000

to P862,150?

ELEMENTS OF FINANCIAL STATEMENTS AND ACCOUNT TITLES USED

The five (5) types of major accounts considered the elements of FS:
Statement of Financial Position
Assets
Liabilities
Owner’s Equity
Statement of Comprehensive Income
Income
Expense

These accounting elements Asset, Liabilities, Owner’s Equity, Income

and Expenses are given account name or account titles.

Account titles are identification or brief description of items that fall to

the same kind, class or nature.

STATEMENT OF FINANCIAL POSITION

OR
Balance Sheet
(Permanent or Real Accounts)

ASSETS are defined as “resources controlled by the enterprise as result

of past transactions and events from which future economic benefits are
expected to flow to the enterprise.”
The following are the essential characteristics of an asset:
a. The asset is controlled by the enterprise;
b. The asset is a result of a past transactions or event;
c. The asset provides future economic benefit;
d. The cost of the asset can be reliably measured.

As per Philippine Accounting Standards (PAS No. 1), Assets are classified
into two, namely: Current assets and Non-current assets.

CURRENT ASSETS – refer to all assets that are expected to be realized,

sold or consumed within the enterprise’s normal operating cycle.

These accounts are normally arranged according to liquidity (ready

conversion to cash) in the Statement of Financial Position.

Operating cycle – is the interval of time from the date of acquisition of

merchandise inventory; sell the inventory to customer and the ultimate
collection of cash from the sale.

Cash – the account title to describe money, either in paper or in

coins and money substitutes like check, postal money orders, bank
drafts and treasury warrants. When cash is within the premise of the
business, the account title is Cash on Bank and Cash in Bank if
deposited in the bank.

Cash Equivalents – PAS No. 7 defines cash equivalents as short term,

highly liquid investments that are readily convertible to known amounts
of cash and which are subject to an insignificant risk of changes in values
because of changes in interest rates.

Petty Cash Fund – an account title for money that is separately

placed inside the box and set aside for petty or small expenses. This
fund is handled by a petty cashier who is accountable for its
disbursements. Petty cash fund should not be mixed with cashiers
personal money.

Notes Receivable – a promissory note that is received by the

business from the customer arising from rendering of services, sale of
merchandise, etc. This can be interest bearing or non-interest bearing.

Accounts Receivable – the account title for amounts collectible

arising from services rendered to a customer or client on credit or sale
of goods to customers on accounts. This can be an oral or verbal
promise to pay by a customer or client.

Estimated Uncollectible Accounts – this is an asset-offset or a

contra-asset account. It provides for possible losses from uncollectible
accounts. Although not actually an asset, it is classified as such because
it is shown as a deduction from the Accounts Receivable. This is called
Estimated Uncollectible Accounts or Allowance for Doubtful Accounts
previously termed as allowance for bad debts.
The difference between Accounts Receivable and the related Estimated
Uncollectible accounts is called Estimated Realizable Value.

Advances to Employees – the account title for amounts collectible

from employees for allowing them to make cash advances which are
deductible against their salaries or wages.

Inventories – per PAS No. 4, these are assets which are:

(1) held for sale in the ordinary course of business;
(2) in the process of production for such sale; or
(3) in the form of materials or supplies to be consumed in the
production process or in the rendering of the services.

Supplies Inventory or Unused Supplies – an account title for cost of

stationery and other supplies purchased for use but are left on hand and
still unused. The account title should be specified as to Unused Office
Supplies if intended for the office, Unused Shop Supplies if intended for
the shop, etc.

Prepaid Expenses – account title for expenses that are paid in

advance but are not yet incurred or have not yet expired such as Prepaid
Rental, Prepaid Insurance, Prepaid Interest, Prepaid Advertising, etc.

Accrued Income – account title for income that is already earned but
it has not yet been collected. It has a semblance of “receivable” account.
The correct account title is “Accrued Rental Income” if from income
from rent, etc.

NON-CURRENT ASSETS:

Property and Equipment – the International Accounting Standards

No. 16 defines property and equipment as tangible assets which are
held by an enterprise for use in production or supply of goods and
services, for rental to others, or for administrative purposes, and which
are expected to be used during more than one period such as:

Land – an account title for the site where the building used as office
or store is constructed.
IF land is reserved for future use, it is classified as “investment
property.”
Land is not subject to depreciation because it is expected to be
useful for an indefinite period of time.

Building – account title for a finished construction owned by the

business where operations and transactions took place.

Equipment – includes calculators, typewriters, adding machines,

computers, steel filing cabinets, and the like. IF it is used in the office the
account title is Office Equipment and if used in the store, Store
Equipment. Trucks, jeeps and other motor vehicles used exclusively for
delivery of goods, the account title is Delivery Equipment.

Furniture and Fixtures – include chairs, tables, counters, display

cases and the like. IF used in the office the account title is Office
Furniture and Fixtures and if used in store, account title is Store Furniture
and Fixtures.

Accumulated Depreciation – is an asset-offset or contra-asset

account. It is shown as a deduction from property and equipment. Each
property and equipment should provide their individual valuation
account.

The assets that are classified a s Property & Equipment or Fixed Assets
are called Depreciable Assets and are subject to depreciation. The
incidental cost that are incurred in acquiring the property and
equipment before it can be used in its operation like installation costs,
freight and handling, trial-run, insurance, etc. are being added to costs.
These are called capital expenditures. The difference between property
and equipment and its related accumulated depreciation is called
carrying value or net book value.

LIABILITIES – are defined as “present obligations of an enterprise arising

from past transactions or events, the settlement of which is expected to
result in an outflow from the enterprise of resources embodying
economic benefits.”

The following are the essential characteristics of a liability:

a. the liability is the present obligation of a particular enterprise.
This means that the enterprise’ liability must be identified;
b. the liability arises from past transactions or events. This means
that the liability is not recognized until it is incurred.
c. the settlement of the liability requires an outflow of resources
embodying economic benefits. This means that the obligation of
the enterprise is to transfer cash and non-cash resources or
provide services at some future time.

As per PAS No. 1, liabilities are classified into two namely: current
liabilities and non-current liabilities.

Current Liabilities – are financial obligations of the enterprise which are

(a) expected to be settled in the normal course of the operating cycle;
(b) due to be settled within one year from the Statement of Financial
Position date.

Accounts Payable – an account title for a financial obligation of an

enterprise or a promise to pay made orally or verbally.

Notes Payable (short-term) – same as Accounts Payable in nature

but only the obligation to pay is evidenced by a promissory note. The
enterprise is the one who issued the note.

Accrued Expenses – these are expenses incurred by the enterprise

but are not yet paid. This normally occurs when the accounting period
ended such as rent payable, salaries payable, interest payable, taxes
payable, etc. It has a semblance of a ”Payable” account. IF it is for
salaries, the correct account title is “Accrued Salaries Expense”.

Unearned Income – an account title for an income collected or

received in advance but services have not been rendered yet.

Non-current Liabilities:
Notes Payable (long-term) – same nature with that of Notes Payable
(short-term) but only, this requires payment for more than a year.

Mortgage Payable – a financial obligation of the enterprise which

requires fixed or tangible property to be pledged as a collateral to
ensure payment.

OWNER’S EQUITY OR CAPITAL – the “residual interest in the assets of

the enterprise after deducting all its liabilities.”
Capital is synonymous to Proprietorship, Proprietary Interest or Net
Worth.

The owner’s capital title can be given by indicating the name, with the
word capital after the name separated by a “comma”.
Example: JP Miao, Capital

Withdrawal – the owner’s withdrawal is likewise indicated by the

use of the owner’s name with the word Drawing or Personal written
after the name separated by a “comma”.
Example: JP Miao, Personal or JP Miao, Drawing

Income & Expense Summary – this is a temporary account created at

the end of the accounting period where Income and Expenses are
temporarily closed to the account.

STATEMENT OF COMPREHENSIVE INCOME

OR
Income Statement
(Temporary Accounts)
INCOME or REVENUE – PAS No. 28 defines revenues as the “gross inflow
of economic benefits during the period arising in the course of ordinary
activities of an enterprise when those inflows result in increase in equity,
other than those relating to contributions from owners”.
Examples are proceeds from services rendered by a servicing firm,
income from use by other entities of the resources of the enterprise like
royalties income, rent income, interest income, etc. and sale of
merchandise by a trading firm.
Gains include income from activities and events that do not form part of
the ordinary course of the business operation. Example is gain on sale of
property and equipment, etc.

Service Income – in general is the account title used for all types of
income derived from rendering of services. Sometimes the account title
used is Service Revenue. Other specific income account title used are:

Professional Income – used by professionals for income earned from

the practice of their profession or may be specified as Accounting or
Auditing Fees Income for Accountants, Legal Fees Income for Lawyers,
Dental Fees Income for Dentists, Medical Fees Income for Doctors, etc.

Rental Income – for income earned on buildings, space or other

properties owned and rented out by the business as the main line of its
activity.

Interest Income – for income received by the business arising from

an amount of money borrowed by a customer and usually covered by a
promissory note. This typical in lending institutions.

Miscellaneous Income – for income earned by the business which is

not the main line of its activity and could not be clearly classified.

EXPENSES – are the “gross outflow of economic benefits during the

period arising in the course of ordinary activities of an enterprise when
those outflow result in decrease in equity, other than those relating to
distribution to owners”.
Examples: salaries expense, rent expense, stationery and supplies
expense, uncollectible accounts, depreciation, taxes and licenses, etc.

Losses represent decreases in assets or increases in liabilities arising

from the activities or events that are outside the ordinary course of
business operation.
Examples: Loss from sale of property and equipment, loss due to theft
or pilferage, etc.

Profit (loss) – the excess of revenues over expenses is called “Profit”.

IF expenses exceed the revenue, it is called a “Loss”.
 Supplies Expense – represents cost of supplies that were used and
consumed that bears specific titles as office supplies expense, store
supplies expense, shop supplies expense, etc.

Rent Expense – for the amount paid or incurred for use of property,
usually premises.

Repairs and Maintenance – for expenses incurred in repairing or

servicing the buildings, machineries, vehicles, equipment, etc. which are
owned by the business.

Salaries Expense – for compensation given to employees of a

business. It may be specified as Office Salaries, Saleman’s Salaries, etc.

Uncollectible Accounts – for the anticipated loss that the business

may incur arising from uncollectible accounts.

Depreciation Expense – for the portion of the cost of property and

equipment or fixed assets that has expired based on rational and
systematic allocation procedure.

Taxes and Licenses – for the amount paid for business permits,
licenses and other government dues except the Income Tax paid which
is NOT allowable by law as a deduction.

Insurance Expense - account title for the expired portion of the

insurance premium paid.

Utilities Expense – the account title for telephone, light and water
bills.

Interest Expense – an expense incurred from borrowed money. This

is separately shown as a deduction from Profit before finance charges to
arrive at Profit.

Miscellaneous Expense – any amount paid as expense which is not

significant enough to warrant a particular classification.

Gas & Oil – the account title for gasoline, diesel, lubricants, grease,
fluids, lube oils, etc. for use by company vehicles.
APPLICATION 1. Self-Check Activity
(Read and understand the reading materials in the Abstraction column.
Afterwards the teacher will provide multiple choice questions for
students to check if they understand the materials provided. Students
will know immediately their score after taking the quiz.)

2. Assignment (Simulation)
 Students will be required to write something about their school
allowances and how they spend it before the COVID-19 lockdown and
how they can relate it to topic they have read or learned today (with
rubrics for scoring. Answers to be submitted in the online platform used).
ASSESSMENT 1. Self-test (quiz on line with scheduled time)
2. Assignment (with rubrics)

Reference(s) Basic Accounting for Non-Accountants & Financial Accounting and

Recording by. R. Lopez
Basic Financial Accounting & Reporting by W. Ballada
Accounting Principles by Weygandt, Kimmel and Kieso