Definition of Accounting In Florence Italy – DEB records wherein debits were

The following authorities on the field of accounting written over credits (Florentine Method or Journal
defined accounting as; Entries)
Accounting Standards Council (ASC) – A Service 1494 – an Italian monk and mathematician,
Activity. wrote “Summa de Arithmetica Geometria, Proportioni
The accounting function is to provide quantitative et Proportionalita” the first book that was published
information primarily financial in nature, about containing a detailed chapter of In this book, Pacioli
economic entities, that is intended to be useful in introduced three (3) important record books;
making economic decision. Memorandum Book – for all information on a
American Institute of Certified Public Accountant transaction
(AICPA) – An Art Journal Book – Book of Original Entry
Accounting is an art of recording, classifying and Ledger Book – Book of Final Entry
summarizing in a significant manner and in terms of
money, transactions and events which are part at least 1700s – French Revolution
of a financial character and interpreting the results The thorough study of accounting and development of
thereof. accounting theory began
American Accounting Association (AAA) - A Process 1760 – 1830 – Industrial Revolution
Accounting is the process of identifying, measuring and Mass production and great importance of Fixed Asset
communicating economic information to permit 1900s – Global Industrial Economy
informed judgment and decision by users of the Developing changes in accounting practice such as
information. mergers, acquisitions and reporting systems
2000s – Technological Advancements & Global Trade
Computer-assisted accounting practice and reporting
Accounting as the "Language of Business" were developed rapidly
Accounting is the medium of communication through Globalization of business and diverse accounting
which financial reports are furnished to intended users practice has been standardized in an international
for decision making. accounting setting
Accounting helps business answer the following
business questions: Sectors of the Accounting Practice
Four (4) SECTORS of the Accounting Practice
Profitability – “How much is the increase in capital as a
result of business operations?” 1. Public Accounting – This practice is when accountant
Liquidity – “Are there available funds to finance the offer their professional services for a fee and who
business operations?” engages NOT as an employee of the company
Solvency – “Can the business pay its long-term • External Auditing – primarily centers on the
obligations to others?” critical examination of financial statements by
Stability – “Can the business sustain its long-term an independent CPA to express an opinion
profitability and cash flow?” regarding the fairness of the contents of the
Capital Structure – “How much investments are from financial statements
Capital or borrowed from Creditors? • Tax Services – deals with the accountant’s
Financial Flexibility – “Is there excess cash available for preparation of the client’s income tax returns,
opportunities and uncertainties? business and transfer taxes.
• Managerial Advisory Services – provide
Accounting as the “Eyes of the Business” assistance and advice to the
Accounting helps owners the following business management to their clients regarding finance,
activities: budgeting,
Check on their financial progress business policies, and organization procedures,
Prepare plans to the future systems, product costs, distribution and other
Avoid material mistakes business activities.
Analyze causes of changes
Choose the best amongst economic alternatives 2. Private Accounting – Accountants that engages as an
Accounting are economic detectives using the audit employee of a private enterprise or non-profit
function by verifying the truthfulness of financial organization
reports • Financial Accounting – Primarily concerned
with the recording and classifying of business
History of Accounting transactions culminating in the preparation of
3600 BC (approx.) general-purpose financial statements or reports
Record keeping already common from Mesopotamia, regarding the business’ financial position,
China, India to Central & South America. operating results and cash activities in
The oldest evidence of this practice was the “clay accordance with the GAAP.
tablet” • Internal Auditing – deals with determining the
13th to 15 century (approx.) operational efficiency of the company
1339 is the earliest recorded history of the “double- regarding protection of the company’s assets,
entry bookkeeping” (DEB) accounting system accuracy and reliability of the accounting data.
“Massari Ledgers of Commune of Genoa” – The • Tax Accounting – embraces the preparation of
oldest DEB because of separate pages were used for various tax returns and tax planning necessary
debit and credit (T-Account or Ledger or Venetian to minimize the impact of taxes on the entity.
Method) • Cost Accounting – The determination of
inventory costs and/or product costs of the
 manufactured goods. Data produced from cost The Accounting Process
accounting are used by the management for
planning, budgeting and controlling purposes. This is also called the "accounting cycle", which refers
• Not-for Profit Accounting – Special accounting to a series of repetitive activities of recording,
for charitable organizations, philanthropic summarizing and reporting economic transaction from
foundations, religious groups, governmental the beginning to the end of the accounting period.
agencies, schools and cooperatives.
• Socio-economic Accounting – concerns the Aspects of the Accounting Process
measurement of the impact of business or The following are the aspects of the accounting process:
governmental agency’s decision on the public 1) Identifying - This includes recognizing business
sector. transaction or events that are reportable
• Accounting Systems Design – includes the 2) Measuring - This assigns peso amounts to the
evaluation of the company’s control system to accountable economic transactions and events.
find out any area of improvement 3) Communicating - This constitute the preparation and
distribution of accounting reports to potential users of
3. Government Accounting – focuses on the proper accounting information
custody of government funds and their purposes. The
following are several agencies that many accountants Steps in the Accounting Cycle
are employed: There are nine (9) basic steps in the accounting cycle,
• Bureau of Internal Revenue (BIR) which includes phases on recording, classifying, and
• Commission on Audit (COA) summarizing.
• Department of Finance (DOF) On this module, the following steps will be discussed;
• Department of Budget and Management (DBM) RECORDING PHASE
• Banko Sentral ng Pilipinas (BSP) 1. Analyzing the transaction (business document)
2. Journalizing
4. Accounting Education – involves teaching and CLASSIFYING PHASE
preparation of curriculums in high schools, colleges, 3. Posting
universities or review centers of the following subjects: SUMMARIZING PHASE
• Financial Accounting 4. Preparing the unadjusted trial balance
• Management Accounting 5. Preparing adjusting entries
• Taxation 6. Preparing the financial statements
• Other business-related subjects 7. Preparing the closing entries
8. Preparing the post-closing trial balance
Forms of Business Organization 9. Preparing reversing entries
Business – is any economic activity conducted primarily
for profit. Below are the most common forms of Analyzing Business Transaction
business
1. Sole or Single Proprietorship – A business entity This is where the accountant gathers information from
owned by one person called a sole proprietor source documents and determines the impact of the
2. Partnership – A business entity owned by two (2) or transaction on the financial position as represented by
more persons called partners who have agreed to the equation “assets equals liabilities plus equity”.
contribute money, property and industry to a common
fund with the intention of dividing the profits among Impact of the transaction
themselves (further discussion will be undertaken on In order to determine if a transaction has an impact to
MODULE 3 and 4) the financial position of an entity, it must be considered
3. Corporation – A business registered as an artificial if it is either a) Accountable or b) Un-Accountable.
person under the operation of law. Its existence is
evidenced by its Articles of Incorporation and Corporate
By-Laws registered with the Securities and Exchange
Commission (SEC) (further discussion will be undertaken
on MODULE 5 and 6)

Business Activities
A business may be classified based on its primary • Accountable events are monetary transaction
activities. The common types of businesses as to their that are recorded in the Accounting Books
nature or main activities are as follows: • Un-accountable events are non-monetary
1. Servicing – This Activity earns through rendering a events that are not recorded in the Accounting
service in exchange for a fee Books
2. Merchandising – The business engages in the buying
and selling of goods. It ears primarily by marking up the Accountable Events
cost from purchased goods that it sells to customers. Accountable events can be further classified into two (2)
3. Manufacturing – This business converts raw namely:
materials into finished goods that are to be sold at 1) Business Transactions -
selling price. These involve the ordinary business activities of an
entity depending on the industry.
There are two (2) types of business transactions namely:
 1. External Business Transaction ▪ Simple journal entry – One
o These are arm's length transactions which contains a single debit
with an outside party in exchange of and a single credit
resources ▪ Compound journal entry – One
▪ Selling of Service or which has two or more
Merchandise elements and often
▪ Collection & Payment representing two or more
2. Internal Business Transaction Accounts are the storage units of accounting
o These are transactions that takes place information and used to summarize changes in assets,
within the enterprise such as: liabilities and equity including income and expenses.
▪ Conversion of Raw Materials to The following are a broad classification of kinds of
Finished Goods accounts:
▪ Supplies Withdrawn or transfer • Real account – Statement of financial position
of supplies to another or so-called permanent accounts. These
department accounts are not closed and carryover to the
2) Accounting Events next accounting period. (ex. Cash, AR and PPE)
These involve the occasional or non-ordinary business • Nominal account – Income statement or
activities of an entity such as: temporary capital accounts. These accounts are
• Losses due to Fortuitous Events(these are unforeseeable closed at the end of the accounting period. (ex.
events or acts of God), ex. theft, earthquake, etc)
Sales and expenses)
• Decline in Market Value • Mixed account – A combination of real and
nominal accounts. (ex. Prepaid expenses)
Source Documents • Clearing account – Holds temporarily certain
It is important for accounting events to information pending transfer to other ledger
have documentation of the transaction. accounts.
Source Documents enhances the verifiability of a • Controlling account – The general ledger
transaction because they are forms, evidence, legal or account that summarizes the detailed
official paper that supports the economic transactions information in a subsidiary
The following are examples of Source Documents: • Suspense account – Is an account that holds
temporarily certain information pending for
disposition.
• Reciprocal account – Has a counterpart in
another book with in the entity or in another
ledger or another
• Principal account – An account that is
independent or can stand alone.
• Auxiliary account – An account that cannot
stand alone and are technically neither assets,
liabilities nor income
Sample Journal Entry

Journalizing
This is the process of recording the transactions in the
appropriate journals. A journal is a chronological record
of transactions also known as the book of original
entry . Although all transactions could be recorded in
the general journal , it is more efficient to use special
journals in recording a large number of like transactions.
Special journals that enterprises usually use are:
•
o Sales Journal – Only sales of Rules of debit and credits
merchandise on account are
o Cash receipts journal – All types of cash
receipts are
o Purchase journal – Used to record all
purchases on account (merchandise,
equipment and supplies).
o Cash disbursement journal – All
payments of cash for any purpose are
recorded.

Type of journal entries according to form:

•
o
Posting
This is the third process of the accounting process What are the causes when Debit and Credits is NOT
wherein, It is the process of transferring data from the EQUAL?
journal to the appropriate accounts in the general • Posting an Item to the wrong side of the
ledger and subsidiary ledger. This process classifies all account
accounts that were recorded in the journals • Erroneous copying of transferring a balance
Kinds of ledgers • Omission of posting of a journal entry either
• General ledger – Includes all the accounts debit or credit
appearing on the financial • Posting the same account twice
• Subsidiary ledgers – Affords additional detail in • Wrong calculation of account balances
support of certain general ledge How to Locate Errors?
Step 1: Calculate the Difference between Debits and
Chart of Accounts Credits
It is a listing of the names of the accounts that a If the difference is;
company has identified and made available for • ₱ .01, ₱ .10, ₱ 1.00, ₱ 10.00,.. Etc = Addition /
recording transactions in its general ledger Subtraction Error
Within the chart of accounts you will find that the • ₱ 9.00, or Multiple of 9,= Transposition Error
accounts are typically listed in the following order: o Example: ₱ 52.00 is Written as ₱ 25.00
• ₱ 2.00 divisible by two = Error of Commission
o Example: Posting in the wrong column
of the Trial Balance
• Divisible by 9 or 99 = Misplacement or Slide
o Example : Misplacement of Decimal
Point, ₱2.00 instead of ₱20.00
Step 2: Workback from Trial balance to Journals
1 . Check the Trial Balance
Preparing the unadjusted trial balance 1.1 Verify Totals
A list of general ledger accounts with their respective 1.2 Check each accounts in the Trial balance back to the
debit or credit balance. Ledger
The purpose of the unadjusted trial balance is 2 . Check the Ledger
to provide evidence that the total debits in the general 2.1 Verify Footings
ledger equal the total credits and prepares the accounts 2.2 Check Posting from Journals
for adjustments.
Before a trial balance is made, amounts on each side of Preparing the adjusting entries
the accounts from the General Ledger are totaled To take up accruals, expiration of prepayments and
or FOOTED. deferrals, estimations and other events often not
• A closed or zero-balance account is when the signaled by new source documents. Adjusting entries
ending balance of the accounts's debit is EQUAL are made at the end of each accounting period. The
to its Credit, concepts involved behind adjusting entries are
• An Open accounts is when either debit or credit ACCRUAL, MATCHING OF COSTS AGAINST REVENUE and
is higher than the other; ACCOUNTING
o Debit balance = Debit > Credit
o Credit balance = Debit < Credit Typical Adjusting Entries classified according to timing
Sample Trial Balance of cash flow.
1.
1. Prepayments and Deferrals – The cash
flow precedes the revenue or the
expense recognition.

Limitation of an unadjusted Trial Balance 2. Accruals – Income or expense recognition precedes

It Does NOT Guarantee the correctness of the the cash
bookkeeping records. • Accrued Income – Income earned but not yet
Answer: It is possible to have a balanced unadjusted received. A receivable is always debited and
trial balance, but may contain errors income is recognized (credited)
What are the Types of Errors? • Accrued expenses – Expenses incurred but not
• Incorrect usage of accounts yet An expense is recognized (debited) and a
• Double Entry or Posting liability is always credited.
• Omission of a journal entry
3. Estimates – Adjusting entries that do not involve cash CODE OF PROFESSIONAL ETHICS FOR ACCOUNTANTS
• Doubtful accounts – The expense to be A distinguishing mark of the accountancy profession is
matched against credit its acceptance of the responsibility to act in the public
• Depreciation - Allocation of the cost of fixed interest. Therefore, a professional accountant’s
assets as expense over its useful life responsibility is not exclusively to satisfy the needs of an
4. Ending inventory - An adjustment to set up the year- individual client or employer.
end physical count of the inventory. This only applies if In acting in the public interest, a professional
the PERIODIC INVENTORY SYSTEM IS USED accountant shall observe and comply with the
following “Code of Professional Ethics”;
Preparing the financial statements
The most important part of the summarizing phase, this FUNDAMENTAL PRINCIPLES
is where the processed information is communicated to Integrity
external users • To be straightforward and honest in all
It can also be called the REPORTING Phase professional and business relationships &
wherein Intended users can make an informed implies fair dealing and truthfulness.
judgement and sound decision • A professional accountant shall not knowingly
Basic financial statements be associated with reports, returns,
1. Statement of financial position communications or other information
2. Income statement or a statement of where the professional accountant believes that
comprehensive income the information:
3. Statement of changes in equity o Contains a materially false or misleading
4. Statement of cash flows statement;
5. Notes and disclosures o Contains statements or information
furnished recklessly; or
Preparing the Financial Statements o Omits or obscures information required
to be included where such omission or
obscurity would be misleading.

Objectivity
• To not allow bias, conflict of interest or undue
influence of others to override professional or
business judgments.
• A professional accountant shall not perform a
professional service if a circumstance or
relationship biases or unduly
influences the accountant’s professional
Preparing the closing entries judgment with respect to that service.
Recorded and posted for the purpose of closing all
nominal or temporary accounts to the income summary Competence and Due Care
account and the resulting net income or loss is • To maintain professional knowledge and skill at
afterwards closed to the capital or retained earnings the level required to ensure that a client or
account. employer receives competent professional
The OPEN ACCOUNTS of the revenue and expense services based on current developments in
accounts is closed to the CAPITAL ACCOUNT practice, legislation and techniques
• To act diligently and in accordance with
What is the income summary account? applicable technical and professional standards.
Income summary is used as another temporary account • Competent professional service requires the
to determine whether the business operations results exercise of sound judgment in applying
to income or loss professional knowledge and skill in the
performance of such service. Professional
Difference between Permanent and Temporary competence may be divided into two separate
Accounts phases:
o Attainment of professional
competence;
o Maintenance of professional
competence.

Professional Behavior
• To comply with relevant laws and regulations
and avoid any action that discredits the
profession.
• In marketing and promoting themselves and
Preparing the post-closing trial balance
their work, professional accountants shall not
A listing of general ledger accounts and their balances
bring the profession into
after closing entries have been made. The post-closing
disrepute (disgrace/shame)
trial balance is the same with the year-end statement of
• Professional accountants shall be honest and
financial position, the only difference is that valuation
truthful and not:
accounts like allowances for assets are found in the
o Make exaggerated claims for the
credit side instead of being deducted from the related services they are able to offer, the
asset
 qualifications they possess, or • The examination for registration of certified
experience they have gained; or public accountants; and
o Make disparaging references or • The supervision, control, and regulation of the
unsubstantiated comparisons to the practice of accountancy in the Philippines.
work of others.
Scope of Practice
Confidentiality The practice of accountancy shall include, but not
• To respect the confidentiality of information limited to, the following:
acquired as a result of professional and business • Practice of Public Accountancy
relationships • Practice in Commerce and Industry
• To not disclose any such information to third • Practice in Education/Academe
parties without proper and specific authority, • Practice in Government
unless there is a legal or professional right or
duty to disclose, nor use the information for the The Professional Regulatory Board of Accountancy
personal advantage of the professional (BOA) and its Composition
accountant or third parties. • composed of a chairman and six (6) members
• The need to comply with the principle of • to be appointed by the President of the
confidentiality continues even after the end of Philippines from
relationships between a professional o a list of three (3) recommendees for
accountant and a client or employer. each position and ranked by the
Exceptions to the Confidentiality Rule: Commission
The following are circumstances where professional ▪ from a list of five (5) nominees
accountants may be required to disclose confidential for each position submitted by
information or when such disclosure may be the accredited national
appropriate: professional organization of
1. Disclosure is permitted by law and is authorized CPA’s
by the client or the employer; • BOA shall elect a vice-chairman from among its
2. Disclosure is required by law, for example: members for a term one (1) year.
o Production of documents or other
provision of evidence in the course of Qualifications of Members
legal proceedings • Must be a natural-born citizen and a resident of
o Disclosure to the appropriate public the Philippines;
authorities of infringements of the law • Must be a duly registered CPA with a least
that come to light ten (10) years of work experience in ANY scope
3. There is a professional duty or right to disclose, of practice of accountancy.
when not prohibited by law: • Must be of good moral character and must not
o To comply with the quality review of a have been convicted of crimes involving moral
member body or professional body; turpitude; and
o To respond to an inquiry or • Must not have any pecuniary interest, directly
investigation by a member body or or indirectly, in any school, college, university or
regulatory body; institution conferring an academic degree
o To protect the professional interests of necessary for admission to the practice of
a professional accountant in legal accountancy or where review classes in
proceedings; or preparation for the licensure examination are
o To comply with technical standards and being offered or conducted, nor shall he/she be
ethics requirements. a member of the faculty or administration
thereof at the time of his/her appointment to
The Philippine Accountancy Act of 2004 (RA 9298) the Board.
It is important for aspiring accountants to understand
that the profession of accountancy is governed and Term of Office
regulated within the Philippine Laws, especially when • The Chairman and members of the Board shall
you are planning to practice being a professional hold office for a term of three (3) years.
accountant in the Philippines. • Any vacancy occurring within the term of a
The Philippine Accountancy Act of 2004 also known as member shall be filled up for the unexpired
R.A. 9298 is divided into 5 rules, portion of the term only.
1. Declaration of Policy, Objectives & Scope of • No person who has served two (2) successive
Practice complete terms shall be eligible for
2. The Professional Regulatory Board of reappointment until the lapse of one (1) year.
Accountancy • Appointment to fill up an unexpired term is not
3. Examination, Regulation and Licensure to be considered as a complete term.
4. Practice of Accountancy
5. Penal and Final Provisions The Certified Public Accountant
In-depth discussion of this law will be tackled on your Examinations (adjusted for BOA Resolution 114 Series
higher years, but to familiarize yourself on the basics, of 2016)
below are the discussion of the following; All applicants for registration for the practice of
Objectives accountancy shall be required to undergo a licensure
• The standardization and regulation of examination to be given by the Board
accounting education;
Qualifications of Applicants for Examinations. o The IASB develops, in the public
• is a Filipino citizen interest, a single set of high-quality,
• is of good moral character; enforceable, and global international
• is a holder of the degree of Bachelor of Science financial reporting standards for
in Accountancy conferred by a school, general-purpose financial statements.
college, academy or institute duly recognized
and/or accredited by the CHED or other What is the benefit of a single set of high-quality
authorized government offices; and accounting standards?
• has not been convicted of any criminal offense • Ensures adequate comparability.
involving moral turpitude o Investors are able to make better
investment decisions if they receive
Scope of Examinations financial information from a Philippine
company that is comparable to an
international competitor
• Promotes efficiency
o Reports for a transaction in Beijing
should be reported the same way in
Philippines, Paris, New York, or London
and may no longer require different
sets of financial statements

International standard-setting structure organizations

1. The IFRS Foundation
Rating in the Licensure Examinations 2. The International Accounting Standards Board
To be qualified as having passed the licensure (IASB)
examination for accountants, a candidate must 3. The IFRS Advisory Council
• obtain a general average of seventy-five percent
4. The IFRS Interpretations Committee
(75%),
• with no grades lower than sixty-five percent
(65%) in any given subject.
o In the event a candidate obtains the
rating of seventy-five percent (75%) and
above in at least a
majority of subjects he/she shall receive
a conditional credit for the subjects
passed:
▪ Provided, That a candidate shall
take an examination in the
remaining subjects within two How are IASB preliminary views and IASB exposure
years from the preceding drafts related to IASB standards?
examination:
• if the candidate fails to obtain at least a general
average of seventy-five percent (75%) and a
rating of at least sixty-five percent (65%) in each
of the subjects reexamined, he/she shall be
considered as FAILED in the entire examination.

International Financial Reporting Standards (IFRS)

What is the IFRS?
International Financial Reporting Standards (IFRS) set
common rules so that financial statements can be
consistent, transparent and comparable around the
world.
IFRS are issued by the International Accounting
Standards Board (IASB).
Characteristics of the IASB
Who are the two key organizations in the development • Membership
of international accounting standards? o The Board consists of 16
• International Organization members (must be from different
of Securities Commissions – IOSCO countries).
• o Members are well-paid and appointed
o The IOSCO does not set accounting for five-year renewable terms.
standards, but ensures that the global • Autonomy
markets can operate in an efficient and o The IASB is not part of any other
effective manner. professional organization.
• International Accounting Standards Board o It is appointed by and answerable only
- IASB to the IFRS Foundation.
 • Independence BOA in carrying out its power and function to
o Full-time IASB members must sever all promulgate accounting standards in the Philippines.
ties from their past employer. The FRSC’s main function is to establish GAAP in the
o The members are selected for their Philippines.
expertise in standard-setting rather The FRSC is the successor of the Accounting Standards
than to represent a given country. Council (ASC).
• Voting
o Nine (9) of 16 votes are needed to issue What is the ASC?
a new IFRS. The ASC was created in November 1981 by the
Philippine Institute of Certified Public Accountants
3 Major Types of Pronouncement of the IASB (PICPA) to establish GAAP in the Philippines.
1. International Financial Reporting Standards.
2. Conceptual Framework for Financial Reporting. What is the PIC?
3. International Financial Reporting Standards The FRSC formed the Philippine Interpretations
Interpretations. Committee (PIC) in August 2006 to assist the FRSC in
Hierarchy of the Pronouncements establishing and improving financial reporting standards
in the Philippines.
The role of the PIC is principally to issue implementation
guidance on PFRSs.
The PIC members are appointed by the FRSC and
include accountants in public practice, the academe and
regulatory bodies and users of financial statements. The
PIC replaced the Interpretations Committee created by
the ASC in 2000.
Sources of Pressure that change and influence the
development of IFRS *PFRSs and Philippine Interpretations–IFRIC approved
for adoption are submitted to the BOA and PRC for
approval.

Major challenges facing the accounting profession

• Nonfinancial measurement—how to report
significant key performance measurements
such as customer satisfaction indexes, backlog
information and reject rates on goods
purchased.
• Forward-looking information—how to report
more future oriented information.
• Soft assets—how to report on intangible assets,
such as market know-how, market dominance,
and well-trained employees.
• Timeliness—how to report more real-time
information.

Philippine Financial Reporting Standards (PFRS)

PHILIPPINE COUNTERPARTS

What is the FRSC?

The Financial Reporting Standards Council (FRSC) was
established by the PRC under the RA 9298 to assist the
REVISED CONCEPTUAL FRAMEWORK Objective of Financial Reporting
The Conceptual Framework for Financial Reporting is a The objective of financial reporting forms the
complete, comprehensive and single document foundation of the Conceptual Framework.
promulgated by the International Accounting The overall objective of financial reporting is to
Standards Board. It is a summary of terms and provide financial information about the reporting entity
concepts that underlie the preparation and that is useful to existing and potential investors, lenders
presentation of financial statements for external users. and other creditors in making decisions about providing
In other words, the Conceptual Framework describes resources to the entity.
the concepts for general purpose financial reporting. The objective of financial reporting is the "why",
The Conceptual Framework is an attempt to provide an purpose or goal of accounting.
overall theoretical foundation for accounting. It is
intended to guide standard setters, preparers and users
of financial information in the preparation and Specific Objectives of Financial Reporting
presentation of statements. It is the underlying theory The Conceptual Framework places more emphasis on
for the development of accounting standards and the importance of providing information needed to
revision of previously issued accounting standards. assess the management stewardship of the entity's
The Conceptual Framework will be used in future economic resources.
standard setting decision but no changes will be made Accordingly, the specific objectives of financial
to the current IFRS. reporting are:
The Conceptual Framework provides the foundation for • To provide information useful in making
Standards that: decisions about providing resources to the
• entity.
o Contribute to transparency by • To provide information useful in assessing
enhancing international comparability the cash flow prospects of the entity.
and quality of financial information. • To provide information about entity resources,
o Strengthen accountability by reducing claims and changes in resources and claims.
information gap between the providers
of capital and the people to whom they Limitations of Financial Reporting
have entrusted their money. • General purpose financial reports do not and
o Contribute to economic efficiency by cannot provide all of the information that
helping investors to identify existing and potential investors, lenders and
opportunities and risks across the world other creditors need. These users need to
consider pertinent information from other
The PURPOSE of the Revised Conceptual Framework as sources, for example, general economic
outlined is to: conditions, political events and industry
• To assist the International Accounting Standards outlook.
Board to develop IFRS Standards based on • General purpose financial reports are not
consistent concepts. designed to show the value of an entity but the
• To assist preparers of financial statements to reports provide information to help the primary
develop consistent accounting policy when no users estimate the value of the entity.
Standard applies to a particular transaction or • General purpose financial reports are intended
other event or where an issue is not yet to provide common information to users and
addressed by an IFRS. cannot accommodate every request for
• To assist preparers of financial statements to information.
develop accounting policy when a Standard • To a large extent general purpose financial
allows a choice of an accounting policy. reports are based on estimate and judgment
• To assist all parties to understand and interpret rather than exact depiction.
the IFRS Standards.
This Conceptual Framework is NOT an IFRS or Qualitative Characteristics of Useful Financial
PFRS, and hence, does not define standards for any Information
particular measurement or disclosure issue. These characteristics are the attributes that make the
If there is a standard or interpretation that specifically information in financial statements useful to investors,
applies to a transaction, the standard or interpretation creditors, and others.
overrides the Conceptual Framework. Nothing in the In deciding which information to include in financial
Conceptual Framework overrides any accounting statements, the objective is to ensure that the
standard. information is useful to the users in making economic
decisions.
The SCOPE of the Revised Conceptual Framework: Under the Conceptual Framework for Financial
• Objective of financial reporting; Reporting, qualitative characteristics are classified
• Qualitative characteristics of useful financial into “fundamental” and “enhancing” qualitative
information characteristics:
• Financial statements and reporting entity
• Elements of financial statements
• Recognition and derecognition
• Measurement
• Presentation and disclosure
• Concepts of capital and capital maintenance.
Fundamental Qualitative Characteristics 2. Faithful Representation
- Financial reports represent economic phenomena in
words and numbers. To be useful, financial information
must not only represent relevant phenomena, but it
must also faithfully represent the phenomena that it
purports to represent.
1. Relevance
- Information in financial statements is relevant when it
is capable of making a difference in the decisions made
by the users.
Ingredients of relevance:
•
o Predictive Value – Information can help
users increase the likelihood of
correctly predicting or forecasting the
outcome of certain events.
Ingredients of Faithful Representation
o Feedback Value – Information can help
• Complete
users confirm or correct earlier
o A complete depiction includes all
expectations.
information necessary for a user to
**Note that the predictive and confirmatory roles of
understand the phenomenon being
information are interrelated.
depicted, including all necessary
descriptions and explanations.
o Also known as Principle of
Full/Adequate Disclosure

Materiality
• Information is material if omitting, misstating
or obscuring it could reasonably be expected to
influence the economic decisions that primary
users make on the basis of those statements
which provide financial information about a
• Neutral
specific reporting entity.
o A neutral depiction is without bias in
• A practical rule when items are not Significant
the selection or presentation of
enough to affect the evaluation, decision and
financial information.
fairness
o A neutral depiction is NOT:
• is an entity-specific aspect of relevance based on
▪ slanted,
the nature or magnitude, or both, of the items
▪ weighted,
to which the information relates in the context
▪ emphasised,
of an individual entity’s financial report.
▪ de-emphasised or
• Also known as the “Doctrine of Convenience”
▪ otherwise manipulated
to increase the probability that
financial information will be
received favourably or
unfavourably by users
• Free from error
o means there are no errors or
omissions in the description of the
phenomenon
o the process used to produce the
reported information has been selected
and applied with no errors in the
process.
▪ Free from error does not mean
a perfectly accurately in all
aspect due to estimates.

SUPPLEMENTARY CONCEPTS of
FUNDAMENTAL CHARACTERISTICS
It is important to note that materiality, though
frequently associated and discussed with the previous
topics, is not referred to as an ingredient of relevance
under the Framework.
 o
3. Timeliness
o Having information available to
decision-makers in time to be capable
of influencing their decisions
o Quarterly or Interim Reports enhances
Timeliness to Financial Information
o The Older the Information the Less
Useful Except When assessing Trends
4. Understandability -
o Financial Information must be:
▪ Clear and Concise
▪ Presented & Expressed with
Enhancing Qualitative Characteristics terminologies intended users
Comparability, verifiability, timeliness and understand readily understands
ability are qualitative characteristics that enhance the Note: Users must have “Reasonable knowledge of
usefulness of information that is relevant and faithfully business & economic activities”, other wise seek
represented. guidance from Advisors
Cost constraint on useful financial reporting
Cost is a pervasive constraint on the information that
can be provided by financial reporting.
Reporting financial information imposes costs, and it is
important that those costs are justified by the benefits
of reporting that information.

1. Comparability is the qualitative characteristic

that enables users to identify and understand
similarities in, and differences among, items.
General Objective of Financial Statements
FINANCIAL STATEMENTS provide information about
economic resources of the reporting entity, claims
against the entity and changes in the economic
resources and claims.
The financial statements provide financial information
about an entity's assets, liabilities, equity, income and
expenses useful to users of financial statements in:
• Assessing future cash flows to the reporting
entity.
• Assessing management stewardship of the
2. Verifiability -
entity's economic resources.
o helps assure users that information
faithfully represents the economic
Types of Financial Statements
phenomena it purports to represent.
The Revised Conceptual Framework recognizes three
o Verifiability means that different
types of financial statements:
knowledgeable and independent
• Consolidated Financial Statements- These are
observers could reach consensus,
the financial statements prepares when the
although not necessarily complete
reporting entity comprises both the parent and
agreement, that a particular depiction is
its subsidiaries.
a faithful representation.
• Unconsolidated Financial Statements- These
are the financial statements prepared when the
reporting entity is the parent alone.
• Combined Financial Statements- These are
financial statements when the reporting entity
comprises two or more entities that are not
linked by a parent and subsidiary relationship.
Reporting Entity
A reporting entity is an entity that is required or
chooses to prepare financial statements.
The reporting entity can be a single entity or a portion
of an entity, or can comprise more than oone entity.
A reporting entity is not necessarily a legal entity.
Accordingly, the following can be considered a reporting INHERENT ASSUMPTIONS OF FINANCIAL STATEMENTS
entity:
• Individual corporation, partnership or Accounting Entity or Separate Entity Concept
proprietorship This assumption means that the entity is separate from
• The parent alone the owners, managers and employees who constitute
• The parent and its subsidiaries as single the entity. Personal transactions of owners shall not be
reporting entity allowed to distort the financial statements of the entity
• Two or more entities without parent and Q: What is a "Single Economic Entity"?
subsidiary relationship as a single reporting A: This is where a Parent and
entity. Subsidiary (PS) Relationship exists.
• A reportable business segment of an entity. •
o
Reporting Period ▪ PS Relationship consolidates
The reporting period is the period when financial there Financial Statements
statements are prepared for general purpose financial ▪ Consolidation, however, does
reporting. Financial statements may be prepared on an not eliminate the legal
interim basis, for example, three months, six months or boundary segregating the
nine months. affiliated entities
Interim financial statements are not required but ▪ Accounting will continue to be
optional. done separately for each entity
However, financial statements must be prepared on
an annual basis or a period of twelve months. Time Period
This assumption requires that the indefinite life of an
UNDERLYING ASSUMPTION (POSTULATES) entity is subdivided into accounting periods, usually of
Accounting assumptions are the basic notions or equal length or time period, for the purpose of
fundamental premises on which the accounting process preparing financial statements. The “one-year” period
is based. Accounting assumptions are also known is traditionally the accounting period.
as postulates. These serve as a foundation or bedrock The accounting period may be;
of accounting in order to avoid misunderstanding but •
rather enhance the understanding and usefulness of the o Calendar year - A twelve (12) – month
financial statements. period that ends on December 31
o Natural business year - A twelve (12) –
The Conceptual Framework for Financial Reporting month period that ends on any month
mentions ONLY ONE ASSUMPTION, that is GOING when the business at its lowest or slack
CONCERN. season
o Fiscal Year - A Twelve (12) - month
Going concern means financial statements presume period that starts from any other month
that an enterprise will continue in operation than January
indefinitely or if that presumption is not valid, disclosure o Interim Period - business period within
and a different basis of reporting are required. Its an accounting period. These are
foundation is the COST PRINCIPLE (assets are recorded financial reports prepared at any date
at COST). even if the 12 month period is not yet
NOTE: If there is evidence that the entity would due. ( weekly, monthly, quarterly or
experience large losses or subject for semi annual)
termination, GOING CONCERN IS ABANDONED.
Monetary Unit
The Accrual accounting, founding on the going concern This assumption pertains to (1) quantifiability of the
assumption, depicts the effects of transactions and peso and (2) stability of the peso. Quantifiability of the
other events and circumstances on a reporting entity’s peso means that the elements of the financial
economic resources and claims in the periods in which statements should be stated under one unit of measure
those effects occur, even if the resulting cash receipts which is the Philippine Peso. Stability of the
and payments occur in a different period. peso means that the purchasing power of the peso is
The illustration below shows changes in economic stable or constant and that instability is insignificant and
resources and claims as reflected by accrual basis and therefore ignored. Stability is also an amplification of
compared with cash basis of accounting: the going concern assumption, that adjustments are
unnecessary to account for nominal pesos only and not
for constant pesos
Elements of Financial Statements (FS)
Refers to the quantitative information reported in the
statement of financial position and income statement
“Building Blocks” from which FS are constructed
With the use of the Elements of FS financial effects can
be grouped into classes according to characteristics
NOTE:
Not all of an entity’s rights are assets of that entity—
To be assets of the entity, the rights must also have the
potential to produce for the entity economic benefits
•
o
▪ Future Economic Benefit - It
is probable that future
economic benefits will flow to
the entity
*Probable = Change is MORE LIKELY than less likely
ASSET - A resource controlled by the enterprise as a **Future economic benefit does not need to be certain
result of past events and from which future economic but only necessary that the right already exists even if
benefits are expected to flow to the enterprise. probability is low.
LIABILITY- A present obligation of the enterprise arising •
from past events, the settlement of which is expected o
to result in an outflow from the enterprise of resources ▪ Control
embodying economic benefits. There is control when;
EQUITY- The residual interest in the assets of the entity •
after deducting all of the liabilities. o Ability for DIRECT USE
INCOME- Increases in economic benefits during the o Ability to enforce LEGAL RIGHTS
accounting period in the form of inflows or o Future Economic Benefits will flow
enhancements of assets or decreases of liabilities that directly or indirectly to the entity
result in increases in equity, other than those relating to
contributions from equity participants. Liability Recognition Principle
EXPENSE- Decreases in economic benefits during the A liability is recognized in the statement of financial
accounting period in the form of outflows or depletions position when it is probable that an outflow of
of assets or incurrence of liabilities that result in resources embodying economic benefits will result from
decreases in equity, other than those relating to the settlement of a present obligation and the amount
distributions to equity participants. at which the settlement will take place can be measured
reliably.
RECOGNITION OF THE ELEMENTS of the FS Liability- A present obligation of the enterprise arising
The Reporting of an asset, liability, income or expense from past events, the settlement of which is expected
on the face of the financial statements of an entity to result in an outflow from the enterprise of resources
RECOGNITION PRINCIPLES embodying economic benefits.
Recognition is the process of incorporating in the Three (3) aspects on the Definition of Assets
financial statements an item that meets the definition • Present Obligation - a duty or responsibility
of an element and satisfies the following criteria for that an entity has no practical ability to avoid.
recognition: TYPES OF OBLIGATION
• It is probable that any future economic benefit •
associated with the item will flow to or from the o Legal Obligation
enterprise; and ▪ Obligations may be legally
• The item's cost or value can be measured with enforceable as a consequence
reliability. of a binding contract or
statutory requirements
Asset Recognition Principle o Constructive Obligation
An asset is recognized in the statement of financial ▪ Arise from normal business
position when it is probable that the future economic practice, custom and a desire to
benefits will flow to the enterprise and the asset has a maintain good business
cost or value that can be measured reliably. relations or act in an equitable
ASSET - A resource controlled by the enterprise as a manner
result of past events and from which future economic • Transfer an economic resource - Another term
benefits are expected to flow to the enterprise. for Settlement of Liability
Three (3) aspects on the Definition of Assets EXAMPLES OF WAYS TO SETTLE LIABILITY
• 1.
o 1. Payment of Cash
▪ Rights - 2. Transfer of Non-Cash Assets
3. Provision of Services
4. Replacement of the obligation with
another obligation
5. Conversion of Obligation to Equity

• Result of Past Event -

A present obligation exists as a result of past events o Upon Declaration
only if; • Installation Fees
o The entity has already obtained o Stage of Completion
economic benefits and • Subscription Revenue
o As a consequence, the entity will o Straight Line Basis over the Subscription
transfer economic resource Period
• Admission
Income Recognition Principle o When the Event Takes Place
Income is recognized in the when an increase in future • Tuition Fees
economic benefits related to an increase in an asset or a o The Period in Which Tuition is Provided
decrease of a liability has arisen that can be measured
reliably. This means, in effect, that recognition of Expense Recognition Principle
income occurs simultaneously with the recognition of Expenses are recognized when a decrease in future
increases in assets or decreases in liabilities economic benefits related to a decrease in an asset or
Income- Increases in economic benefits during the an increase of a liability has arisen that can be
accounting period in the form of inflows or measured reliably. This means, in effect, that
enhancements of assets or decreases of liabilities that recognition of expenses occurs simultaneously with the
result in increases in equity, other than those relating to recognition of an increase in liabilities or a decrease in
contributions from equity participants. assets.
Expense- Decreases in economic benefits during the
accounting period in the form of outflows or depletions
of assets or incurrence of liabilities that result in
decreases in equity, other than those relating to
distributions to equity participants.

POINT OF SALE
•
o Legal title to the goods passes to the Matching Principle
buyer “the risk & rewards” of • It requires that cost and expenses incurred in
ownership at point of sale earning a revenue shall be reported in the same
o It is usually the point of delivery. period
• There must be a Cost in earning a Revenue " NO
EXCEPTIONS to the POINT OF SALE PAIN,,, NO GAIN "
1. Installment Method
o Revenue is recognized at the point of Application of Matching Principle
collection Cause and Effect Association - Expense
o Revenue = Gross Profit Rate x is recognized when Revenue is
Collections Recognized
2. Cost Recovery Method Examples
o Revenue is recognized at the point of • Cost of Merchandise Inventory
collection • Doubtful Accounts
o Collections are applied first to cost of • Warranty Expense
merchandise sold • Sales Commission
3. Percentage of Completion Method
o Contract Revenue and Contract Cost Systematic and Rational Allocation
associated with construction contract - Expensed by Allocating over
shall be recognized as revenue and the PERIODS benefited
expenses, respectively Examples
4. Production Method • Depreciation
o Revenue is recognized at the point of • Amortization
productio • Allocation of Prepayments
o Applicable to Agricultural, forest and
mineral products Immediate Recognition - Cost Incurred
is Expense outright because;
Other Income Recognition 1. NO future economic
• Interest Revenue Benefit
o Revenue is Recognized on 2. Cease to qualify as an
a TIME Proportion basis that takes into asset
account the EFFECTIVE YIELD on the Examples
asset • Administrative & Selling
• Royalties Expenses
o Accrual = Based on AGREEMENT • Loss from Disposal of Asset
• Dividends
DERECOGNITION 2. Current Value -
The Revised Conceptual Framework introduced the • Also known as "Current Purchase Exchange
term derecognition Price"
Derecognition is defined as the removal of all or part of • Current Value includes
a recognized asset or liability from the statement of o Fair value (at measurement date)
financial position. o Value in use for asset- the present
• Derecognition of an asset normally occurs value of the cash flows that an entity
when the entity loses control of all or part of expects to derive from the use of an
the asset. asset and from the ultimate disposal.
• Derecognition of a liability occurs when the o Fulfillment value for liability- the
entity no longer has a present obligation for all present value of cash that an entity
or part of the liability. expects to transfer in paring or settling
a liability.
MEASUREMENT OF THE ELEMENTS of the FS o Current Cost- the cost of an equivalent
Measurement involves assigning monetary amounts at asset at the measurement dare
which the elements of the financial statements are to comprising the consideration that
be recognized and reported. would be received less any transaction
The Revised Conceptual Framework mentions two cost at measurement date.
categories, including: NOTE:
1. Historical Cost - Also known as“Past Purchase The Framework does not include concepts or principles
Exchange Price” & it is the Most Commonly Adopted for selecting which measurement basis should be used
• for particular elements of financial statements or in
o The Amount of: particular circumstances.
A) Cash or Cash Equivalent PAID or RECEIVED
The Conceptual Framework (Presentation & Disclosure
and Concepts of Capital)

Overview
The objective of general purpose financial statements is
*Transaction Cost to provide information about the financial position,
Costs that is directly attributable to the acquisition, financial performance, and cash flows of an entity that
issue or disposal of an asset or liability is useful to a wide range of users in making economic
Examples: Legal Fees, Finders Fee, *Transportation Cost decisions.
To meet that objective, financial statements provide
B) Fair Value (FV) of the consideration given to acquire information about an entity's:
the asset “at the time of acquisition” • Assets.
• Liabilities.
What is Fair Value? • Equity.
The price that would be received • Income and expenses, including gains and
• to sell an asset or losses.
• Transfer a liability • Other changes in equity.
in an orderly transaction between market participants • Cash flows.
at the measurement date. That information, along with other information in the
notes, assists users of financial statements in predicting
Hierarchy or best evidence of fair value the entity's future cash flows and, in particular, their
• Level 1 -INPUTS timing and certainty.
o Quoted Price in an active Components of Financial Statements
market for Identical Assets A complete set of financial statements comprises:
*Active Market – transactions take place with sufficient 1) A statement of financial position as at the end of the
regularity and volume period
• Level 2 -OBSERVABLE INPUTS 2) A statement of comprehensive income for the
o Quoted Price in an active period
market for Similar Assets or 3) A statement of changes in equity for the period
o Quoted Price in an inactive 4) A statement of cash flows for the period
market for Similar Assets or Identical 5) Notes, comprising a summary of significant
• Level 3 - UN-OBSERVABLE INPUTS accounting policies and other explanatory information
o Assets Developed by the entity 6) A statement of financial position as at the beginning
using BEST AVAILABLE of the earliest comparative period when an entity
INFORMATION from entity’s own data applies an accounting policy retrospectively or makes a
retrospective restatement of items in its financial
NOTE: statements, or when it reclassifies items in its financial
Historical Cost Does not change in statements.
value EXCEPT, Changes related to; Statement of Financial Position
• Impairment of assets Shows the financial condition of an entity of a particular
• Onerous Liabilities date
Current/Noncurrent Distinction Accumulated profits and losses that have not been
An entity must normally present a classified statement declared as dividends.
of financial position, separating current and noncurrent Classified into retained earnings that are prohibited
assets and liabilities. Only if a presentation based on from being declared as dividends due to legal and
liquidity provides information that is reliable and more contractual requirements or upon the decision of the
relevant may the current/noncurrent split be omitted. Board of Directors, “appropriated” and retained
earnings available as dividends to shareholders,
Current assets “unappropriated”.
1. Increases – Effect of changes in accounting policy and
An entity shall classify an asset as current when: correction of prior period errors, Net Income and Quasi
(a) It expects to realize the asset, or intends to sell or re-organization.
consume it, in its normal operating cycle 2. Decreases - Effect of changes in accounting policy
(b) It holds the asset primarily for the purpose of trading and correction of prior period errors, Dividends, Losses
(c) It expects to realize the asset within twelve months on share transactions like retirement and reissuance of
after the reporting period treasury shares, conversion of preference shares and
(d) The asset is cash or a cash equivalent (as defined in recapitalization of par value other than share splits.
IAS 7) unless the asset is restricted from being Forms of Statement of Financial Position
exchanged or used to settle a liability for at least twelve 1.Report Form -
months after the reporting period. This form set forth the three (3) major sections in
An entity shall classify all other assets as non-current. Downward sequence of Assets, Liabilities and Equity
SAMPLE
Normal Operating Cycle – The time between the
acquisition of assets for processing and their realization
cash or cash equivalents. When the entity’s normal
operating cycle is not clearly identifiable, its duration is
assumed to be twelve months.

Current liabilities
An entity shall classify a liability as current when:
(a) It expects to settle the liability in its normal
operating cycle
(b) It holds the liability primarily for the purpose of
trading
(c) The liability is due to be settled within twelve 2.Account Form
months after the reporting period Assets are shown in the Left side and the liabilities and
(d) The entity does not have an unconditional right to equity on the Right
defer settlement of the liability for at least twelve SAMPLE
months after the reporting period
An entity shall classify all other liabilities as non-
current.

SHAREHOLDERS’ EQUITY

I. CONTRIBUTED (PAID-IN / INVESTED CAPITAL)

CAPITAL
Represent the amount invested or contributed by
owners.
This is divided into: NOTE: In the Philippines, the common practice is to
1. Capital Share – the contributions equal to the par or present current assets/liabilities before non-current
stated value of the share purchased by owners; or the assets/liabilities
total contribution by owners in case of no-par share. Income Statement / Statement of Comprehensive
2. Share Premium – contribution in excess of the par or Income
stated value, gains from share transactions and “other” An entity shall present all items of income and expense
equity items that are not included in earnings or other recognized in a period:
comprehensive income. (a) In a single statement of comprehensive income, or
(b) In two statements: a statement displaying
II. RETAINED EARNINGS components of profit or loss (separate income
statement) and a second statement beginning with
profit or loss and displaying components of other concern basis, in which case PAS 1 requires a series of
comprehensive income (statement of comprehensive disclosures.
income). Accrual Basis of Accounting
PAS 1 requires that an entity prepare its financial
Components of Comprehensive Income statements, except for cash flow information, using the
1. Profit and Loss - Income minus Expenses including accrual basis of accounting.
Tax expense and any Income or Loss from Discontinued Consistency of Presentation
Operations. The presentation and classification of items in the
2. Other Comprehensive income – –Items of income financial statements shall be retained from one period
and expenses including reclassification adjustments (RA) to the next unless a change is justified either by a
that are not included in Profit and Loss as required by a change in circumstances or a requirement of a new
standard or interpretation. There are two types of OCI PFRS.
items, those that are reclassified to profit or loss (RA) Materiality and Aggregation
and those that are reclassified to Retained Earnings Each material class of similar items must be presented
(RE). OCI includes the following; separately in the financial statements. Dissimilar items
• Unrealized gain or loss on equity investments may be aggregated only if they are individually
measured at FVOCI (RE) immaterial.
• Unrealized gain or loss on debt investments Offsetting
measured at FVOCI (RA) Assets and liabilities, and income and expenses, may
• Unrealized gain or loss from derivative contracts not be offset unless required or permitted by a
designated as cash flow hedge (RA) Standard or an Interpretation.
• Revaluation Surplus (RE)
• Remeasurement Gains and losses for defined Comparative Information
benefit plans (RE) PAS 1 requires that comparative information shall be
• Change in fair value arising from credit risk for disclosed in respect of the previous period for all
financial liabilities measured at FVPL (RE) amounts reported in the financial statements, both face
• Translation gains and losses of foreign of financial statements and notes, unless another
operations Standard requires otherwise. If comparative amounts
are changed or reclassified, various disclosures are
An entity shall present either an analysis of expenses required.
using a classification based on either;
• the nature of expenses or Concepts of Capital & Capital Maintenance
• their function within the entity, Concepts of Capital
whichever provides informationthat is reliable and more Financial concept of capital - capital is synonymous
relevant. with net assets of the enterprise. This is the concept of
Nature of expense method – Expenses are aggregated capital adopted by most enterprises. A financial concept
in the income statement of capital, e.g. invested money or invested purchasing
according to their nature and are not reallocated among power, means capital is the net assets or equity of the
various functions within the entity.
entity.
SAMPLE Physical concept of capital – capital is regarded as
the productive capacity of the enterprise based on, for
example, units of output per day.
Concepts of Capital Maintenance

Financial capital maintenance – Under this concept, a

profit is earned only if the financial (or money) amount
Function of expense or cost of sales method – Classifies of the net assets at the end of the of the period exceeds
expenses according to their the financial (or money) amount of the net assets at the
function as part of cost of sales or, for example, the cost beginning of the period, after excluding any
of distribution or administrative distributions to, and contributions from, owners during
activities. the period.
SAMPLE NET ASSET END > NET ASSET BEGINNING = PROFIT
Physical capital maintenance – Under this concept, a
profit is earned only if the physical productive capacity
(or operating capability) of the enterprise (or the
resources need to achieve that capacity) at the end of
the period exceeds the physical productive capacity at
the beginning of the period, after excluding any
distributions to, and contributions from, owners during
Presentation and Disclosure the period.
Going Concern
An entity preparing PFRS financial statements is
presumed to be a going concern.
If management has significant concerns about the
entity's ability to continue as a going concern, the
uncertainties must be disclosed. If management
concludes that the entity is not a going concern, the
financial statements should not be prepared on a going
 business in order not to impair the independence of
Nature and Definition of a Partnership CPA’s
3. Mutual Agency
Basic Considerations A Partnership is formed based on the “Trust and
What are the common classification of business Confidence” of the individuals to each othe
organizations? Trust and confidence is the "CORD" that binds the
partnership
A Partnership is VOLUNTARY FORMED by each partner,
and has the RIGHT TO CHOOSE the people with whom
he/she would like to associate
Every partner is assume an agent of the partnership
meaning, any partner can legally bind all the partners by
an action that is part of the usual conduct of the
Definition of Partnership partnership business
By the contract of partnership, TWO or MORE persons
bind themselves to CONTRIBUTE money, property or 3. Ease of Formation
industry, to a COMMON FUND with the intention of Partnership is perfected by the mere CONSENT of the
DIVIDING the PROFITS among themselves parties
Formation can be;
Requisites of Partnership Informal – Hand Shake or Oral Agreement
According to the New Civil Code of the Philippines, the Formal – Articles of Co-Partnership
Essential Elements of the formation of partnership are Partners does not need SEC or BIR Permission, UNLESS ;
the following; the partnership’s capitalization is P3,000 or more
investment that involves real property
Voluntary & Valid AGREEMENT between partiesLAWFUL Partners are still strongly advised to have a formal
purposes for which partnership is agreement to avoid potential problems that arise during
organizedCONTRIBUTIONS: Money, property and/or the operation of the business
IndustryObjective to earn PROFIT that is to DIVIDED
among the partnersMUTUAL AGENCY among 4. Co-ownership of Partnership Property
partnersPractice of TRANSPARENCY on the records & Assets invest by any of the partners become the
transactions. property of the partners because they co-own the
partnership
Major Characteristics of a Partnership The Partner Investing an asset no longer retains
Based on the Definition and Essential Elements of personal right to it.
Partnership, the following characteristics where derived If the partnership is terminated, the individual partners
therein; may not receive back the same assets the invested,
EXCEPT there is an agreement
1. Based on Contract
The relation of partners arises from contract NOT 5. Income Participation
Statute or Operation of LAW or InheritanceThe Partnerships business objective is carried on sharing the
agreement of partnership - whether in oral from or in Profit or Loss (P/L) among the partners
writing - becomes a contract that is binding to all Sharing of profit is arrived by mutual consent and is
partners. specified in the articles of the partnership
What is written inside a Partnership Contract? If no agreement, partners will share P/L base on
CAPITAL CONTRIBUTION
Below are itemized details inside a partnership but not
limited to the following; 6. Assignment of Partner's Interest
Names of partners A partner can assign his interest to an Assignee partner
Name and Nature or Business can be assignor
Location of the Business The Assignee has no right to Participate in MANAGING
Start Date of the Partnership the AFFAIRS of the business
Contribution/Description of each partner The Assignee’s rights are limited to receiving the share
Amount of Investment or Can Withdraw for each of P/L or proceeds in case the partnership is dissolved
partner
Profit and Loss Sharing 7. Unlimited Liability
Stipulation for the termination of Agreement Under the "Separate Entity Concept" of accounting
Business is viewed as existing separately from owners,
2. Association of Individuals HOWEVER, Partners are NOT considered separate from
In order to constitute a partnership, it is necessary that the partnership when involves to 3rd party creditors
there are at least two persons, having reciprocal and Each partner whether general or industrial is at risk of
obligations towards each other his/her personal assets for partnership debts in the
The Law provides the minimum of TWO but it did not event the partnership becomes INSOLVENT
specify the maximum number of persons Limited partners risk only for their investment Provided
In Business however, it is considered sound practice to they do not perform any task of a general partner
organize a corporation when there are five or more
persons desiring to form a business 8. Limited Life
HOWEVER, This is not applicable when a business is a A partnership is automatically DISSOLVED when there is
professional partnership of CPA’s to form a corporate a Change in Relationship within the partners such as;
–Admission of New Partner
–Withdrawal of a Partner
–Death of a Partner
–Personal Bankruptcy
–Incapacitated of a partner

Advantages & Disadvantages

The characteristics of a Partnership as a business
organization offers several advantages and
disadvantages as shown below:

Difference from other Business Organizations

It is important for entities that has entrepreneurial Partnership Classifications and Kind of Partners
plans to choose which business organization is more
applicable to their purposes and economic business- Kinds of Partnerships
setting, below are some attributes to be compared to As to NATURE of Business
other business organization; Trading Partnership - Also known as "Business co-
Sole Proprietorship VS Partnership partnership"
Buying & Selling of Finished Merchandise or
Manufacturing of Goods
Non-Trading Partnership
Renders Services Only for a Fee

As to PURPOSE
Commercial Partnership
Engages in trading, merchandising, or manufacturing of
goods for a profitService Industry may be classified as
commercial IF it is not engaged in the Practice of a
common Profession
General Professional Partnership (GPP)
Engaged in the exercise of a COMMON profession and
renders services based on their profession. (Ex. CPA's,
Corporation VS Partnership Doctors & Lawyers)NOTE: A group of professionals can
be in a commercial partnership if it not related to their
Professional Practice

As to OBJECT
Universal Partnership
of all present PROPERTIES
ALL present property is contributed into a common
fund.All profit will be divided among themselves.
of Profits
Partners RETAIN OWNERSHIP placed into the common
fund. Only profits from their industry will be distributed.
Particular Partnership
Partnership which has a specific undertaking or
exercises of a profession or vocation
Co-Ownership VS Partnership
As to LIABILITY
General Partnership
Comprised of a General or a combination of General +
Industrial PartnersPersonally Liable for the partnership's
debts after the exhaustion of its assets
Limited Partnership
Comprised of Limited + General PartnersOnly Limited
partner shall be liable to the extend of his contributions
to the partnershipAt Least 1 General Partner to protect
the 3rd party liabilities

As to DURATION
Partnership at will
May be terminated any time at willNo fixed period of
existence
Partnership with a Fixed Term
Formed with a specific period of existencePeriod could advisable to put it writing as conflicts and disagreement
be a time, target profit or event. may arise because of the number of persons involved.

As to Legality of EXISTENCE The "Articles of Co-Partnership" is a written contract

De jure partnership made by the partners that will act as a form of
Established & organized in accordance with all the governance of partnership activities and will clearly
LEGAL requirements reflect the relationships of the partners among each
De facto partnership other and with third parties.
Established & organized without complying with the
legal requirement It is need to appear in a PUBLIC INSTRUMENT and to
registered with the SEC if partners contributed REAL
PROPERTY (land or building) or REAL RIGHTS or if the
Kinds of Partners total partnership capital amounted to P3,000 or more.
As to CONTRIBUTION
Capitalist Partner - Contributes money and/or property If a partnership fails to register with the SEC, it cannot
to the Partnership acquire legal personality to maintain an action against
Industrial Partner - Contributes only his skills, third persons, but the partners may file a suit jointly
knowledge; industry or personal service to the against third party persons.
partnership
Capitalist-Industrial Partnership - Contributes money, Failure to comply with the registration requirement
property and industry does not affect the liability of the partnership and its
partners to the third party persons.
As to LIABILITY
General Partner - Assumes unlimited liability (liable for The partnership agreement commonly contains the
partnership debt up to his personal assets) following information:
Limited Partner - Liable only up to his Capital • Name of the partnership
Contribution • Names and address of the partners
• Kinds of partners
As to PARTICIPATION • Principal place and purpose of business
Managing Partner - Appointed to run the business • Manner of Management of the Partnership
(Appointment may be either in the Articles or after the • Duration of the contract (date of effectiveness
formation of partnership) and life of the partnership)
Silent Partner - Known as partner but NOT ACTIVE in • Contributions of the partners
business Operations (can be a limited partner) • Duties and rights of each partner
Liquidating Partner - Appointed to liquidate • Conditions for withdrawals
partnership assets and settle unfinished transactions of
• Salary and the profit and loss agreement
the partnership after dissolution
• Dissolution and Liquidation Procedures
• Arbitration of disputes
As to Third Persons
Secret Partner - NOT KNOWN as partner but takes
Partnership Formation
ACTIVE in business operations
This refers to the PERFECTION of the partnership
Dormant Partner - NOT KNOWN & INACTIVE in business
contract by the partners. When a partnership is formed,
operations
partners commonly observe the following to effect fair
Nominal / Ostensible Partner - Partner in name only
and honest business:
for accommodation or consideration
Execution of partners' agreement (See Articles of Co-
Partnership)
Rights of a Partner
Valuation of partners' investment
A Partner has a right over;
Adjustments of accounts
1. Specific partnership property
2. Share in the Profits resulting from business
operation
Valuation of Partners' investment
3. Share in the remaining assets upon partnership
The accounting issues regarding initial investments and
liquidation after the partnership creditors have
other capital contribution are;
been paid
4. To co-manage the partnership
How much the contribution to be made by the
5. To ask that the books be kept in the principal
partners? and
place of business subject to inspection at a
What amount the capital contribution shall be
reasonable time
recognized?
The answers to the issues above depend on the
following:
Is there an agreement? and
what was contributed? Cash or Non cash?
The following rules shall then be observed when capital
Articles of Co-Partnership
contribution issues arise:
An agreement concerning formation, operation
dissolution and liquidation of the partnership is
1st Rule:
embodied in a contract called "Articles of Co-
The amount of contribution shall based on partner's
Partnership". Although a verbal agreement is valid, it is
agreement, in absence of agreement contribute equally
 The DIFFERENCE, however, lies in the owner's equity
accounts.

Partners' Equity
The rights of the partners over the net assets of the
business is called Partners' Equity.
Each partner's equity is represented by two (2)
accounts:
1. Partner's Capital
2. Partner's Drawing
Illustration for the 1st Rule: (YES) - With Agreement on
Individual Contribution
Partner's Capital Account
The capital account represent original investment which
Alpha and Bravo formed a partnership with a TOTAL
becomes its permanent or fixed interest. Each partner
AGREED CAPITAL of Php 150,000 to be contributed as
has his own capital account which has a normal credit
cash of 40% and 60% by Alpha and Bravo, respectively,
balance. The balance in the capital account represents
through a issuance of personal checks. (below is the
the partner's share in the net asset of the partnership.
journal entry for the formation)
The partner's capital account gives information on the
increase or decrease in his interest in the partnership.
Specifically, the transactions affecting the partner's
capital account are summarized as follows:

Notes:
The journal entries of their respective investments are a
single journal entry because of two (2) separate source
documents (individual checks).
As per previous notes, each partner will have a separate
capital account
Illustration for the 1st Rule: (NO) - Without Agreement
on Individual Contribution Investment - contribution made are credited to each
partner's capital account to increase the partner's
Alpha and Bravo formed a partnership with a TOTAL equity
AGREED CAPITAL of Php 150,000 to be contributed as Permanent Withdrawal- represents partner's decrease
cash. (below is the journal entry of the formation) in its interest into the partnership which is debited to its
capital account.
Income Summary Account - this is the accounting
device used to close the temporary accounts in its
capital account for the period ended:
Net Debit Balance = Loss,
Net Credit Balance = Income,
2nd Rule:
The valuation of partners' non-cash investment is based Notes:
on the partner's AGREED VALUE, in the absence of any A debit balance in the partner's capital account is called
agreement, use FAIR VALUE of the property on the a deficiency or partner's deficit.
investment date. Deficit - partner's share in losses and/or withdrawals
exceeds (>) his capital contribution and share of profits
If cash contribution is made, it is valued at FACE
AMOUNT Partner's Drawing Account
This is the account title used to reflect temporary
decrease in the interest of a partner and is periodically
closed to the partner's capital account.

Each partner has his own drawing account to reflect

temporary withdrawals and other minor amounts taken
by the partner from the partnership in anticipation of
his profit share.

The transactions affecting the partner's drawing

Partnership Accounting account are as follows:
Accounting for Partnership
In general, the accounting principles, process and
procedures used in recording partnership transactions
are the SAME as Sole Proprietorship & Corporations
 When the agreed partner’s capital shares are credited
with the same value as their actual net contributed
Assets. Our previous illustrations from 8.1 are all
examples of the Actual Investment Method.

TOTAL CONTRIBUTED CAPITAL (TCC) = TOTAL AGREED

CAPITAL (TAC) & Partner's CONTRIBUTED CAPITAL =
Partner's AGREED CAPITAL

2. Bonus Method
When the agreed partner’s capital shares is not the
same value as their actual net contributed Assets
Share in P/L - The agreement as to the manner of
distribution provided in the Articles of Co-Partnership TOTAL CONTRIBUTED CAPITAL (TCC) = TOTAL AGREED
Profit - Credited to Drawing Account CAPITAL (TAC) & Partner's CONTRIBUTED CAPITAL ≠≠
Loss - Debited to Drawing Account Partner's AGREED CAPITAL
Personal Drawings
Often Called salaries, but are in fact withdrawals from There is a bonus to a partner when his capital credit is
profit more than hid actual contributed capital and the total
Informal or irregular withdrawals may also be made net assets contributed by partners are equal to toal
when the needs of partners arises (with the consent of capital of the partnership.
all partners)
The ending balance of the drawing account is closed to Illustration
the capital account: Kappa, a sole proprietor, allows Gamma, decided to
Profit > Withdrawals = Increase in Capital Account pool their net assets to form a partnership, provided
Profit < Withdrawals = Decrease in Capital Account that the latter would contribute cash amounting to
P70,000. Kappa's contributions comprised of the
Other Partnership Accounts (Loans) following:
Loans Receivable from Partners
Also called “loans to partner” or “due from partner” or P 10,000 Cash
“loans receivable from partners” or (Utang o Bale ng P 30,000 Accounts Receivable
Kasosyo) P 20,000 Merchandise
Represent ADVANCES of the Partners with the intention P 8,000 Accounts Payable to be assumed by the
of repayment partnership
Generally presented and classified as part of the They agreed that their initial capital balances would be
CURRENT ASSETS except when collection period is of equal amount upon formation of the partnership.
beyond one-year. (Non-current Asset)
Do not be confused between loans and withdrawals, Assume that Kappa & Gamma agreed that the
because the intention of the loan is a "creditor-debtor partnership capital would be P122,000.
relationship", wherein the Partner = Debtor; Partnership
= Creditor To record the investments of the partners using the
bonus approach, the following journal entries shall be
Loans Payable to Partners made:
Also called “loans from partner” or “due to partner” or
(Utang ng Partnership sa Kasosyo)
Represent SUBSTANTIAL amount LENT by the partners
to the Partnership
Generally presented and classified as part of the
CURRENT LIABILITIES except when payment or due date
is beyond 1 year
"creditor-debtor relationship", wherein the Partnership
= Debtor; Partners = Creditor

Loans to and from Partners

This account title is the COMBINATION of loans
receivable from partner and loans payable to partner
accounts
Represents both a claim and obligation (asset and *To equalize the capital credits of partners
liability, respectively), (P122,000/2), P9,000 has to be transferred from
If ending balance is found at; Gamma's capital as bonus to Kappa
Debit Side - Claims
Credit Side - Obligation/Liability

IMPORTANT NOTE: It is emphasized at this point that

"Loans to and from Partners" are either ASSET or
LIABILITY, and therefor shall not be considered in
determining the balances of partner's equity
Methods for Accounting the Initial Contribution Stages from which Partnership are Formed
1. Actual Investment Method
The complexity of accounting for partnership formation
depends on the stage from which a partnership is
formed. The stages would be:
• First time in business
• Conversion of a single proprietorship to a
partnership
• Admission of a new partner to an existing
partnership ( to be discussed in Module 4 ) Conversion of proprietorship to a partnership
This could be made when:
First time in business
The stage wherein individual persons without an A sole proprietor admits into his business another
existing business, decided to form a partnership. The individual who has no business of his own
formation of such partnership is accounted by recording Two or more sole proprietorship joined together and
the individual contribution and the valuation of the formed a partnership.
contributions of each partner. The conversion of sole proprietorship(s) to partnership
is accounted for by the following procedures:
The rules on the amount of contribution and its
valuation shall be used (see previous tab), therefor, no Close the nominal accounts (temporary accounts) of the
accounts are to be adjusted at the time of formation. sole proprietorship business
Record the adjustments (based on the agreed or fair
value) of the assets and liabilities directly to the sole
proprietor's capital account
Illustration Close the books of the sole proprietorship
Charlie, Delta and Epsilon formed CDE partnership with Open the new set of partnership books by recording the
an agreed total capitalization of Php 300,000, which partner's contributions.
shall be contributed equally by Charlie & Delta. Note: The books of the sole proprietor are not
applicable for use by the newly formed partnership
Meanwhile Epsilon was to manage the operations of the
partnership business as an industrial partner with a Why??
share of 20% from the profits.
A partnership is a legal entity (artificial person)
Charlie & Delta's contribution is as follows: SEPARATE & DISTINCT from its owners . As a
consequence, a partnership should maintain its own
books of account under its registered name as provided
by law.

As per Section 236A to 236J of the National Internal

Revenue Code (NIRC), every person subject to any
internal revenue tax is required to register once with
the appropriate Revenue District Officer (RDO).
To record the contributions, the journal entries would
be It shall therefor acquire its own Tax Identification
Number (TIN) separately from the TIN of the partners.

Illustration:

Omega is the owner of an existing single proprietorship.

Notes:
Omega, together with Rho and Tau, decides to convert
The fair value or FMV or Appraised Value was used for
his single proprietorship into a partnership.
the valuation of the non-cash contribution because this
They agree to start the partnership with total
supports the Cost Principle stated in IAS 16
capitalization of Php 150,000 to be contributed equally
Liabilities attached to invested properties may be
by the partners.
assumed by the partnership in which case the capital
Rho and Tau are to contribute cash.
partner will be credited only for the net amount of the
Omega shall also contribute additional cash if the net
assets contribution. (Asset - Liability)
assets of his business after the agreed valuation will not
be enough to cover his contribution requirement.
Q: What if there is no agreement for the partnership to
Omega's single proprietorship trial balance shows the
assume the liability attached to the property?
following:
A: The Liability will not be recorded, therefor, there will
be no effect on the interest of the investing partner and
the asset is will still recorded at FMV.

For the recording of the contribution of Epsilon

(industrial partner), the memorandum entry in the
general ledger would be as follows:
 Notes:
Adjustments are made directly to capital account and
Step 1: Closing the Nominal Accounts NOT the nominal accounts because the business is now
Prior to the formation, the sole proprietorship's nominal in its liquidating concern.
accounts should first be closed to effect the correct Adjustments are made before the partnership
balance on his capital. The nominal accounts of A should formation to comply the principles of fairness &
then be closed as follows: objectivity. Any increase or decrease in the value of the
assets should accrue to the benefit or expense of the
sole owner and not the partnership
The adjusting entries must be posted to show the
updated balance of the capital account of the sole.

The post-closing trial balance of A's single

proprietorship is presented below:
Step 3: Close the Proprietor's Accounts
Since the single proprietorship is dissolved, it follows
that the books should be closed, or all the accounts
(nominal or real) are to be brought to ZERO BALANCE.

The closing of the sole proprietorship's books will

require the following journal entry:

Step 2: Record the Adjustment

Adjustments are necessary to effect the proper value of

assets and liabilities in accordance with the valuation
agreement or FMV Step 4: Recording the Partners' Contribution
The initial investments of the partners will be recorded
The following valuation adjustments were agreed upon in the new set of partnership's books as follows:
based on the post-closing balances:
a) Accounts Receivable is 98% realizable Contribution of Omega
b) Merchandise inventory is to be valued at Php 9,000|
c) Interest of Php 600 on note payable should be
recognized

To record the agreed adjustments would require the

following entry in the Omega's books:
Contribution of Rho & Tau

2 or more Sole Proprietorship Form a Partnership

The new accounting standards mention only one
instance when goodwill would be recognized, that is , in
a BUSINESS COMBINATION, applying the purchase
method.

The forming of two (2) single proprietorship into a

partnership will NOT be considered as a business
combination. Instead, this could be considered more as
putting together of resources of two or more existing
business into a common fund, which is more of
POOLING OF INTEREST rather than purchase.

The accounting procedures & steps in converting 2 or

more existing sole proprietorship into a partnership are
the SAME as when a single proprietorship is converted
into a partnership.

However, there are more books that needs to be

adjusted and closed before the formation.
SHARING OF PARTNERSHIP PROFITS AND LOSSES 2. Loss sharing based on Capital Contribution
The primary objective of the accounting for partnership In the ABSENCE of a Profit-sharing agreement, losses
operations is the determination of periodic net income shall be divided among the partners in proportion to
and its distribution to the partners. their respective capital contributions
The determination of net income is calculated in a
traditional manner-that is, by relating the partnership's 3. Loss Sharing for a "pure" Industrial Partner (no
periodic revenues and expenses capital contribution)

In measuring partnership income for the period, the 3.1. if there is no agreed loss or profit sharing ratio,
expenses should be scrutinized to make sure that The industrial partner is totally EXEMPT from sharing
personal expenses are not included among the the losses. The Purely industrial partner is exempt
partnership's expenses because he already rendered his service in vain

Rules of Profit and Loss Sharing 3.2 if there is a profit and loss agreement wherein he is
Article 1799 of the New Civil Code provides that any included in the P/L sharing.
STIPULATION that EXCLUDES one or more partners from The industrial partner is bound to respect the contract
any share in the profits or losses is VOID. The reason for between the co-partners. He shall therefor share in the
this is that partnership must exist for the common loss equivalent to his agreed loss ratio even if he is an
benefit and interest of the partners. industrial partner.

Article 1797 of the New Civil Code provides the 3.3 if there is only a profit agreement
following guidelines on how partnership profits and The industrial is not bound in the share of the
losses shall be distributed among the partners: partnership losses because he did not give consent to
have his share in partnership losses.
Rules on Profit Sharing
1. Profit sharing based on partner's agreement 4. Loss sharing for industrial-capitalist partner
Profits of the partnership shall be divided among the If there is no loss sharing agreement but there is profit
partners in accordance with their profit-sharing ratio sharing agreement, he shall be liable in the same
agreement proportion as his profit sharing ratio.

Note: The capital contributions of the partners have no An industrial partner is no longer exempt from loss
bearing in the profit distribution because their profit sharing once he become a capitalist partner
ratio agreement should be followed.
Arbitrary Agreement in Computing Profits and Losses
2. Profit sharing based on Capital Contribution Partners may share the partnership profits and losses in
In the ABSENCE of a Profit-sharing agreement, profits any manner they wish. The profit and losses agreement
shall be divided among the partners in proportion to should contain specific and complete provisions to
their respective capital contributions avoid misunderstanding and disputes among the
partners
3. Profit sharing Based on Capital Contribution and on
Service The agreement on partnership's profit and losses may
3.1. If there is a industrial partner: be divided into one of the following ways:
The industrial partner first gets a just and equitable 1. Equally
share for his services (industry), before the capitalist 2. Specified ratio or percentage
partners divide the balance of the profits in proportion 3. Capital Ratio
to their capital contributions or P/L Agreement 4. Interest allowed on partner's capital, the
remainder to be divided in an agreed ratio
3.2 If there is no specified profit sharing for an 5. Salaries or Bonus allowed for services, the
industrial partner remainder to be divided in an agreed ratio
If there is no specified profit sharing for an industrial 6. Multiple bases of allocation
partner, he shall receive a share equal to the share of
the CAPITALIST PARTNER having the SMALLEST share To Illustrate the methods:
Assume Eva and Ren formed "EVAREN" partnership
3.3 If there is a partner which is both a Capital and with original capital contributions of P60,000 and
Industrial partner P30,000 respectively. In the second year of the
The partner gets just and equitable share as an partnership operations, the capital and drawing
industrial partner and another share as a capitalist balances of partner's Eva and Ren are trance fro the
partner according to agreement or his capital general ledger as follows:
contributions.

Rules on Losses Sharing

1. Loss sharing based on partner's agreement
1.1 Loss of the partnership shall be divided among the
partners in accordance with their Loss-sharing ratio
agreement
1.2 In the absence of a Loss-Sharing ratio, the profit- During the year, the partnership generated an income
sharing ratio shall be used. of P 200,000.
Note: Unless otherwise stated, the data above shall be 3.1 Original Capital Contribution
used as the basis for illustrations in the succeeding To distribute the P200,000 net income the following
discussions computation should be made

1. Equally Total Original Capital = P60,000 + P 30,000 = P 90,000

The partners may mutually agree that the partnership (6:3)
profit shall be equally divided between them. In case of
losses, and in the absence of a specific agreement Ren = (P200,000 x 6/9) = P133,333.33
regarding division of losses, the existing equal division Eva = (P200,000 x 3/9) = P 66,666.67
of profit agreement is to be followed by the partners
3.2 Beginning Capital Balance of the Accounting Year
If Eva and Ren Agreed to divide the partnership equally,
the distribution of P200,000 profit would be: The opening partners' capital balances of the current
year shall be the basis
Eva = P100,000
Ren = P100,000 Total Beginning Capital Balances = P 60,000 + P 50,000 =
P 110,000 (6:5)
It is to be observed that Eva and Ren shared on the
partnership profit equally regardless of the unequal Ren = (P200,000 x 6/11) = P 109, 091
balances of their capital contributions. Eva = (P200,000 x 5/11) = P 90,909

2. Specified Ratio or Percentage

Whenever the presence of one of the partners is 3.3 Ending Capital Balance of the Accounting Year
perceived more vital to the success of the business due All capital transaction affecting the capital accounts
to experience, ability and reputation the partnership shall be considered to get the ending balances of the
may stipulate an unequal sharing expressed in agreed partners
ratio or percentage, otherwise known called arbitrary
ratio. The ending capital balances of each partner is should
first to determine:
In specified ratio, the difference in the partner's capital
balances has NO BEARING in the P/L sharing. The Ren = (P60,000 + P40,000+ P110,000 - P60,000) = P
agreed profit and loss ratio may be based on the 150,000 (15/25)
partners' better capability or influenceover the other Eva = (P50,000 + P30,000 + P80,000 - P 60,000) = P
100,000 (10/25)
To illustrate assume that Eva is perceived more vital Total Ending Capital Balances
than Ren for the success of the partnership business, so P250,000 (25/25)
much that they agreed to share in the P/L of 60% and
40%, respectively. Ren = (P200,000 x 15/25) = P 120,000
Eva = (P200,000 x 10/25) = P 80,000
Ren = (P200,000 x 40%) = P 80,000
Eva = (P 200,000 x 60%) = P 120,000 3.4 Average Capital Balances of the Accounting Year
When partners agreed to divide profits to recognize
3. Relative Capital Balances CAPITAL CHANGES during the current period, the use of
When money or properties invested by the partners partners' average capital balances shall be employed.
represent the vital contribution to the success of the This method also encourages partners' to contribute
partnership business, partners may agree that their during the year additional investments to the
respective capital balances shall be the basis of the P/L partnership
Sharing.
3.4.1 Simple Average Capital Method
This manner of dividing P/L is different from a arbitrary This method is computed by simply dividing the sum of
ratio P/L Sharing, since there is NO P/L sharing the beginning and ending capital by 2.
agreement at all. This is so for the allocation of P/L
distribution is NOT FIXED due to fluctuation of the The simple average capital balances of EVEREN
capital balances of the partners partnership are computed as follows:

However, there is an accounting issue to be addressed Ren = (P60,000 +P 150,000) / 2 = P 105,000 (105/180)
by the partnership on what amount of the partner's Eva = (P50,000 + P 100,000) / 2 = P 75,000 ( 75/180) _
capital shall be considered in the computation of P/L Totals P180,000
distribution. For this reason, the agreement should
indicate specifically whether the ratio is to be defined in Ren = (P200,000 x 105/180) = P116,666.67
terms of: Eva = (P200,000 x 75/180) = P 33,333.33
3.4.2 Weighted Average Capital Method
Original Capital Contribution
Beginning Capital Balance of the Accounting Year This method is also known as "peso-month" or "peso-
Ending Capital Balance of the Accounting Year day" average capital method. Under this method, the
Average Capital Balance of the Year computation of the average capital considers the period
in which capital contributions have been used in a given
accounting period.
The weighted average capital base on peso months is 5.2 Bonus
computed as follows: A partnership agreement nay provide that a managing
partner be allowed a bonus on the earnings of the
business to encourage PROFIT MAXIMIZATION. The
bonus may computed as follows:

BONUS = Bonus rate % x Base net Income

FINANCIAL REPORTS OF PARTNERSHIPS

Financial statements are a structured representation
with the objective of providing information about the
financial position, financial performance and cash flows
of an entity that is useful to a wide range of users in
making economic decisions. Financial statements also
Ren = (P200,000 x 875/1400) = P125,000 show the results of the management's stewardship of
Eva = (P200,000 x 525/1400) = P 75,000 the resources entrusted to it.
Notes:
1. The weighted average capital method should be Overall Considerations
assumed in the absences of evidence to the contrary. In the same way the financial statements of a sole
Average capital means weighted average unless another proprietorship is prepared, the below are also
interpretation of average capital is specified in the considered:
agreement 1. Fair Presentation and Compliance with International
2. The average method is the best alternative compared Financial Reporting Standards
to beginning and ending capital methods, because it 2. Going Concern Assumption
provides the most equitable basis for allocating 3. Accrual Basis of Accounting
partnership income. 4. Materiality and Aggregation
5. Offsetting
4. Allowance of Interest on Partner's Capitals 6. Frequency of Reporting and Comparative Information
This agreement provides that the cost of money on the 7. Consistency of Presentation
capital contributions ff partners will be added as a profit 8. Identification of the Financial Statements.
sharing device in addition to the P/L ratio agreement
Complete Set of Financial Statements
It is based on the philosophy that if the capital A complete set of financial statements for a partnership
contributions have been invested in other earning business comprise of the following:
activities such as trading securities the partner should 1. Statement of Financial Position
have realized additional revenue. 2. Statement of Comprehensive Income
3. Statement of Changes in Partner's Equity (Showing
The allowance for interest may be computed on the the total amounts attributable to partIncom
following bases: 4. Statement of Cash Flows
4.1 Interest on Capital Balances 5. Notes to the Financial Statements
This method allocated first a portion of profit equivalent
to a certain interest rate of the partner's capital Partnership Dissolution
balances. Accordingly, the capital balances should The dissolution of a partnership is the change in the
clearly be defined in the agreement. The remaining relation of the partners caused by any partner ceasing
balance of the profit shall be distributed in accordance to be associated in the carrying on of the business.
with the agreed arbitrary ratio. The change of partners in the partnerships ends their
original agreement, thus terminating the partnership. In
4.2 Interest on Excess Investments this topic, we will be discussing the causes of dissolution
This method allows interest in the excess capital as follows:
balance of one partner over that of another • Admission of New Partner
• Withdrawal, Retirement or death of a Partner
5. Salaries or Bonus Allowed for partners' Services • Insolvency of a partnership or insolvency of
An equitable division of profits and losses frequently Partner and
requires that financial consideration be given to the • Conversion of the partnership into a
skills, talents, efforts, and work hours that active corporation
partners devote to the partnership business in addition
to their capital investment. Consequently, salaries Admission of a New Partner
and/or bonus may be given to a partner before the Giving due regard to the mutual agency any admission
agreed P/L sharing are to be made. of a new partner is possible only with the CONSENT OF
ALL the partners.
5.1 Salaries Technically, the admission of a new partner brings
To recognize personal contribution by the partner to the about a new association of individuals even if the
business, they may agree to receive salary, and divide partnership will not undergo the liquidation process.
the remaining profit among themselves by the agreed Accordingly, the original association has been dissolved
specified ratio. Except when stated otherwise, salary by the common consent resulting n the formation of a
allowance are part of the net income/loss allocation to new partnership.
the partners
The admission of a new partner can be alternatively Accordingly, the admission of a new partner will
accomplished by two (2) methods, namely: increase the partnership's total assets with the same
1. By purchases of Interest of existing partner(s), or amount of the incoming partner's contribution. The
2. By direct investment to partnership capital credit to the incoming partner is not equal to his
net assets contribution
The newly formed partnership may continue to use
either the books of the old partnership or an entirely Bonus to New Partner
new set of books. This shows that the new partner's agreed capital credit
is greater than his actual capital contribution
Admission by Purchasing a Partner's Interest Credit > Contribution
An incoming partner may buy a partnership interest
directly from one (1) or more of the current partners. Bonus to Old Partner
This shows that the new partner's agreed capital credit
In this method, a personal transaction is engaged is lesser than his actual capital contribution. The
between the (withdrawing) partner who is selling his difference will be added to the capital credits of the old
interest and the buying partner (admitted partner). As partners based on their respective P/L ratio or capital
such, any gain or loss in the purchase of interest balances.
transaction is a PERSONAL gain or loss of the partner/s Credit < Contribution
involved.
Cause for Dissolution - Withdrawal, Retirement or
The selling partner could sell his interest in the Death of a Partner
partnership at a amount:
Withdrawal or Retirement of a Partner
Equal to book value of his interest being sold By reason of insolvency or incapacity, a partner may
Less than the book value of his interest being sold or voluntary withdraw or retire from the partnership. He
More than the book value of his interest being sold must obtain the consent of his fellow partners and
The purchase of interest of existing partner may be a: determine among them the amount of his capital
refund in the absence of a stipulated amount in the
Purchase of interest of just one partner or partnership agreement.
Purchase of partial interest if all partners Whenever dissolution is made due to the withdrawal or
Admission of additional partner(s) by purchase of retirement of a partner, he may sell his interest to the:
interest of existing partner(s) DOES NOT FALL under the
description of a business combination applying the Outside Party,Remaining Partner(s), orPartnership.
purchase method as contemplated in IAS/PAS 38
Interest is Sold to Outside Party
Admission by Direct Investment to the Partnership The withdrawing or retiring partner could sell his
This manner of admitting a new partner is a transaction interest to an outsider with the mutual consent of the
between the incoming partner and the partnership. remaining partners.

To acquire interest in the partnership, the incoming This change in partnership ownership is to be accounted
partner directly invests cash and.or other non-cash in the same manner as that of an admission of a new
assets to the partnership, thereby increasing the total partner by purchase if interest of an existing partner.
assets of the partnership
Interest is Sold to Remaining Partners
The accounting concern in the acquisition of an Instead of selling interest to an outsider, one of the
incoming partner's interest in the partnership by partners or the remaining partners agree to buy the
investment may be classified in the following situations: interest of the outgoing partner.

Investment = Capital Credits (interest) Again, this is a personal transaction between a

Bonus Method withdrawing partner and the remaining partner(s). The
New Partners' Investment Equals Partner's Individual personal loss (or gain) of a withdrawing partner in the
Capital Credits transaction should not be recorded in the parnetship's
books. The only concern of the partnership is to transfer
There is no accounting problem in this method of the capital of outgoing partner to the remaining partner
admitting a new part because all partners will be given a who is interested to buy the outgoing partner's interest.
capital credit exactly the same as their respective asset
contributions to the partnership. The total capital Interest is Sold to the Partnership
contributions of the partners are the same as the total When the capital interest of the withdrawing partner is
agreed capital of the new partnership. purchased by the partnership, it results in the reduction
of the firm's assets (cash or non-cash) accompanied by
Bonus Method cancelllation of the withdrawing partner's capital. n
Under the bonus method, the TOTAL CONTRIBUTED incoming partner may buy a partnership interest
CAPITAL is equal to the TOTAL PARTNERSHIP AGREED directly from one (1) or more of the current partners.
CAPITAL BUT some INDIVIDUAL PARTNER's
CONTRIBUTION is not equal to their respective capital The withdrawing partner may receive payment at
credit because there is a transfer of capital from one • Equal to book value
partner to another. • Less than the book value
• More than the book value
The accounting procedures commonly used when the When a partnership becomes insolvent, its remaining
partnership purchased the interest of withdrawing assets are confined to the settlement of its obligations
partner would be; resulting in its inability to continue normal operations.

Adjust the assets of the partnership to their current Dissolution Procedures when Partnership is Insolvent
FAIR MARKET VALUE (FMV) before accounting for the The partnership must answer if "Are all general partners
retirement of the partner. and Solvent"?:
Record the retirement
if Yes: The General partners must invest additional
Dissolution Due to the Death of a Partner amount to pay the outside creditors
Death is an involuntary termination of one's
participation in the partnership which automatically if No: The solvent general partner will absorb the
dissolves the partnership. required payment to outside creditors and will have
The business activities of the partnership may continue existing claim against the other general partners.
with the remaining partners and an heir to serve in lieu
of a deceased partner as provided in the partnership As a rule, the personal assets of the partners shall first
contract be applied to their respective personal creditors.
In the absence of an heir to take the deceased partner's
place, the remaining partner may still continue the The personal creditors of the general partners have
business and the deceased partner's equity shall be paid priority in the claim against the personal assets of the
by the partnership. partners over those of the claims of the partnership
The accounting procedures to be used in death of a creditors. Therefor, the partnership creditors could run
partner are basically similar to those of the withdrawal after the assets of the general partner to the extent of
of a partner. However, if the partnership cannot effect the latter's remaining assets after his personal creditors
immediate payment, the following accounting are paid.
procedures may be observed:
Incorporation of a Partnership
Determine the deceased partner's profit and loss share As the partnership continues to grow, the partners may
from the beginning of accounting period to the date of decide to incorporate the business to obtain more
death. capitalization from public and get hold of other
Adjust the capital accounts (include the P/L and asst advantages found in a corporate form of business
valuation as of the time of death) organization
Close the adjusted capital account of the deceased If a partnership is incorporated, the partners will
partner to the liability account become the stockholders of the corporation. The
Accrue the interest on the said recognized liability from corporation then takes over the assets and assumes the
the date of death to the settlement date liabilities of the partnership. As a result, the partnership
Close the liability account at the settlement date. is dissolved.

Insurance on Partner's Lives At the time of corporation, the assets and liabilities
In order not to severely impair the working capital and should be revalued at their fair market values. The
operation of the business, the partnership may insure adjustments are allocated to the partner's capital
the lives of its partners with the partnership or the account based on their P/L ratio.
individual partner's heir as the beneficiary.
Partnership Liquidation.
If the partnership is the beneficiary, the proceeds of life Overview
insurance may be used to pay the estate or heirs of the Nature of Partnership Liquidation
deceased partner. Liquidation is the process of converting all assets of the
business into cash (realization), followed by the final
Insolvency of Partnership or a Partner payments of the creditors' claims and the partners'
Insolveny arises when a business (or individual) cannot capital balances in the Partnership.
pay outstanding debts as they mature. This process is usually called the "winding up of
A person is deemed insolvent when the aggregate of his business activities".
property at a far valuation is less in amount that his
total liabilities. It usually happens once the partners decide to end or
Assets< Liabilities terminate business operations after the partnership has
Common reasons for insolvency are the result of the been dissolved.
following:
The dissolution and liquidation of a partnership are not
Excessive losses from operations the same. Dissolution stops the partner's original
Over-extension of credit customers, or association while liquidation converts all non-cash
Excessive investment in inventories or in plant assets assets into cash.
that does generate revenue.
The insolvency of a partner practically dissolves the Dissolution does not always lead to liquidation while
partnership because it impairs the mutual agency liquidation is always a result of dissolution.
principle. The law provides that an insolvent partner
shall have no legal authority to act on behalf of the The liquidation of the partnership must observe the
partnership and the other partners have no authority to "principle of equitable distribution of the assets," which
act for him. requires the protection of the creditors' and partners'
legal rights.
 realization of non-cash assets should be accounted as
Accordingly, gains or losses and liquidation expenses, if follows:
any, must be allocated to the partners before actual If the partner incurring capital deficiency has loans
cash payments are made to the individual partners. receivable from the partnership, he is allowed to
exercise the right of offset.
Failure to consider these factors may result in improper Under this procedure, the capital deficiency of the
distribution of assets to partners, which makes the partner would be charged against his receivable from
authorizing partner liable for such distributions. the partnership.
If, after the exercise of right of offset, there is still
Further discussion of liquidation will be outlined by the capital deficiency, then the following steps should
following subtopics: follow:
Methods of Liquidation If the partner incurring capital deficiency is a solvent
Installment Liquidation general partner, he is required to make additional
investment to close his capital deficiencyIf the partner
Rules in Settling Accounts After Dissolution incurring capital deficiency is a limited partner or
Payment of Partnership Liabilities insolvent partner, the other partners would absorb his
This legal doctrine refers to the segregation of assets capital deficiency
owned by the partnership and the personal assets based on their existing P/L ratiosThe available cash of
owned by the several partners. It defines the priority the partnership undergoing liquidation proceeding
claims against the assets of the partnership and of the would be distributed according to the following priority:
partners when the partnership and/or one or more of 1) Payment to creditors other than partners
the partners are insolvent 2) Payment of payable to partners
3) Payment of partners' capital
The partnership's assets are first applies for paying the
debits of the partnership; the excess will be available to
satisfy the claims of the partners over the partnership.
The personal assets of a partner are applied in the
following order of priority:

Settlement of debts to personal creditorsSettlement of

debts to partnership creditorsSettlement of obligations
to other partners by way of contribution
Notes:

In accordance with the unlimited liability principle,

general partners are liable to the extent of their
personal assets in satisfying third party creditors
The personal assets of the partners are used first to
settle their personal obligations before these are used
to satisfy the claims of the partnership.

Methods of Liquidation
Lump Sum Liquidation Statement of Liquidation
Under this method, all non-cash assets of the The statement of liquidation is a report that shows the
partnership are first converted into cash before summary of winding up the affairs of the partnership
payments are made to the creditors, the to the including the priority of cash distributions.
partners.
The payment to the partners is made only once in a It is prepared as the basis of the journal entries which
lump sum amount after all the outside creditors has are needed in recording the liquidation process.
been paid.
The statement of liquidation would have the following
This method is also called "Total Liquidation" or "Simple basic format:
Distribution"

Process observed in Lump Sum Liquidation

The following processes are usually observed in winding

up and recording the lump sum liquidation of the
partnership assets:

Adjustments of accounts and closing of nominal

accountsThe non-cash assets of the partnership are
either:
Sold to 3rd parties orDistributed to the interested
partner at an agreed price to offset his capital
balance.Any gain or loss in the realization process would
be distributed to the partners' capital balances based on
the existing P/L agreement.Any capital deficiency
resulting from the distribution of loss from the
Gain on Realization *The maximum loss possible may be comprised of the
There is gain on realization when the non-cash assets of following items:
the partnership are sold at a price more than their Unsold non-cash assets
recorded value. Estimated liabilities
The excess cash received over the recorded value of the Expected liquidation expenses
assets is closed to partners' capital according to profit
and loss ratio agreement. Cash Priority Program
In lieu of safe payment schedule, the other tool to
Loss on Realization guarantee that no overpayment will happen in making
There is loss on realization when the non-cash assets of premature payments under installment liquidation is
the partnership are sold at a price lesser than their the Predistribution Plan or Cash Priority Program.
recorded value .
The deficit of cash received over the recorded value of The cash priority program will determine the partner to
the assets is closed to the partners' capital according to whom and how much available cash (after payment to
profit and loss ratio agreement. creditors and liquidation expenses are made) shall be
distributed even prior to the total actual realization.
A loss on realization usually happens because buyers
are generally willing to buy the partnership's non-cash Like the safety payments schedule, the predistribution
assets only if sold at plan
a price less than its book value since the partnership is
already in its liquidating concern. Combines the partners' loan balances with their
respective capital
Installment Liquidation Anticipates all possible liabilities, losses on realization
This method involves payments to creditors and and liquidation expenses.
partners as proceeds of sale of non-cash assets are In addition, it recognizes that the partner with the
made. Consequently, cash payments to creditors and highest rank or ability to absorb anticipated losses will
partners are on installment basis cash becomes be the first partner to received safe payments.
available.
It is determined by computing the partner's respective
This method is also called "Piecemeal liquidation" maximum loss absorption capacity.
To guarantee that premature cash distribution to
partners would not result in overpayment, the following The formula in computing the maximum loss absorption
tools are available to direct accurate premature cash capacity is as follows:
distribution:
1. Safe Payments Schedule
2. Cash Priority Program
Steps in completing the cash priority program
Safe Payment Schedule 1. Equalize the absorption capacity of all the partners by
This statement shows a conservative approach to deducting the difference of first priority and second
liquidation. It is prepared when there is availability of priority and so on.
cash after payment to outside creditors was made. It 2. Determine the amount of priority cash payments by
indicates how the availability cash should be distributed multiplying the difference with the P/L ratio of the
to partners. partner having the highest capacity.
3. When the absorption capacity for all partners
The preparation of safe payments schedule assumes the becomes equal to each other, then any succeeding cash
following as possible losses: for distribution will be shared based on P/L ratio at this
stage.
Anticipation of all possible liabilities and expected losses In other words, after steps 1 and 2 cash distribution
/ expenses to be incurred in the process of liquidation priority are satisfied, the remaining cash available shall
All unsold non-cash assets will be worthless be distributed according to the partner's profit and loss
The assumed losses are allocated to the partners' ratio. It is because the ratio of the partner's capital
capital balances based on the profit and loss balances becomes equal to their respective profit and
agreements. This may result in an assumed partner loss ratio.
debit capital balance. The assumed debit capital balance 4. Compute the cash available for distributions
of a partner is allocated to those partners with credit 5. Distribute the cash available according to cash
balances according to their profit and loss ratio. priority program. The balance shall be distributed based
on the P/L ratio.
The amount of safe payments is the remaining credit
capital balances of partners after allocating the
assumed debit capital balance.

The basic format of the safe payments schedule would

appear as:
Characteristics of Corporation A shareholder is not legally liable for the corporation's
unpaid indebtedness. They are liable only to the extent
of their subscription.
1. Artificial Being 6. Managed by Board of Directors (BOD)
A corporation is not a real or natural person, but the law A corporation is managed by a group of shareholders
assumes it as a person so that is can perform practically called "board of directors". The Corporation Code
all business functions which a natural person can do. provides that the board of directors should be
Consequently, a corporation can enter into contract, comprised of at least 5 natural persons but not more
own and dispose properties, or sue and be sued in its than 15.
own name. A shareholder cannot bind the corporation into
As an artificial being, it has a separate and distinct contracts. Only the BOD and other authorized officers
personality from its shareholders, authorized officers can bind the corporation into contracts.
and employees. Hence, the personal liabilities of the
corporate shareholders are not obligations of the
corporation. Advantages of a Corporation
2. Created by Operation of Law 1. Limited Liability of Shareholders
This means that corporations cannot come into Corporate stockholders are liable only to the extent of
existence by mere agreement of the parties as in the their subscriptions. They are not held liable for
case of business partnerships. They require special corporate liabilities not covered by corporate assets.
authority or grant by the State through the legislative
In other words, stockholders are not covered by the
department either by a special incorporation law.
principle of unlimited liability. When a corporation
Bring a mere creation of law, a corporation can only be becomes bankrupt, shareholders are not labile for the
allowed to exist for lawful purposes. Hence, its corporation's unpaid debts
existence cannot be extended to any unlawful activities.
2. Transferability of Shares
3. Power of Succession
A shareholder can sell and transfer his acquired share
The shares of stock, which is an evidence of ownership capital even without the knowledge or consent of all the
in a corporation, can be transferred from one person to stockholders. It is sufficient that proper annotation of
another. Consequently, a corporation can continue to transfer is made in the Corporate Stock and Transfer
exist despite the death, withdrawal, insolvency or Book
incapacity of the individual members or stockholders
3. Continued Life Existence
composing it.
The existence of a corporation, however, should not A corporation can continue to exist for the duration of
exceed 50 years from the date of incorporation, unless its lifetime, unaffected by the internal changes which
extended. As its life can be renewed every 50 years, it may arise within the corporation, such as death,
becomes indefinite, unless not extended. insanity, insolvency of any of its shareholders, directors,
officers, agent or employees.
4. Powers, Attributes and Properties
4. Greater Source of Funds
As a creation of law, a corporation can only exercise
powers that it is expressly authorized to perform in When there is a need for a large amount of capital in
accordance with the Corporation Code, its Articles, By- establishing a business, parties will normally find it
Laws, and other special laws. necessary to adopt the corporate form of organization.

A corporation can exercise its incidental powers as long The corporation sources its funds from the public
as they are inherently necessary for its existence or for through the issuance of the authorized capital stock. In
the accomplishment of its objectives. addition, it can issue a certificate of indebtedness
(bonds) to the public to raise funds.

Disadvantages of a Corporation
1. Complicated in Formation and Operation
A corporate is not formed by mere desire of an owner
or agreement of parties. Its formal existence would start
only upon the issuance of its certificate of incorporation
5. Ownership Interest by the SEC. Also, its formation requires some
organization costs which are not usually incurred in
The ownership interest in a corporation is represented
other forms of business.
by share capital which are divided into several shares of
stock. Any person who bought a share capital becomes Its operation is more expensive because its requires
a part owner of the corporation and e is called more administrative persons to manage its affairs such
"shareholder" or "stockholder". as the board of directors, president, vice presidents,
corporate secretary and corporate treasurer.
2. Centralized Management b. Foreign Corporation - Organized under the laws of
other countries.
The management of a corporate business is vested in
the BOD or Board of Trustees (BOT), the governing and 1. Resident Foreign Corporation - Established a Branch
controlling body of a corporation. Operating in the Philippines just like a domestic
corporation
The BOD is the policy-making body of a profit
corporation is called "board of directors," while the BOT 2. Non-Resident Foreign Corporation - Does not
is the policy-making body of a non-profit corporation. establish a branch in the Philippines but earns in the
Philippines in the form of rent, interest, and dividend
Not all shareholders (stockholders) participate in the
management of the corporation. The ultimate control in *Income of foreign corporation is taxable only in the
the corporation belongs to the BOD who compose the Philippines if derived within
majority shareholders. This condition may lead to a
greater possibility of abuse of power. c. Multi-National Corporation - A domestic or foreign
corporation which extends its corporate business to
3. Heavier Income Tax other territories or countries
Although tax exemptions are given to nonprofit and
non-stock corporations, stock and profit corporations
are subject to a flat rate of 30%. 2. As to Purpose

They also have more government requirements are a. Government Corporation - These corporations are
compared with other formed of business. formed by the government either for governmental
functions or proprietary functions
After the imposition of the income tax, the corporate
1. Public Corporations - These corporations are
income declared as dividend to individual taxpayers is
still subject to a 10% final dividend tax created for the governance of a State territory.
Examples are province, cities and municipalities
4. Great Degree of Government Control and 2. Government Owned and Controlled
Supervision Corporations - These corporations are primarily
intended for profit but owned or controlled by
Corporations are required to meet pre-incorporation the State. Examples are National Power
requirements such as the 25% actual payment of the Corporation (NPC) and Philippine Gambling
25% required subscription of the total capital stock,
Corporation (PAGCOR)
submission of By-Laws and Articles of Incorporation and
approval of the SEC. In addition, they are required to b. Privately Owned Corporation - These are corporation
submit minutes of their meeting and financial reports to not owned by the government
the government.
1. Civil Corporation - A corporation established for
It can only issue shares of stock and certificate of business or for profit
indebtedness if authorized by the government (SEC) 2. Wasting Asset Corporation - A corporation
whose main purpose is to extract natural
resources. Examples are Mining property, oil or
Kinds of Corporation gas
3. Eleemosynary Corporation- A corporation
In general, private corporations can be classified into: established for charitable purposes
1. Stock Corporations 4. Ecclesiastical Corporation - A corporation
established for religious purposes
These corporations issue shares of stock to the
shareholders, who are entitled to receive dividends c. Quasi- Public Corporation - These are privately
representing their earnings from the corporation. These financed and managed corporations for a public
corporations are subject to income and business taxes purposes. Examples are public utility corporations such
as BATELLEC, Meralco, PLDT etc.
2. Non-Stock Corporations
These corporations do not issue shares of stock because
they are created for civic, charitable, or religous 3. As to Legal Right
purposes. They are composed of members not a. De Jure Corporation - A corporation duly registered
shareholders. These corporations are generally tax- for having complied with all the requirements of the law
exempt. for its legal existence
b. De Facto Corporation - A corporation that fails to
Other Classes of Corporation completely comply with the requirements of law

Stock and non-stock corporations are further classified

according to the following: 4. As to Number of Persons
1. As to Nationality a. Sole Corporation - A corporation owned and
a. Domestic Corporation - Organized through the registered by only one corporator or member and his
operation of Philippine laws - the Corporate Code of the successors, who are members of a religious
Philippines and other special corporate laws denomination
b. Aggregate Corporation - A corporation comprised of
more than one corporator or member
5. As to Extent of Membership 3. Formal Organization
a. Open Corporation - The stocks of this corporation are Formal organization requires the adoption of by-laws
open to public subscription (Initial Public Offer). and the election of the Board of Directors (BOD) and of
Generally, stockholders are not related to each other. the officers by the board pursuant to the by-laws.
b. Closed Corporation - This is owned and managed by a It also includes the taking of other steps that are
family or close relatives or friends not exceeding 20 necessary to enable the corporation to transact the
persons. The stocks of this corporation are not open for legitimate business or accomplish the purpose for which
public subscription it was created.
Below are the officers of the corporation evidencing its
formal organization and commencement of business
6. As to Relation to Other Corporations
1. Corporate President - Must be a member of the
a. Parent or Holding Corporation - A corporation that BOD according to law
acquired significant influence over another corporation 2. Vice President - The corporation may employ
and has the power to elect directly or indirectly the several Vice Presidents who may be assigned to
majority directors of a subsidiary corporation the operation, finance, marketing, production,
b. Subsidiary Corporation - This corporation is etc.
controlled by the parent or holding corporation 3. Corporate Secretary - responsible to keep the
corporate records such as minutes of the
Example: meeting, entries of stockholders votes, directors
Parent Corporation = Ayala Holdings Corporation and stockholder's resolution in directing the
affairs of the corporation
Subsidiary Corporation = Globe, BPI, Ayala Land 4. Corporate Treasurer - Authorized to receive and
keep the money of the corporation. He may
disburse funds of the corporation based on the
Steps in Organizing a Corporation authorization given to him.

The following are the three main stages in the creation

and organization of a corporation.
Commencement of Corporate Business
1. Promotion
Section 22 of the Corporation Code of the Philippines
A "promoter" undertakes the promotional stage of a states:
corporation.
"If a corporation dies not formally organize and
As one of the preliminary steps to the organization of a commence the transaction of its business or the
corporation, a promotor work involves issuing of construction of its work within two (2) years from the
prospectus, procuring of subscriptions from prospective date of its incorporation, its corporate powers cease
investors, and securing a charter for the proposed and the corporation shall be deemed dissolved.
corporation by the persons interest in the firm
However, if a corporation has commenced the
transaction of its business but subsequently becomes
continuously inoperative for a period of at least five (5)
2. Incorporation years, the same shall be a ground for the suspension or
Incorporation includes the following process: revocation of its corporate franchise or certificate of
incorporation"
2.1 Registration of Corporate Name with SEC - The
name of the corporation should not be the same as or
similar to the name of existing registered corporation. Articles of Incorporation
2.2 Drafting and Execution of the Articles of This refers to the basic instrument by which a
Incorporation. - The incorporators shall draft this corporation is formed under the corporation statutes,
corporate basic instrument which must be duly executed by several persons as incorporators and filed
executed and acknowledged by a notary public in some designated public office such as the SEC as
2.3 Execution of Sworn Affidavits and Bank Deposit evidence of its corporate existence.
Certificate - The Articles of Incorporation should be Pre-Incorporation Subscription Requirement
submitted to the SEC together with a corporate
treasurer's sworn statements regarding the capital The Corporation Code provides that the SEC cannot
subscribed and paid-up, and the statements of the accept the Articles of Incorporation of any stock
corporation's assets and liabilities. corporation if it does not have the following:

The incorporators should also attach thee bank deposit 1. Sworn Statement of the Treasurer - Showing that at
certificate to the credit of the corporation evidencing least twenty-five (25%) percent of the authorized capital
payment of the 25% of the subscribed capital stock. stock of the corporation has been subscribed, and

2.4 Payment of the filing and publication fees - 2. At least twenty-five (25%) of the total subscription
has been fully paid in actual cash and/or in property,
2.5 Issuance of Certificate of Incorporation - The SEC the fair value of which is equal to at least twenty-five
issues certificate of incorporation to evidence approval (25%) of the said subscription, such paid-up capital
of incorporation being not less than five thousand (P5,000.00) pesos
Organization Expenses Rights of Shareholders
Organization expenses incurred in connection with the 1. Right to Vote - Vote by himself or by proxy at all
formation of the corporation prior to the meetings of the corporation
commencement of corporate business are treated as 2. Right to profit - receive his proportionate share
expense. from the corporate profits
3. Right to inspect - inspect corporate books and
Examples records
• Payment of Filing & Publication Fees 4. Right to financial statements - request financial
• Promoter's Fee statements and reports
• Registration & Permit Fees 5. Right to corporate assets - participate in the
distribution of corporate assets in case of
dissolution
Direct Issue Cost for Share Capital Issuance
Direct costs related to share capital issuance like: 4. Subscribers
• cost of printing, Those who have made an agreement with the
• stock books, corporation to buy the corporate capital stock at future
• corporate seal and other legal or accounting payments.
fees in relation to stock issuance
A subscriber who does not pay his subscriptions at the
shall be charged against the related share premium or date agreed upon may be declared delinquent by the
additional paid-in capital (APIC) BOD, and loses his rights as provided above.
Note:
By-Laws Sec. 72 of the Corporation Code of the Philippines -
Holders of subscribed shares not fully paid which are
A By-Law is the "regulations, ordinances, rules or laws not delinquent shall have all the rights of a shareholder.
adopted by any association or corporation for its
government" Sec. 71 of the Corporation Code of the Philippines -
makes an exception for the provision above, meaning
the delinquent subscriber is still entitled to a dividend
According to Sec 5. of the Corporate Code, a however, the following restrictions must be observed:
corporation may be comprised of the following: Cash dividend are not to be actually paid to the
1. Corporators delinquent subscriber, but applied as payment for his
delinquent shares
They represent the several classifications of owners of a
corporation after its formation. Stock dividends are to be withheld until the delinquent
subscriber shall have fully paid his subscription
Specifically, corporators are incorporators, shareholders
and/members
2. Incorporators SHARE CAPITAL TRANSACTIONS

They are also called the "founders of a corporation". • Shareholder's Equity

• Share Capital
They are the original organizers of the corporation, • Methods of Accounting for Share Capital
stock or non-stock, whose names appear in the Articles • Legal Capital & Trust Fund Doctrine
of Incorporation. The primary function of an
incorporator is to organize the corporation
Artificial persons like partnerships or corporations Shareholders' Equity
cannot be incorporators.
This represents the residual interest of the shareholders
3. Shareholders or Members in the assets of the corporation after deducting the total
amount of corporate liabilities.
Owners of a corporations are commonly called
"stockholders" or "shareholders". The shareholder's equity also known as:

Their ownership is evidenced by acquiring shares in a • net assets

stock corporation either by subscription, or by direct • net worth
purchase or by transfer of a stock from another • book value
stockholder. • stockholder's equity
• equity
A "member" refers to a corporators of a non-stock
corporation.
A shareholder may be a natural person or an artificial Elements of Shareholders' Equity
person.
The presentation of the elements in the current practice
includes three (3) subsections of the equity section of
the statement of financial position:
1. Total Share Capital 2. Subscribed share capital (subscribed capital stock)
Share Capital (Capital Stock) The portion of the share capital that an investor agreed
to purchase. This portion of share capital is not yet
Subscribed Share Capital issued because it may only be partially paid.
Subscription receivable - generally treated as a 3. Subscription Receivable
deduction from subscribed share capital or part of
current assets if due within a year. The unpaid portion of the subscribed share capital.
Treasury Shares - deduction from total shareholders' This claim is usually treated as a deduction from the
equity subscribed scare capital, except when collectible within
one (1) year, which may be classified as part of the
2. Other Reserves current assets
Appropriation reserve (retained earnings appropriated) 4.Treasury Share
Additional paid-in capital (APIC) This represents issued shares reacquired by the issuing
Share premium (APIC on excess over par or stated value corporation which is treated as a reduction from the
; APIC on treasury shares) total shareholders' equity.

Donated Capital Issued Shares - fully paid shares wherein a stock

certificate is issued to the shareholder.
Equity share option issued
Outstanding Shares - total issued shares less those in
Revaluation surplus the treasury. The shares still in the hands of
*Share Capital & Other Reserves represent total shareholders
contributions made by the shareholders. The first section of the shareholders' equity will appear
3. Accumulated Profits (Retained Earnings) as follows for par value shares

Represents accumulated profit earned or losses

incurred in the operation of the business.

Share Capital
The share capital subsection of shareholders' equity
consists of the following elements
1. Share Capital
Major Classifications of Share Capital
This refers to the paid-in capital representing the
amount of the total par or stated value of the shares A corporation may be authorized to issue two classes of
issued. It represents the portion of authorized share share capital which must be accounted separately for
capital that has been fully paid each class:

The Share Capital may be Par Value or No Par Value 1. Ordinary Share (Common Stock)
share but with Stated Value Represents basic interest of ownership in a corporation.
• Par Value When a corporation issues only one class of stock,
The fixed amount assigned to each equity share. therefor, the stock must be an ordinary share.
This also refers to a nominal peso amount Shareholders holding ordinary shares are called
assigned to each equity share by the company's "ordinary shareholders" because they receive the same
charter. It is the face value of the shares privilege's and rights.
appearing on the certificate
*In the Philippines, issuing the shares of stock at They assume greater risk but exercise greater control in
an amount below par value is prohibited the corporation, and may receive greater reward in the
• No Par Value , Stated Value form of dividends and capital appreciation.
A Stated Value is when a company's charter
An ordinary shareholder has the right to vote and be
contains no par value stock, its BOD can
voted upon as a board of director.
arbitrarily select an amount for its stock when
issued. 2. Preference Share (Preferred Stock)
A stated value serves the same purpose as par
value but is not printed in the share certificate A separate class of corporate shares accorded by the
The issued price of no par shares may vary corporate by-laws. A preference share has a preference
(usually the book value), but they may not be with respect to dividends and/or assets over ordinary
issued for a values less than P5.00 per share shares.
*The primary advantage of a no par stock is that The preference dividends have a fixed dividend
it may be issued at any price without having a percentage based on its par value (for example, 10%
discount liability attached preference share). Accordingly, the law provides that
preference shares may only be issued only with a stated
par value.
Preference as to Dividends 1. Founders' stock
A preference share is given first priority over ordinary Equity share given to the incorporators with certain
shares with respect to dividend distribution privileges on dividends and voting rights not enjoyed by
ordinary corporators such as voting rights and rights to
Preference as to Assets be elected as an officer. The founders' stocks are
In case of corporate liquidation, preference subject to SEC approval and its exercise is limited only
shareholders are given preference over the residual to five (5) years.
assets of the corporation. 2. Bonus stock (Stock warrant)
NOTES: Equity share given as a premium in connection with, or
*Despite this preferential treatment, preference to encourage, the sale of another class of securities.
shareholders generally have no voting rights in the Ex. equity shares issued to the purchasers of bonds as
corporation, hence they cannot be voted into office as an inducement to them to purchase bonds or loan
members of the BOD. money
**A corporation is not authorized to issue preference 3. Promotion Stock
share alone, but it can issue ordinary share even
without a preference share. Equity share usually issued as incentive or payment to
those who take the preliminary steps to the
*** When there are two classes of corporation's organization of a corporation
authorized share capital, each class should be
accounted separately by a memorandum entry upon 4. Donated Stock
authorization
Securities given to a corporation by its own
shareholders commonly for resale.
Classification of Preference Share Capital 5. Watered Stock
A Corporation may issue several classes of preference An equity share that is issued by a corporation as fully-
shares as follows: paid share capital, when in fact the whole amount of
the par value has not been paid, as a result of
1. Cumulative Preference Shares overstated of the value of consideration received.
The right of preferred shareholders to receive dividends
in arrears (undeclared dividend in previous years) is
protected and given priority before any payment of Accounting for Shares of Stocks
dividend is made to common shareholders.
1. Authorization
2. Noncumulative Preference Shares
This involves the recording of the maximum number of
The right of preferred shareholders to receive dividends shares a corporation is authorized to issue as stated in
in arrears is lost. Only entitled to receive the current the articles of incorporation upon approval by the
year's declared dividend. Securities and Exchange Commission (SEC).
3. Participating Preference Shares Accordingly, the maximum number of share multiplied
by the par value per share is called Authorized Share
The preferred shareholders are entitled to receive Capital or Authorized Capital Stock.
additional dividend after the dividend for both ordinary
and preferred shares are paid Whenever a corporation increase or decrease its
authorized share capital, it would need to amend its
4. Nonparticipating Preference Shares corporate articles which will subsequently need the
The preferred shareholders are NOT entitled to receive approval from the SEC
additional dividends, only to receive dividends that are 2. Share Subscription
declared during the current year. Any excess dividends
are all distributed to ordinary shareholders A Share Subscription is a written contract by which one
engages to take and pay for the share capital of a
5. Convertible Preference Shares corporation at some future date.
The preferred shareholders are given the option to A Subscriber enters into a contract to buy a number of
convert the preference share into ordinary shares or shares.
some other securities of the investee corporation.
A down payment is usually required with the balance
6. Redeemable or Callable Preference Shares payable on fixed dates or upon call by the BOD,
The issued preference shares can be bought back (call however, A corporation cannot issue its share capital if
or redeem) by the issuing corporation with a specific its is not yet fully paid.
call or redemption price The shares are called Subscribed Share Capital
3. Sale
Other Classifications of Share Capital When a shareholder buys and pays immediately in full,
The ordinary shares and/or preference shares can be the shares are considered sold and a stock certificate is
further be classified according to the purpose for which issued.
they are issued or acquired. They may be classified as: The shares are called Share Capital.
4. Collection of Subscription Subsequent Share Capital Transactions
The subscription may be paid by the shareholders in After the original issuance of share capital, there may
cash, or non-cash consideration* be some other share capital transactions that may
affect the equity section of the statement of financial
5. Issuance of Certificate position.
Once the subscription is collected in full, a certificate is Basically, these may involve transactions related to the
issued following:
*Share Certificate - also known as stock certificate, is an 1. Treasury Shares
evidence of the shareholder's ownership interest in 2. Share Capital Donation
profit corporation. 3. Conversion of preference shares to ordinary
**It is the investee corporation's acknowledgement of shares
the shareholders' right to participate (through voting 4. Retirement of Share capital
rights) in the company's general management and to
share proportionately in corporate profits or assets in
case of dissolution. Treasury Shares
6. Reacquisition of Shares This refers to the equity shares owned by the issuing
corporation that has been issued and then reacquired
The issuing corporation may reacquire (purchase or but not cancelled
redeem) the shares of stock which were originally
issued with the intention of either reselling or retiring "Also included in the equity section of the statement of
these shares in the near future. financial position are treasury share representing issued
shares reacquired by the issuer. These are generally
These are called Treasury Shares. stated at their cost of acquisition and as a reduction of
7. Retirement shareholders' equity."

This involves accounting for the acquisition and When a company reacquired its own shares and these
retirement of the corporation's owned share capital shares are not cancelled, the accumulated profits must
be appropriated equivalent to the cost of the said
shares (treasury shares/stock)
Issuance of Share Capital for Noncash Consideration The law provides that treasury shares shall have no
A non-cash consideration may refer to the value voting rights as long as such equity shares remain in the
received other than cash. For Example Treasury. For this reason, treasury shares are not
entitled to receive dividend.
Tangible or Intangible property
Treasury shares do not affect the number of issued
If issued for tangible or intangible property, the value of shares, but they reduce the number of outstanding
share capital is equal to values according to the shares. They are deducted from the total amount of
following order of priority: share capital contribution.
1. Fair Market Value of the property Received
2. Fair Market Value of the share capital issued
3. Par Value of the share capital issued Sources of Treasury Shares
The following share capital transactions are the sources
of treasury shares:
Service received
1. Repurchase of own shares but not cancelled
If issued for services received, the value of share capital 2. Delinquent subscription without a highest
is equal to values according to the following order of bidder assumed by the corporation
priority: 3. Corporate own shares donated by the
shareholder to the company itself.
1. Fair Market Value of the Services Received
2. Fair Market Value of the share capital issued
3. Par Value of the share capital issued
Accounting for Treasury Shares

Equity share issued by other corporation Treasury share is accounted for at cost, irrespective of
the par value, stated value or market value of the share
If issued in consideration for equity shares owned by capital acquired.
other corporation, the value of share capital is equal to
values according to the following order of priority: This means that treasury shares are recorded based on
the actual consideration given by the acquiring
1. Fair Market Value of the equity shares Received corporation, regardless of whether the share is acquired
2. Fair Market Value of the share capital issued below or above the par or stated value
3. Par Value of the share capital issued
The accounting for treasury shares involves the
following transactions:
Unpaid liabilities of the issuing corporation 1. Acquisition
2. Reissuance
If it is an exchange of liability, the basis value of share
3. Retirement
capital is the amount of liability set off
Acquisition Accumulated Profits
P 65,000
When a company buys back its own shares, it decreases
the number of shares outstanding, while simultaneously Cancellation (reversal) of appropriated retained earned
increasing the amount of treasury stock it owns of treasury shares reissued
The par value and the market value of the shares
acquired are not considered in recording the value of
the treasury shares. 3. Reissuance of Treasury Shares below Cost

The accumulated profits are immediately appropriated Using ALPHA COMPANY details, assume 1,000 treasury
to the extent of the cost of treasury shares acquired. shares were reissued at P50 per share, the journal entry
would be:
Example:
A) Cash P 50,000
ALPHA COMPANY acquired 1,000 shares of its
previously issued share capital for a total cost of Share Premium - Treasury Shares 6,000
P65,000. The market value of the shares of stock at the Accumulated Profits 9,000
time of purchased is P70 per share.
Treasury Shares P 65,000
The journal entry to record the acquisition of treasury
shares is: Reissuance of treasury shares below cost

A) Treasury Shares P 65,000 B) Appropriate reserve for treasury shares P 65,000

Cash P 65,000 Accumulated Profits

P 65,000
Acquisition of company's own equity shares previously
issued Cancellation (reversal) of appropriated retained earned
of treasury shares reissued
B) Accumulated Profits P 65,000
Notes:
Appropriate reserve for treasury shares P 65,000
1. When treasury share is issued below cost, the
Appropriate for treasury shares deficiency ("loss" on sale of treasury shares) shall be
absorbed by the following accounts in the following
order of priority:
Reissuance
a. Share premium (APIC) from treasury share of the
When a company reissued the reacquired shares same class of share capital if any (to the extent of the
(treasury shares) to outside investors. There are three APIC balance)
(3) ways to reissue treasury shares;
b. Accumulated Profits
1. Reissuance of Treasury Shares at Cost
2. The share premium (APIC) from excess over par is not
Using ALPHA COMPANY details, assume 1,000 treasury used to absorb the "loss" on sale of treasury shares,
shares were reissued at P65 per share, the journal entry even if the APIC from treasury shares were exhausted.
would be: Instead, the accumulated profits are charged to
absorbed the remaining "loss" of P9,000
A) Cash. P 65,000
Treasury Shares P 65,000
Retirement of Treasury Shares
Reissuance of treasury shares at cost
When a company retired reacquired shares instead of
B) Appropriate reserve for treasury shares P 65,000 reissuance.
Accumulated Profits Using ALPHA COMPANY details, assume 1,000 treasury
P 65,000 shares were retired, the journal entry would be
Cancellation (reversal) of appropriated retained earned
Share Capital (P 50 x 1000) P 50,000
of treasury shares reissued
Share Premium in excess of par (P100,000 x
1,000/20,000) 5,000
2. Reissuance of Treasury Shares above Cost Share Premium - treasury shares 6,000
Using ALPHA COMPANY details, assume 1,000 treasury Accumulated Profits. 4,000
shares were reissued at P80 per share, the journal entry
would be: Treasury Shares Shares. P 65,000
A) Cash P 80,000 Retirement of treasury shares
Treasury Shares P 65,000 Notes:
Share Premium - Treasury 15,000 1. When treasury share are retired resulting in a "loss" (
the cost of the treasury exceeds its par value, the loss
Reissuance of treasury shares above cost shall be absorbed by the following accounts in the
B) Appropriate reserve for treasury shares P 65,000 following order of priority:
a. Share premium (APIC) in excess of par to the extent Date of Sale
of the credit when the share capital was originally
issued The journal entry for the subsequent issuance of the
treasury shares would be:
b. Share premium, APIC from treasury shares
Cash P 60,000
c. Accumulated Profits
Donated Capital(P60 x1000) P 60,000
2. When treasury shares are retired resulting in a "gain"
(par value of treasury exceeds its cost), the excess is Issuance of donated share capital
credited to the share premium, APIC from treasury Donated Assets (other than own share capital)
shares.
A donated asset is an economic resource received by a
3. The accounting methods for treasury shares with corporation for free from its shareholders or other
stated value (NO PAR) are the same as those for persons. Consequently, such donation increases the
treasury share with par value. assets and shareholders' equity of the corporation.
As a rule, the assets donated to a corporation are
Share Capital Donation recorded at its fair market value.

When a corporation acquired its own shares from its Any expense incurred directly related to the acquisition
shareholders by mode of donation, such transactions is of donated property is charged against the donated
called Share Capital Donation or Stock Donation. capital account.

Stock Donation is in substance a treasury share Example:

provided that the related shares reacquired are not Assume that AUSTRIA COMPANY donated a parcel of
retired. Accordingly, the corporation can sell the land as donation from its shareholder, with a condition
donated shares to increase its share premium. that the expenses related to the transfer of title of
The accounting issue usually encountered in relation to ownership shall be borne by the corporation.
share capital donation is the valuation of the treasury It was determined that the fair market value of the land
shares because they are acquired without any was P750,000 and the corporation incurred P50,000 as
consideration. expense for the transfer of land title.
Notes: The related journal entry for the donated land in the
books of AUSTRIA COMPANY is as follows:
1. Since treasury shares are accounted for at acquisition
cost, there is no journal entry to be made on the date of A) Land P 750,000
donation because there is no cost on the part of the
corporation to acquire donated shares Cash P 50,000

2. Only Memorandum entry is made for donated shares. Donated Capital (P750,000-50,000) 700,000
The Journal entry shall only be made when the donated Conversion of Preference Share into Ordinary Shares
shares are subsequently reissued for a price.
A convertible preference shares gives the right or
3. The memorandum entry method is based on the privilege to its holder to exchange the same for other
argument that the acquisition of donated capital has no securities of the issuing corporation.
effect on the assets, liabilities, and shareholders' equity
accounts of the corporation. Preference Shares are normally converted into ordinary
shares because when business operations are
4. The only effect it could provide to the corporation is successful, the earnings for ordinary shares are
the reduction of the number of shares issued and unlimited.
outstanding, which basically has no effect on the
corporate resources. When preference shares are to be reclassified such as in
the case of conversion, all accounts related to the
preference shares should be closed.
Dates to be considered
1. Date of Donation Any "indicated gain" from conversion is credited to
2. Date of Sale share premium and any "indicated loss" is debited to
accumulated profits.
Example:
ILLUSTRATION
Assume that ALPHA COMPANY received 1,000 shares of
its own equity share capital from its shareholders as a Assume the following data of X Corporation:
donation. The share capital has a par value and fair
• Preference Shares (Issued 5,000 shares, P100
market value per share of P50 and P60, respectively.
par) P 500,000
The shares are subsequently sold for P60.
• Ordinary shares (Authorized, 150,000 shares;
Date of Donation Issued and outstanding 100,000 shares, P20
par) 2,000,000
There is no journal entry but the receipt of donated • Share Premium - preference share 100,000
share capital is to be recorded in a memorandum entry • Share Premium - ordinary share 600,000
in the general ledger. • Accumulated profits 3,000,000
Preferred shareholders converted all of the preference Ordinary Shares (Issued 50,000 shares, P50 par ) or (
shares into common shares. P50 Stated for other cases) P 2,500,000
Share Premium - Ordinary Shares 1,000,000
CASE 1: There is no indicated gain or loss on conversion Accumulated profits 2,500,000
Assuming that the conversion is 1 preference share to 6 1. Change from Par Value to No Par Value
common shares, the journal entry would be:
Case 1: Stated Value of New Share is greater than the
Preference Share Capital P 500,000 par value of old share
Share Premium - Preference share 100,000 Assuming that all the 50,000 ordinary shares were
cancelled and issued 50,000 new ordinary no par shares
Ordinary Share (P20 x 5,000 x 6) P 600,000 with stated value of P100 per share. The journal entry
would be:

CASE 2: There is indicated gain on conversion Ordinary Share Capital (old). P2,500,000

Assuming that the conversion is 1 preference share to 5 Share Premium - Ordinary Share 1,000,000
common shares, the journal entry conversion. Accumulated Profits 1,500,000
Preference Share Capital P 500,000 Ordinary Share Capital (P100 x 50,000) P 5,000,000
Share Premium - Preference share 100,000 Note: As a rule, if the new share's stated value is greater
Ordinary Share (P20 x 5,000 x 5) P 500,000 than the original issue price of the par value share, the
difference is charged to accumulated profits.
Share premium on conversion 100,000 Consequently, there is capitalization of the earnings.
NOTE: The indicated gain is enjoyed by the issuing
company, but not by the preference shareholder.
Case 2: Stated Value of New Share is lesser than the par
value of old share
CASE 3: There is indicated loss on conversion Assuming that all the 50,000 ordinary shares were
Assuming that the conversion is 1 preference share to 8 cancelled and issued 50,000 new ordinary no par shares
common shares, the journal entry would be: with stated value of P30 per share. The journal entry
would be:
Preference Share Capital P 500,000
Ordinary Share Capital (old) P 2,500,000
Share Premium - Preference share 100,000
Share Premium - Ordinary Share 1,000,000
Accumulated Profits 200,000
Ordinary Share Capital (P30 x 50,000) P 1,500,000
Ordinary Share (P20 x 5,000 x 8) P 800,000
Share Premium - Recapitalization 2,000,000
NOTE: The indicated loss is sustained by the issuing
company, but not by the preference shareholders Note: The share premium from recapitalization is
established which will be used for capital restructuring.
(The topic on capital restructuring is discussed in higher
financial accounting subject)
Recapitalization
A recapitalization is a change in the capital structure of
a corporation by canceling the old shares and changing 2. Change from No Par to Par Value
them with new shares. Generally, recapitalization is
undertaken to establish a share premium (APIC) that Case 1: Par Value of New Share is greater than the
will be used in capital restructuring. stated value of old share

The usual types of recapitalization are as follows: Assuming that all the 50,000 ordinary shares were
cancelled and issued 50,000 new ordinary shares with
1. Change from par value to no-par value shares Par value of P100 per share. The journal entry would be:
2. Change from no-par value to par value shares Ordinary Share Capital (old) 2,500,000
3. Reduction of par value Accumulated Profits 2,500,000
4. Reduction of no-par value Ordinary Share Capital (P100 x 50,000) P 5,000,000
5. Share Splits
Case 2: Par Value of New Share is less than the stated
value of old share
ILLUSTRATION
Assuming that all the 50,000 ordinary shares were
Assume the following data of X Corporation for all types
cancelled and issued 50,000 new ordinary shares with
of recapitalization
Par value of P30 per share. The journal entry would be:
Ordinary Share Capital (old) P 2,500,000 Ordinary Share Capital P50 (old) P 2,500,000
Ordinary Share Capital (P30 x 50,000) P 1,500,000 Ordinary Share Capital P10 (new) P2,500,000
Share Premium - Recapitalization 1,000,000 Note: In practice, the memorandum entry is preferred
over the journal entry method

3. Reduction of Par Value

Retirement of Share Capital
Assuming that the par value to reduced to P40 Par per
share to effect recapitalization, the journal entry would Retirement of Share Capital is when shares are
be: purchased and immediately retired, all capital items
relating to the specific shares are removed from the
Ordinary Share Capital (old) (P50 x50,000) accounts.
P 2,500,000
Retirement of Share Capital
Ordinary Share Capital - new par (P40 x 50,000)
o Increase Earning Per Share
P 2,000,000 o Provide cash flow to shareholders in
Share Premium - Recapitalization 500,000 lieu of dividends
o Acquire shares when they appear to be
undervalued
4. Reduction of Stated Value o Buy out one or more particular
shareholders and to thwart takeover
Assuming that the stated value to reduced to P40 Par bids
per share to effect recapitalization, the journal entry o Reduce future dividends payments by
would be: reducing the shares outstanding
Ordinary Share Capital [(P50 -40) x50,000]
P 500,000
ILLUSTRATION
Share Premium - Recapitalization 500,000
Assume the following data of X Corporation:

• Ordinary shares (Issued and outstanding 10,000

5. Share Splits or Stock Splits shares, P10 par)2,000,000
• Share Premium in excess of par 200,000
A Stock Split is a share capital transaction which may
• Accumulated profits 500,000
change the number of original shares and par or stated
value per share but not the total amount of the share • Share capital is reacquired and immediately
capital of the company. This share capital change is retired, the following accounting procedures
effected only if authorized by the SEC. should be observed:

The change in the original number of shares may be:

1. Split up - An increase in the number of shares CASE 1: If the purchase price is equal (=) to par value or
outstanding resulting in a reduction in the par value (or stated value, debit the share capital and credit cash
stated value) per share share. It is made when the Assuming that the X Company retired 30% of the
corporation believes that a lower price of share capital outstanding shares at a retirement price of P100, the
would attract more investors to the company. journal entry would be:
2. Split down - A decrease in the number of shares Share Capital (P100 x 3,000 shares) P 300,000
outstanding with a corresponding increase in the par
value (stated value) per share. Also known as opposite Cash P 300,000
share split or reverse share split, usually happens when
the corporation determines that a higher price of share
capital would create prestige and other business CASE 2: If the purchase price is lesser (<) to par value or
advantages to the company. stated value, debit the share capital and credit cash and
share premium on share retirement (APIC)
ILLUSTRATION
Assuming that the X Company retired 30% of the
X Corporation decided to effect stock splits that for outstanding shares at a retirement price of P90, the
every 1 share such will be changed to 5 shares journal entry would be:
Methods of Accounting for share splits Share Capital (P100 x 3,000 shares) P 300,000
1. Memorandum Entry Method - A memorandum is to Cash (P90 x 3,000 shares) P 270,000
be made to record the split up as follows:
Share premium on share retirement 30,000
" Issued 250,000 (5 x 50,000) shares new ordinary
shares with par of P 10 (P50/5) per share, as a result of
a 5 for 1 split of 50,000 old ordinary shares with par
CASE 3: If the purchase price is greater than (>) to par
value of P50 per share "
value or stated value, the excess of cash payment over
2. Journal Entry Method - A journal entry to record the the par value or stated value may be:
split-up as follows:
a) Charged to additional paid in capital applicable to
that class of share capital when originally issued
b) Allocated between share premium (APIC) and
accumulated profits
c) Charged entirely to accumulated profits
Assuming that the X Company redeemed and retired
30% of the outstanding shares at a retirement price of
P130, the journal entry for the retirement would be:
Share Capital (P100 x 3,000 shares) P 300,000
Share Premium (P200,000 x 30%) 60,000
Accumulated Profits 30,000
Cash (P130 x 3,000 shares) P 390,000
Note: The P200,000 share premium (APIC) in excess
over par is not entirely charged to absorb the "loss" on
retirement of P90,000 (P390,000 - P300,000)
Retained Earnings Date of Record: The record date selected by the BOD is
stated in the declaration and it usually follows the
Retained Earnings (RE) declaration date by period of two (2) to three (3) weeks.
The account Retained Earnings (termed Accumulated On this date, a list of current shareholders who will be
Profits under IFRS) represents the firm's accumulated entitled to the dividend is prepared and the dividend
profit or loss, including prior-period adjustments less payment is based on this list. (No journal entry is made
the dividends declared and other amounts transferred on the date of record)
to the contributed capital accounts. Date of Payment or Distribution: This date is also
A debit balance in RE (deficit) would arise if the determined by the BOD and stated in the declaration.
accumulated losses and distributions exceeds the The date of payment typically follows the declaration
accumulated earnings. date by four (4) to six (6) weeks. On this date, an entry
is made in the books to record the settlement of the
The following transactions are the most common items dividend.
that affect the RE summarized in for form of increases
(credits) and decreases (debits) to the account
Forms of Dividend Distribution (kinds)
Dividends may take the following forms:
1. Cash Dividend
2. Property Dividend
3. Share Dividends (Bonus Issue)

Appropriation of Retained Earnings

Current PROFIT or (LOSS)
To indicate that a portion of retained earnings is
At the end of each accounting period, closing entries are unavailable for dividends, a corporation may
made to separate the effects of transactions of the appropriate or restrict retained earnings. An
current period with the ensuing period. The final closing appropriation of retained earnings involves the
entry in a corporation's books transfers the net profit or establishment of a formal policy by the BOD whereby a
loss to the Retained Earnings account. portion of retained earnings is earmarked for a
designated purpose and is unavailable for dividends.

CREDIT BALANCE OF P/L Summary indicating a PROFIT:

The BOD may appropriate retained earnings for the
Profit or Loss Summary P XXX
following reasons:
Retained Earnings P XXX
1. Legal Requirements - The Corporation Code of the
DEBIT BALANCE OF P/L Summary indicating a LOSS: Philippines requires of retained earnings when a
corporation reacquires of retained earnings when a
corporation reacquires its own shares as treasury. The
Retained Earnings P XXX amount of appropriation is equal to the cost of the
treasury shares.
Profit or Loss Summary P XXX
2. Contractual Agreements - As a result of a contractual
agreement, as when the corporation issues long-term
bonds, retained earnings may also be appropriated. This
Dividends
provides
A dividend is a distribution of corporate income to its
3. Discretionary Actions - Retained earnings may also
shareholders on a pro-rata basis. Potential buyers and
be appropriated as a result of management discretion.
seller of a corporation's shares are keenly interested in
This includes restriction related to planning for future
a company's dividend policies and practices. Dividends
expansion or in anticipation of potential future losses.
are distributed out of accumulated earnings of the
These may be called as retained earnings appropriated
corporation, except for a liquidating dividend that
for plant expansion or retained earnings appropriated
represents a return to the shareholders of their
for loss contingencies.
investment.
The power to declare dividends is vested upon the
BOARD OF DIRECTORS (BOD) of the corporation. Quasi- Reorganization
Three important dates noted in a formal dividend A corporation that incurs losses over a long period may
announcement: find itself in serious financial difficulty. With continued
losses, retained earnings may have been reduced to a
Date of Declaration: This is the date when the BOD
very low amount or to a deficit. Rather than enter into a
formally approves and announces the dividend. It is on
formal bankruptcy or other legal proceedings, it may be
this date that the reduction in retained earnings is
more beneficial for the corporation to establish a new
recognized in the accounts
management group and at the same time engage in a
process termed as quasi-reorganization.
Revaluation Surplus SMALL BONUS ISSUE
An entity may choose to value its property, plant and This is the type of issue that when the number of shares
equipment (PPEs) and intangible assets using either cost of the bonus issue represents less than 20% of the
model or revaluation model. shares previously outstanding. The current market value
of the additional shares should be transferred from
The choice of the model used is applicable to an entire retained earnings to paid-in capital accounts.
class of PPEs and Intangible Assets. The use of
revaluation model gives rise to an unrealized increment
in capital termed as revaluation surplus. This item is
reported in the stated of financial position as a separate LARGE BONUS ISSUE
item in the SHE's section. While, the proportion of the additional share issued is
large in relation to the total shares previously
outstanding (20% or more), the amount capitalized is
Cash Dividends equal to the par or stated value of the share capital.
This is the most common type of dividend. This dividend
is in fact when used without a qualifying adjective,
"dividend" refers to cash dividend. For a cash dividend Liquidating Dividends
to occur, a corporation must have retained earnings and Liquidating Dividends are those dividends declared and
adequate cash to pay the dividend. The cash dividend paid out of capital.
declaration may be expressed as a percentage (%) of
the par value of the share capital or as a peso amount These are in short, returns of capital, which in
per share. accordance with the trust fund doctrine, the capital
corporation shall only be returned to the shareholders
When Cash Dividends are declared, a current liability when the corporation is dissolved and liquidated.
(Cash Dividend Payable) is recognized in the accounts
with a corresponding charge to retained earnings. The An exception to the trust fund doctrine is when a
liability is extinguished upon payment. corporation is a wasting asset: such as a mining
corporation. A wasting asset corporation is allowed to
Note: Declaration of dividends decreases total SHE, include a return of capital as part of the dividends it
while payment of dividend decreases total ASSETS of declared.
the corporation.

Dividends on Ordinary and Preference Shares

Property Dividends
A corporation may issue two types of share capital -
A corporation occasionally declares dividend that is ordinary and preference shares.
payable in assets other cash. This property dividend
may be distributed in the form of equity or debt When there is only one (1) class of share capital, the
securities held in other companies in order to facilitate amount declared as dividend is payable to the ordinary
the divisibility and delivery of the assets to the shareholder. When there are two (2) classes of share
shareholders. However, the dividend may also be in the capital, it is necessary to apportion the cash dividend
form of any other non-cash assets designation by the declared between the ordinary and preference share.
BOD.
The International Financial Reporting Interpretations Dividends on Preference Shares
Committee (IFRIC) requires an entity to recognize
liability (Property Dividend Payable) for the dividend The preference shareholders are generally given priority
payable when it declares a distribution. Such liability over the corporate earnings and assets. This privilege is
shall be measured at the fair value of the assets to be commonly called "preferred as to dividends" and
distributed. "preferred as to assets"
1. Preferred as to dividends - The holder of preference
share is to receive dividends first before the ordinary
Share Dividends shareholders are paid dividends.
A share dividend is a pro-rata distribution of a 2. Preference as to Assets - The holder of preference
corporation's own shares to its shareholders. A bonus share is entitled to receive not only to the liquidating
issue usually consists of the same class of the shares; value but also to the amount of dividends in arrears.
that is, ordinary share dividend is declared on ordinary
shares outstanding. This is referred to as ordinary share
dividend or ordinary bonus issue. When the distribution
Dividends Rights of Preference Shares
is of a different class of share capital, it is referred to as
special share dividend or special bonus issue. The appointment of any cash dividend declared
between the ordinary and preference shareholders will
Unlike cash and property dividends, a bonus issue does
depend on the dividend right of the preference share
not affect total assets and total shareholders' equity
because it simply represents a transfer of capital from
retained earnings to contributed capital; this termed
capitalization. The total assets and total shareholders'
equity are the same before and after the declaration of
bonus issue.
The following are the preference share rights ILLUSTRATIVE PROBLEM
1. Cumulative Preference Share - The holder is entitled A. CASH DIVIDENDS
to any undeclared dividends accumulated each year
until paid. On April 1, 20x5, the board of directors of XYZ Co.
declared P 60 dividends per share to shareholders of
The dividends has to be declared by the BOD for it to record as of April 15, 20x5 for distribution on May 1 of
become payable. The undeclared dividend and unpaid the same year. Data of the company as of April 1, 20x5
dividends are called dividend in arrears. are as follows:
2. Participating Preference Share - The holder is
entitled to receive dividends in excess of the basic fixed
rate. Share capital, authorized capital 10,000 shares, P 100
par 800,000
Each preference share carries with it a certain interest
rate. The par value of outstanding shares times the Subscribed share capital 220,000
interest rate is the basic dividend. Share premium. 100,000
Based on the basic dividend right of the preference Retained Earnings. 454,000
shares mentioned above, the dividend right could be
expanded to the following combination features: Treasury shares at cost (P 120 per share) (144,000)

1. Noncumulative and nonparticipating Other components of equity 70,000

2. Noncumulative and participating Total shareholder's equity 1,500,000

3. Cumulative and nonparticipating

4. Cumulative and participating Required: Journal entries on April 1 and May 1, 20x5

In the absence of any indications, the preference shares Note that only the OUSTANDING SHARES are entitled to
as to dividends are assumed to be noncumulative and dividends.
nonparticipating. Shares issued (P 800,000 / P100 par) 8,000
The computation of dividend apportion between Shares subscribed (P220,000/ P 100 par) 2,200
ordinary and preference shares starts with the
determination of share capital entitled to dividends. The Treasury shares (P 144,000 / P 120 cost each) (1,200)
share capitals entitled to dividends are those which are
Number of Outstanding shares 9,000
outstanding. Outstanding shares are those which are
issued and subscribed less treasury stocks.
ACCOUNTING FOR DIVIDENDS
B. SCRIP DIVIDENDS C. PROPERTY DIVIDENDS

C PROPERTY DIVIDENDS
D. CHOICE BETWEEN CASH AND SHARE DIVIDENDS SHARE DIVIDENDS. TOTAL SHAREHOLDER's EQUITY
BEFORE AND AFTER the ISSUANCE of SHARE DIVIDENDS
*Property Dividends payable will be equal to the fair will NOT CHANGE.
value of each alternative considering the probability
that those alternative will be chosen
 FRACTIONAL SHARE WARRANTS Customers. When a customer is considering which
supplier to select for a major contract, it wants to
What if a shareholder holds 335 shares and the review their financial statements first, in order to judge
company declares 10% share dividend? The shareholder the financial ability of a supplier to remain in business
will receive 33.5 shares. The corporation can choose long enough to provide the goods or services mandated
one of the following options: in the contract.
* Issue fractional share warrants Employees. A company may elect to provide its financial
* Pay the shareholder an amount equal to the market statements to employees, along with a detailed
price of the fractional shares explanation of what the documents contain. This can be
used to increase the level of employee involvement in
* Require the shareholder to pay the sufficient amount and understanding of the business.
to receive a full share.
Government. A government in whose jurisdiction a
Example: Assume that a large bonus issue of 35,000 company is located will request financial statements in
shares declared includes 25,000 full shares and 10,000 order to determine whether the business paid the
fractional shares. The par value of the shares is P 10 per appropriate amount of taxes.
share.
Investment analysts. Outside analysts want to see
financial statements in order to decide whether they
should recommend the company's securities to their
clients.
Investors. Investors will likely require financial
statements to be provided, since they are the owners of
the business, and want to understand the performance
of their investment.
Lenders. An entity loaning money to an organization will
require financial statements in order to estimate the
ability of the borrower to pay back all loaned funds and
related interest charges.
Rating agencies. A credit rating agency will need to
review the financial statements in order to give a credit
rating to the company as a whole or to its securities.
Suppliers. Suppliers will require financial statements in
order to decide whether it is safe to extend credit to a
company.
Unions. A union needs the financial statements in order
Basic Financial Statement Analysis
to evaluate the ability of a business to pay
Financial Statement Analysis involves the evaluation of compensation and benefits to the union members that
an entity’s past performance, present condition and it represents.
business potentials by way of analyzing the financial
statements to obtain information about:
The following sections describe the two forms of ratio
Profitability of the business firm;Ability to meet
analysis.
company obligations;Safety of investment in the
business; andEffectiveness of management in running 1. Horizontal and Vertical Analysis
the firm.
2. Ratio Analysis

The Users of Financial Information and the Significance

of Financial Statement Analysis. Vertical and Horizontal Analysis

There are many users of the financial statements Vertical Analysis

produced by an organization. The following list Vertical Analysis is the process of comparing figures in
identifies the common users of financial statements, the financial statement of a single period. It involves
and the reasons why they need this information: conversion of amounts in the financial statement to a
common base. This is accomplished by expressing all
figures in the financial statement as percentages of an
Company Management. The management team needs important item such as total assets (in the balance
to understand the profitability, liquidity, and cash flows sheet) or net sales (in the income statement). These
of the organization every month, so that it can make converted statement are called common size
operational and financing decisions about the business. statements or percentage composition statements.
Competitors. Entities competing against a business will Percentage composition statements are used for
attempt to gain access to its financial statements, in comparing:
order to evaluate its financial condition. The knowledge
they gain could alter their competitive strategies. Multiple years of data from the same firmCompanies
that are different in sizeCompany to industry average
Horizontal Analysis
Horizontal analysis (also called “trend” or “index”
analysis) involves comparison of amounts shown in the
financial statement of two or more consecutive periods.
The difference and percentage change of the amounts
are calculated using the earlier period as the base
period. The below formula is considered:
Comparisons can be made between an actual amount
compared against a budgeted amount, with the budget
serving as the basis or pattern of performance.

Ratio Analysis Working Capital Activity Ratios. Working capital

turnover ratio is an activity ratio that measures dollars
Financial Ratios
of revenue generated per dollar of investment in
Financial ratios involve development of mathematical working capital. Working capital is defined as the
relationships among accounts found in the financial amount by which current assets exceed current
statements. Financial ratios provide relevant liabilities. A higher working capital turnover ratio is
information about the firm’s liquidity, solvency, better. It means that the company is utilizing its working
stability, profitability and other aspects of an entity’s capital more efficiently i.e. generating more revenue
financial situation and potential. using less investment.

Basic rules in computing financial ratios:

When calculation a ratio using balance sheet amounts
only, the numerator and and denominator should be
based on amounts as of the same balance sheet date.
The same is true for ratios using only income statement
numbers.If an income statement amount and a balance
sheet amount are used at the same time to calculate a
ratio, the balance sheet amount should be expressed as
an average for the time period represented by the
income statement amount.If the beginning balance of a
balance sheet account is not available and cannot be
computed from the given data, the ending balance of
the account is used to represent the average balance.If
sales and/or purchases are given without making
distinction as to whether made in cash or on credit,
assumptions are made depending on the ratio be
calculated
Turnover ratios; Sales and purchases are made on
creditCash flow ratios; Sales and purchases are made in
cashAs a rule, an operating year is assumed to have 360
days, unless specified otherwise. Solvency Ratios. Solvency refers to the ability of a
company to pay its debts. These ratios involve leverage
A 360-day year is generally preferred as this is
ratios which refer to how much of company’s resources
consistent with a 12-month year and a 30 days
are financed by debt and/or preferred equity, both of
month;Alternatively, a year may be comprised of 365
which require fixed payment of interests and dividends.
calendar days, 300 working days or any appropriate
number of days. (ReSA, 2018)
Financial ratios are categorized into (1) liquidity ratios,
(2) working capital activity ratios or efficiency ratios, (3)
solvency ratios, and (4) profitability ratios.

Liquidity Ratios. Liquidity refers to the company’s

ability to pay its current liabilities as they fall due.
Liquidity ratios are important because they show you
whether a business will be able to pay off its short term
debt. They focus on short term debt (current liabilities)
because liquidity is about daily income and expenses.
Profitability Ratios. Profitability ratios are a set of
measurements used to determine the ability of a
business to create earnings. These ratios are considered
to be favorable when they improve over a trend line or
are comparatively better than the results of
competitors. Profitability ratios are derived from a
comparison of revenues to difference groupings of
expenses within the income statement.