FINANCIAL ACCOUNTING AND REPORTING (FAR)

Final Exam Reviewer

Chapter 1
Introduction to Accounting

ACCOUNTING – process of identifying, recording, and communicating economic information that is

useful in making economic decisions.

ESSENTIAL ELEMENTS OF THE DEFINITION OF ACCOUNTING

a. Identifying- analyzes each business transaction and identifies whether the transaction is an
accountable event or non-accountable. ONLY ACCOUNTABLE EVENTS ARE RECORDED IN THE BOOK OF
ACCOUNTS.

 accountable events - those that affect the assets, liabilities, equity, income, or expenses of
a business.

b. Recording- accountant recognizes the identified

accountable events. This process is called journalizing.

 After the journalizing, it classifies the effects of the event on the “accounts”. The process is
called posting.
 Account- basic storage of information in
accounting

c. Communicating- at the end of each accounting period, the accountant summarizes the information
processed in the accounting system in order to produce meaningful reports.

 Information processed in the accounting system is useless unless it is communicated.

 Most common form of accounting reports is
financial statements

NATURE OF ACCOUNTING

Accounting is a process with a basic purpose of providing information about economic activities that is
intended to be useful in making economic decisions.

TYPES OF INFORMATION PROVIDED BY ACCOUNTING

1. Quantitative information- expressed in numbers, quantities, or units.

2. Qualitative information- expressed in words or descriptive form. It is found in the notes to
financial statements and in the face of other components of the financial system.
3. Financial information- expressed in money. It can also be a quantitative information because
monetary amounts are expressed in numbers.
ACCOUNTING AS SCIENCE AND ART

1. As a Social science, accounting is a body of knowledge which has been systematically gathered,
classified and organized.

2. Practical art, accounting requires the use of creative skills and judgment.

ACCOUNTING AS AN INFORMATION SYSTEM

*A system is one that consists of an input, process, and output.

In the accounting system, the inputs are the identified accountable events; the process are
recording, classifying and summarizing; the output is the accounting report that is
communicated to others.

BOOKKEEPING refers to the process of recording the accounts or transactions of an entity.

 Ends with trial balance

 Does not require interpretation of the significance of the information processed.

ACCOUNTING- covers the whole process of identifying, recording and communicating information to
interested users.

FUNCTIONS OF ACCOUNTING IN BUSINESS

Accounting is the language of business because it is fundamental to the communication of

financial information.

FUNCTIONS:

1. TO PROVIDE EXTERNAL USERS WITH INFORMATION THAT IS USEFUL IN MAKING INVESTMENT

AND CREDIT DECISIONS

2. TO PROVIDE INTERNAL USERS WITH INFORMATION THAT IS USEFUL IN MANAGING THE

BUSINESS.

USERS OF ACCOUNTING INFORMATION

1. INTERNAL USERS- DIRECTLY INVOLVED IN MANAGING THE BUSINESS

2. EXTERNAL USERS- NOT DIRECTLY INVOLVED IN MANAGING THE BUSINESS

TYPES OF ACCOUNTING INFORMATION

1. GENERAL PURPOSE ACCOUNTING INFORMATION- DESIGNED TO MEET THE COMMON NEEDS OF

MOST STATEMENT USERS.

 PROVIDED BY FINANCIAL ACCOUNTING AND PREPARED PRIMARILY FOR EXTERNAL USERS

2. SPECIAL PURPOSE ACCOUNTING INFORMATION- DESIGNED TO MEET THE SPECIFIC NEEDS OF
PARTICULAR STATEMENT USERS.

 PROVIDED BY MANAGEMENT ACCOUNTING AND PREPARED PRIMARILY FOR EXTERNAL

USERS.

BRIEF HISTORY OF ACCOUNTING

 SINCE THE DAWN OF CIVILIZATION WHEN MANKIND BEGAN TO ENGAGE IN TRADE, MORE
THAN 10,000 YEARS AGO, METHODS OF RECORD KEEPING AND ACCOUNTING HAVE BEEN
INVENTED.
 8500 BC, ACCOUNTING HAS ALREADY EXISTED
 TOKENS: CONES, DISKS, SPHERES, PELLETS,
WET CLAY TABLETS
 MESOPOTAMIA, BABYLONIA, EGYPT, CHINA
AND GREECE WERE PLACES THAT WERE KEEPING ACCOUNT RECORDS.
 1211 AD, ONE OF THE SYSTEMS IN ACCOUNTING WAS KEPT BY A FLORENTINE BANKER.
HOWEVER, CONCEPT OF EQUALITY FOR ENTRIES WAS ABSENT.
 DOUBLE ENTRY RECORDS FIRST CAME OUT
DURING 1340 A.D. IN GENOA.
 FRA LUCA PACIOLO (FATHER OF MODERN ACCOUNTING) FORMULATED THE “DOUBLE
ENTRY RECORDING SYSTEM” IN 1494 AND WAS INCLUDED IN HIS BOOK “SUMMA DE
ARITHMETICA GEOMETRIA PROPORTIONI AND PROPORTION VISTA”

COMMON BRANCHES OF ACCOUNTING

1. FINANCIAL ACCOUNTING- FOCUSES ON GENERAL PURPOSE FINANCIAL STATEMENTS

 GOVERNED BY PFRS
 GENERAL PURPOSE FINANCIAL STATEMENTS- CATER TO THE COMMON NEEDS OF EXTERNAL
USERS, PRIMARILY THE POTENTIAL AND EXISTING INVESTORS, LENDERS AND
OTHER CREDITORS

FINANCIAL ACCOUNTING VS. FINANCIAL REPORTING

- BOTH FOCUS ON GENERAL PURPOSE FINANCIAL STATEMENTS. HOWEVER, FINANCIAL

REPORTING ENDEAVORS TO PROMOTE PRINCIPLES THAT ARE USEFUL TO “OTHER
FINANCIAL REPORTING”

“OTHER FINANCIAL REPORTING”- COMPRISES INFORMATION PROVIDED OUTSIDE THE FINANCIAL

STATEMENTS THAT ASSISTS IN THE INTERPRETATION OF A COMPLETE SET OF Financial Statement.

FINANCIAL sTATEMENTS- STRUCTURED REPRESENTATION OF AN ENTITY’S FINANCIAL POSITION

AND RESULTS OF ITS OPERATIONS. IT IS THE END PRODUCT OF THE ACCOUNTING PROCESS.

 FINANCIAL REPORT- INCLUDES THE FINANCIAL STATEMENTS PLUS OTHER INFORMATION

PROVIDED OUTSIDE THE FINANCIAL STATEMENTS

PRIMARY OBJECTIVE OF FR
 - PROVIDE INFORMATION ABOUT AN ENTITY’S ECONOMIC RESOURCES (ASSETS), CLAIMS
TO THOSE RESOURCES (Liabilities and equity), AND CHANGES IN THOSE RESOURCES
(INCOME, EXPENSES, AND OTHER CHANGES)

SECONDARY OBJECTIVE OF FR
-PROVIDE INFORMATION USEFUL IN ASSESSING THE ENTITY’S
MANAGEMENT STEWARDSHIP

2. MANAGEMENT ACCOUNTING- INVOLVE IN THE ACCUMULATION AND COMMUNICATION OF

INFORMATION FOR USE BY INTERNAL USERS. AN OFFSHOOT OF MANAGEMENT ACCOUNTING IS
MANAGEMENT ADVISORY SERVICES.

3. GOVERNMENT ACCOUNTING ACCOUNTING FOR THE GOVERNMENT AND ITS INSTRUMENTALITIES,

FOCUSING ATTENTION ON THE CUSTODY OF PUBLIC FUNDS, PURPOSE TO WHICH THOSE FUNDS
ARE COMMITTED, AND THE RESPONSIBILITY AND ACCOUNTABILITY OF THE INDIVIDUALS ENTRUSTED
WITH THOSE FUNDS.

4. AUDITING- INVOLVES THE INSPECTION OF AN ENTITY’S FINANCIAL STATEMENTS TO ASCERTAIN

THEIR CORRESPONDENCE WITH AN ESTABLISHED CRITERIA.

5. TAX ACCOUNTING- PREPARATION OF TAX RETURNS AND RENDERING OF TAX ADVICE

TYPES OF BUSINESS ACCORDING TO ACTIVITIES

1. SERVICE BUSINESS- ONE THAT OFFERS SERVICES AS ITS MAIN PRODUCT RATHER THAN PHYSICAL
GOODS. IT MAY OFFER PROFESSIONAL SKILLS, EXPERTISE, ADVICE, LENDING SERVICE, AND
SIMILAR SERVICES.

2. MERCHANDISING BUSINESS (TRADING BUSINESS)- ONE THAT BUYS AND SELLS GOODS
WITHOUT CHANGING THEIR PHYSICAL FORM.

3. MANUFACTURING BUSINESS- ONE THAT BUYS RAW MATERIALS AND PROCESSES THEM
INTO FINAL PRODUCTS. IT CHANGES THE PHYSICAL FORM OF THE GOODS IT HAS PURCHASED IN A
PRODUCTION PROCESS.

 SOME BUSINESS, CALLED HYBRID BUSINESS, ENGAGE IN MORE THAN ONE TYPE OF ACTIVITY.
 Chapter 2
ACCOUNTING CONCEPTS AND PRINCIPLES

ACCOUNTING CONCEPTS AND PRINCIPLES

(ASSUMPTIONS OR POSTULATES)- SET OF LOGICAL IDEAS AND PROCEDURES THAT GUIDE THE
ACCOUNTANT IN RECORDING AND COMMUNICATING ECONOMIC INFORMATION. THEY PROVIDE A
GENERAL FRAME OF REFERENCE BY WHICH ACCOUNTING PRACTICE CAN BE EVALUATED AND THEY
SERVE AS GUIDE IN THE DEVELOPMENT OF NEW PRACTICES AND PROCEDURES.

 PROVIDE REASONABLE ASSURANCE THAT INFORMATION COMMUNICATED TO USERS IS

PREPARED IN A PROPER WAY.

BASIC ACCOUNTING CONCEPTS

- CONCEPTS AND PRINCIPLES ARE SOURCED FROM THE STANDARDS (PFRS),

THE CONCEPTUAL FRAMEWORK FOR FINANCIAL REPORTING, OR GENERAL ACCEPTANCE IN
THE PROFESSION DUE TO LONG-TIME USE. BELOW ARE THE BASIC AND COMMON
ACCOUNTING CONCEPTS AND PRINCIPLES:

1. SEPARATE ENTITY CONCEPT- BUSINESS IS VIEWED AS A SEPARATE PERSON, DISTINCT FROM ITS
OWNERS. ONLY THE TRANSACTIONS OF THE BUSINESS ARE RECORDED IN THE BOOKS OF
ACCOUNTS.

 THE APPLICATION OF THE SEPARATE ENTITY CONCEPT IS NECESSARY SO THAT THE

FINANCIAL POSITION AND FINANCIAL PERFORMANCE OF A BUSINESS CAN BE MEASURED
PROPERLY.

2. HISTORICAL COST CONCEPT- ASSETS ARE INITIALLY RECORDED AT THEIR ACQUISITION COST.

3. GOING CONCERN ASSUMPTION- BUSINESS IS ASSUMED TO CONTINUE TO EXIST FOR AN INDEFINITE

PERIOD OF TIME. THIS IS NECESSARY FOR ACCOUNTING MEASUREMENTS TO BE MEANINGFUL.
 OPPOSITE OF THIS IS LIQUIDATING CONCERN.
THE ASSETS OF A LIQUIDATING CONCERN ARE MEASURED AT NET SELLING PRICE.

4. MATCHING (ASSOCIATION OF CAUSE AND EFFECT)- SOME COSTS ARE INITIALLY RECOGNIZED AS
ASSETS AND CHARGED AS EXPENSES ONLY WHEN THE RELATED REVENUE IS RECOGNIZED.

5. ACCRUAL BASIS OF ACCOUNTING- ECONOMIC EVENTS ARE RECORDED IN THE PERIOD IN WHICH
THEY OCCUR RATHER THAN AT THE POINT IN TIME WHEN THEY AFFECT CASH.
6. PRUDENCE OR CONSERVATISM- ACCOUNTANT OBSERVES SOME DEGREE OF CAUTION WHEN
EXERCISING JUDGMENTS NEEDED IN MAKING ACCOUNTING ESTIMATES UNDER CONDITIONS OF
UNCERTAINTY.

7. TIME PERIOD (PERIODICITY, ACCOUNTING PERIOD, REPORTING PERIOD CONCEPTS)- THE

LIFE OF THE BUSINESS IS DIVIDED INTO SERIES OF REPORTING PERIODS.

 THE LIFE OF THE BUSINESS IS DIVIDED INTO SERIES OF EQUAL SHORT PERIODS
CALLED REPORTING PERIOD OR ACCOUNTING PERIOD.
 A REPORTING PERIOD IS USUALLY 12 MONTHS, CAN EITHER BE A CALENDAR YEAR PERIOD OR A
FISCAL YEAR PERIOD.
 AN ACCOUNTING PERIOD THAT IS SHORTER
THAN 12 MONTHS IS CALLED “INTERIM PERIOD”

CALENDAR YEAR PERIOD- STARTS ON JANUARY 1 AND ENDS ON DECEMBER 31 OF THE SAME YEAR

FISCAL YEAR PERIOD- COVERS 12 MONTHS BUT STARTS ON A DATE OTHER THAN JANUARY 1

8. STABLE MONETARY UNIT- ASSETS, LIABILITIES, EQUITY, INCOME, AND EXPENSES ARE STATED
IN TERMS OF A COMMON UNIT OF MEASURE, WHICH IS THE PESO IN THE PHILIPPINES. PURCHASING
POWER OF THE PESO IS REGARDED AS STABLE.

9. MATERIALITY CONCEPT- THIS GUIDES THE ACCOUNTANT WHEN APPLYING ACCOUNTING

PRINCIPLES. THIS IS BECAUSE ACCOUNTING PRINCIPLES ARE APPLICABLE ONLY TO MATERIAL ITEMS.

 AN ITEM IS CONSIDERED MATERIAL IF ITS OMISSION OR MISSTATEMENT COULD

INFLUENCE ECONOMIC DECISIONS.
 MATERIALITY IS A MATTER OF PROFESSIONAL JUDGMENT AND IS BASED ON SIZE AND
NATURE OF AN ITEM.

 ACCOUNTING PRINCIPLES DO NOT SPECIFY A CERTAIN AMOUNT THAT IS

CONSIDERED MATERIAL

10. COST-BENEFIT (COST CONSTRAINT)- THE COSTS OF PROCESSING AND COMMUNICATING

INFORMATION SHOULD NOT EXCEED THE BENEFITS TO BE DERIVED FROM THE INFORMATION’S
USE.

11. FULL DISCLOSURE PRINCIPLE- RELATED TO BOTH THE CONCEPTS OF MATERIALITY AND COST-
BENEFIT. UNDER THIS, INFORMATION COMMUNICATED TO USERS REFLECT A SERIES OF
JUDGMENTAL TRADE-OFFS THAT STRIVE FOR:

A. SUFFICIENT DETAIL TO DISCLOSURE MATTERS THAT MAKE A DIFFERENCE TO USERS, YET

B. SUFFICIENT CONDENSATION TO MAKE THE INFORMATION UNDERSTANDABLE, KEEPING IN

MIND THE COSTS OF PREPARING AND USING IT.

12. CONSISTENCY CONCEPT- THIS CONCEPT REQUIRES A BUSINESS TO APPLY ACCOUNTING

POLICIES CONSISTENTLY, AND PRESENT INFORMATION CONSISTENTLY, FROM ONE PERIOD
TO ANOTHER.
  ACCOUNTING POLICIES CAN BE CHANGED IF IT IS REQUIRED BY A STANDARD OF THE
CHANGE WOULD RESULT IN MORE RELEVANT AND MORE RELIABLE INFORMATION.

ACCOUNTING STANDARDS

- ACCOUNTING CONCEPTS AND PRINCIPLES ARE EITHER EXPLICIT OR IMPLICIT.

EXPLICIT- THOSE THAT ARE SPECIFICALLY MENTIONED IN THE CONCEPTUAL FRAMEWORK FOR
FINANCIAL REPORTING AND IN THE PHILIPPINE FINANCIAL REPORTING STANDARDS (PFRS).

IMPLICIT- NOT SPECIFICALLY MENTIONED IN THE FOREGOING BUT ARE CUSTOMARILY USED
BECAUSE OF THEIR GENERAL AND LONGTIME ACCEPTANCE WITHIN THE ACCOUNTANCY
PROFESSION.

RELEVANT REGULATORY BODIES

1. SECURITIES AND EXCHANGE COMMISSION-TASKED TO REGULATE CORPORATIONS, INCLUDING

PARTNERSHIP. IT REQUIRES BOTH TO FILE AUDITED FINANCIAL STATEMENTS.

2.BUREAU OF INTERNAL REVENUE- TASKED IN COLLECTING NATIONAL TAXES AND

ADMINISTERING THE PROVISIONS OF THE TAX CODE.

3. BANGKO SENTRAL NG PILIPINAS- TASKED IN REGULATING BANKS AND OTHER ENTITIES

PERFORMING BANKING FUNCTIONS. IT INFLUENCES THE SELECTION AND APPLICATION OF
ACCOUNTING POLICIES BY THESE BUSINESS.

4. COOPERATIVE DEVELOPMENT AUTHORITY- TASKED IN REGULATING COOPERATIVES. IT

INFLUENCES THE SELECTION AND APPLICATION OF ACCOUNTING POLICIES BY COOPERATIVES.

THE CONCEPTUAL FRAMEWORK FOR FINANCIAL REPORTING

- ALSO PRESCRIBES ACCOUNTING CONCEPTS THAT ARE RELEVANT TO THE PREPARATION OF

FINANCIAL STATEMENTS.
- IT IS NOT A STANDARD. IT SERVES AS A GENERAL
FRAME OF REFERENCE DEVELOPING THE STANDARDS.

QUALITATIVE CHARACTERISTICS OF USEFUL FINANCIAL INFORMATION

QUALITATIVE CHARACTERISTICS- TRAITS THAT DETERMINE WHETHER AN ITEM OF INFORMATION IS

USEFUL TO OTHERS. WITHOUT THESE, INFORMATION MAY BE DEEMED USELESS. THESE ARE
BROADLY CLASSIFIED INTO TWO:

A. FUNDAMENTAL QUALITATIVE CHARACTERISTICS- MAKE INFORMATION USEFUL TO OTHERS.

CONSIST OF THE FOLLOWING:

1. RELEVANCE- CAN AFFECT THE DECISIONS OF USERS. WITHOUT THIS TRAIT, INFORMATION
IS DEEMED USELESS. THREE ASPECTS:

 PREDICTIVE VALUE- IF IT CAN HELP USERS TO MAKE PREDICTIONS ABOUT FUTURE OUTCOMES
 CONFIRMATORY VALUE (FEEDBACK VALUE)- IF IT CAN HELP USERS CONFIRM THEIR PAST
PREDICTIONS
  MATERIALITY- IS AN ENTITY-SPECIFIC ASPECT OF RELEVANCE, MEANING IT DEPENDS ON THE
FACTS AND CIRCUMSTANCES SURROUNDING A SPECIFIC ENTITY.

2. FAITHFUL REPRESENTATION- IF IT IS FACTUAL, MEANING IT REPRESENTS THE ACTUAL

EFFECTS THAT HAVE TAKEN PLACE. THREE ASPECTS:

 COMPLETENESS- ALL INFORMATION FOR USERS TO HAVE A COMPLETE UNDERSTANDING OF THE

FS IS PROVIDED
 NEUTRALITY- INFORMATION IS SELECTED WITHOUT BIAS, NOT MANIPULATED.
 FREE FROM ERROR- INFORMATION IS NOT MATERIALLY MISSTATED. THIS DOES NOT MEAN
THAT INFORMATION MUST BE PERFECTLY ACCURATE. THIS MEANS THAT THERE ARE NO ERRORS
IN THE DESCRIPTION AND IN THE PROCESS BY WHICH THE INFORMATION IS SELECTED AND
APPLIED.

B. ENHANCING QUALITATIVE CHARACTERISTICS- SUPPORT THE FUNDAMENTAL CHARACTERISTICS.

THEY ENHANCE THE USEFULNESS OF INFORMATION. CONSIST OF THE FOLLOWING:

1. COMPARABILITY- IF IT CAN HELP USERS IDENTIFY SIMILARITIES AND DIFFERENCES BETWEEN

SETS OF INFORMATION.

2. VERIFIABILITY- IF DIFFERENT USERS COULD REACH A GENERAL AGREEMENT AS TO WHAT THE

INFORMATION INTENDS TO PRESENT.

3. TIMELINESS- IF IT IS AVAILABLE TO USERS IN TIME TO BE ABLE TO INFLUENCE THEIR DECISIONS.

4. UNDERSTANDABILITY- IF IT IS PRESENTED IN A CLEAR AND CONCISE MANNER.

 Chapter 3
The Accounting Equation

THE BASIC ACCOUNTING EQUATION

ASSETS= LIABILITIES + EQUITY

ASSETS

-ECONOMIC RESOURCES YOU CONTROL THAT HAVE RESULTED FROM PAST EVENTS AND CAN
PROVIDE YOU WITH ECONOMIC BENEFITS.

CONTROL

-OWNERSHIP IS NOT NECESSARY TO HAVE CONTROL.

-WHAT IS IMPORTANT IS THAT YOU CONTROL THE RIGHT OVER THE ECONOMIC BENEFITS THAT THE
RESOURCE MAY PRODUCE.

-CONTROL MEANS YOU HAVE THE EXCLUSIVE RIGHT TO ENJOY THOSE BENEFITS AND THE ABILITY
TO PREVENT OTHERS FROM ENJOYING THOSE

PAST EVENTS

-THE CONTROL OF AN ECONOMIC RESOURCE HAS RESULTED FROM A PAST EVENT OR TRANSACTION.

-RESOURCES FOR WHICH CONTROL IS YET TO BE OBTAINED IN THE FUTURE DO NOT QUALIFY AS
ASSETS IN THE PRESENT.

-PHYSICAL POSSESSION IS ALSO NOT NECESSARY FOR CONTROL TO EXIST. (EX. MONEY IN THE BANK)

ECONOMIC BENEFITS

-TO BE AN ASSET, THE ECONOMIC RESOURCE MUST HAVE THE POTENTIAL TO PROVIDE YOU WITH
ECONOMIC BENEFITS IN AT LEAST ONE CIRCUMSTANCE.

-EXAMPLES: THE ECONOMIC RESOURCE CAN BE

1. SOLD, LEASED, TRANSFERRED OR EXCHANGED FOR OTHER ASSETS

2. USED SINGLY OR IN COMBINATION WITH OTHER ASSETS TO PRODUCE GOODS OR PROVIDE

SERVICES
 3. USED TO ENHANCE THE VALUE OF OTHER ASSETS

4. USED TO PROMOTE EFFICIENCY AND COST SAVINGS

5. USED TO SETTLE A LIABILITY

LIABILITIES

-PRESENT OBLIGATIONS THAT HAVE RESULTED FROM PAST EVENTS AND CAN REQUIRE YOU TO GIVE
UP ECONOMIC RESOURCES
WHEN SETTLING THEM.

OBLIGATION

-OBLIGATION MEANS A DUTY OR RESPONSIBILITY. IT CAN EITHER BE:

A. LEGAL OBLIGATION- AN OBLIGATION THAT RESULTS A FROM A CONTRACT, LEGISLATION OR

OTHER OPERATION OF LAW

B. CONSTRUCTIVE OBLIGATION- AN OBLIGATION THAT RESULTS FROM YOUR PAST ACTIONS (PAST
PRACTICE OR PUBLISHED POLICIES) THAT HAVE CREATED A VALID EXPECTATION ON OTHERS THAT
YOU WILL ACCEPT AND DISCHARGE CERTAIN RESPONSIBILITIES.

EQUITY

-ASSETS MINUS LIABILITIES

-CAPITAL, NET ASSETS, NET WORTH

*LIABILITIES REPRESENT THE CREDITORS’ CLAIM WHILE EQUITY REPRESENTS THE OWNERS’ CLAIM,
AGAINST THE TOTAL ASSETS OF THE BUSINESS.

*THE QUALITY OF THE ACCOUNTING EQUATION MUST BE MAINTAINED IN ALL THE ACCOUNTING
PROCESSES OF RECORDING, CLASSIFYING AND SUMMARIZING.

THE EXPANDED ACCOUNTING EQUATION

-SHOWS ALL THE FINANCIAL STATEMENT ELEMENTS

ASSETS= LIABILITIES +EQUITY +INCOME – EXPENSES

INCOME

-INCREASES IN ECONOMIC BENEFITS DURING THE PERIOD IN THE FORM OF INCREASES IN ASSETS, OR
DECREASES IN LIABILITIES THAT RESULT IN INCREASES IN EQUITY.

EXPENSES
-ARE DECREASES IN ECONOMIC BENEFITS DURING THE PERIOD IN THE FORM OF DECREASES IN ASSETS
OR INCREASES IN LIABILITIES, THAT RESULT IN DECREASES IN EQUITY, EXCLUDING THOSE RELATING TO
DISTRIBUTIONS TO THE BUSINESS OWNERS.

*the difference between income and expense represents PROFIT OR LOSS

-If income is greater than expenses, the difference is profit.
-if income is less than expenses, the difference is loss.
Chapter 4
Types of Major Accounts

THE ACCOUNT
-BASIC STORAGE OF INFORMATION IN ACCOUNTING

-RECORD OF INCREASES AND DECREASES IN A SPECIFIC ITEM OF ASSET, LIABILITY, EQUITY, INCOME OR
EXPENSE

-IT CAN BE DEPICTED THROUGH A “T-ACCOUNT”

-THE T ACCOUNT HAS THREE PARTS

A. ACCOUNT TITLE- DESCRIBES THE SPECIFIC ITEM OF ASSET LIABILITY, EQUITY, INCOME OR
EXPENSE
B. DEBIT SIDE- LEFT SIDE OF THE ACCOUNT
C. CREDIT SIDE- RIGHT SIDE OF THE ACCOUNT

Debit (Dr.)- value received

Credit (Cr.)- value parted with

Balance- difference between the total debits and credits

THE FIVE MAJOR ACCOUNTS

-ELEMENTS OF FINANCIAL STATEMENTS

1. ASSETS ARE THE ECONOMIC RESOURCES YOU CONTROL THAT HAVE RESULTED FROM PAST EVENTS
AND CAN PROVIDE YOU WITH FUTURE ECONOMIC BENEFITS.

2. LIABILITIES- ARE YOUR PRESENT OBLIGATIONS THAT HAVE RESULTED FROM PAST EVENTS AND
CAN REQUIRE YOU TO GIVE UP RESOURCES WHEN SETTLING THEM.

3. EQUITY- ASSETS MINUS LIABILITIES

4.INCOME- INCREASES IN ECONOMIC BENEFITS DURING THE PERIOD IN THE FORM OF INCREASES IN
ASSETS, OR DECREASES IN LIABILITIES, THAT RESULT IN INCREASES IN EQUITY, EXCLUDING THOSE
RELATING TO INVESTMENTS BY THE BUSINESS OWNER.

-INCLUDES BOTH REVENUE AND GAINS

A. REVENUE- ARISES IN THE COURSE OF THE ORDINARY ACTIVITIES OF A BUSINESS (SALES,
SERVICE FEES)

B.GAINS- REPRESENT OTHER ITEMS THAT MEET THE DEFINITION OF INCOME AND MAY OR MAY NOT
ARISE IN THE COURSE OF THE ORDINARY ACTIVITIES OF THE ENTITY.

-CARRYING AMOUNT- NET AMOUNT TO WHICH AN ITEM IS CARRIED OR RECORDED IN THE

BOOKS OF ACCOUNTS

5. EXPENSES- ARE DECREASES IN ECONOMIC BENEFITS DURING THE PERIOD IN THE FORM OF
DECREASES IN ASSETS OR INCREASES IN LIABILITIES THAT RESULT IN DECREASES IN EQUITY
EXCLUDING THOSE RELATING TO DISTRIBUTIONS TO THE BUSINESS OWNER.

-INCLUDE BOTH EXPENSES AND LOSSES

A. EXPENSES- ARISE IN THE COURSE OF THE ORDINARY ACTIVITIES OF A BUSINESS

B. LOSSES- REPRESENT OTHER ITEMS THAT MEET THE DEFINITION OF EXPENSES AND MAY OR MAY
NOT ARISE IN THE COURSE OF THE ORDINARY ACTIVITIES OF THE ENTITY.

“CLASSIFICATION OF THE FIVE MAJOR ACCOUNTS”

BALANCE SHEET ACCOUNTS

-ASSETS, LIABILITIES, EQUITY

INCOME STATEMENT ACCOUNTS

-INCOME AND EXPENSES

BALANCE SHEET/STATEMENT OF FINANCIAL POSITION- ONE OF THE COMPONENTS OF A COMPLETE

SET OF FS. IT SHOWS THE FINANCIAL POSITION OF THE BUSINESS.

INCOME STATEMENT- A SUB-COMPONENT OF THE STATEMENT OF COMPREHENSIVE INCOME (ALSO

A COMPONENT OF COMPLETE FS), IT SHOWS THE PROFIT OR LOSS OF THE BUSINESS.

CHART OF ACCOUNTS- LIST OF ALL ACCOUNTS USED BY A BUSINESS

ACCOUNT NUMBERS- ASSIGNED TO THE ACCOUNTS TO FACILITATE RECORDING, CROSS-REFERENCING,

AND RETRIEVAL OF INFORMATION.

COMMON ACCOUNT TITLES

BALANCE SHEET ACCOUNTS
ASSETS
1. CASH- MONEY OR EQUIVALENT READILY AVAILABLE FOR UNRESTRICTED USE (ON HAND OR IN
BANK)
2. ACCOUNTS RECEIVABLE- RECEIVABLES SUPPORTED BY ORAL INFORMAL PROMISES TO PAY
3. ALLOWANCE FOR BAD DEBTS- ESTIMATED LOSSES FROM UNCOLLECTIBLE ACCOUNTS RECEIVABLE
(ALLOWANCE FOR DOUBTFUL ACCOUNTS)
4. NOTES RECEIVABLE- SUPPORTED BY WRITTEN OR FORMAL PROMISES TO PAY (PROMISSORY
NOTES)
5. INVENTORY- GOODS HELD FOR SALE, UNDERGOING THE PROCESS OF PRODUCTION AND RAW
MATERIALS
6. PREPAID SUPPLIES- UNUSED OFFICE AND OTHER SUPPLIES
7. PREPAID RENT- RENT PAID IN ADVANCE
8. PREPAID INSURANCE- INSURANCE PAID IN ADVANCE
9. LAND- LOT ON WHICH THE BUILDING OF THE BUSINESS IS CONSTRUCTED
10. BUILDING- STRUCTURE OWNED BY A BUSINESS
11. ACCUMULATED DEPRECIATION-BUILDING- TOTAL AMOUNT DEPRECIATION EXPENSES RECOGNIZED
SINCE THE BUILDING WAS ACQUIRED AND USED
12. EQUIPMENT- MACHINERIES, TRANSPORTATION EQUIPMENT, OFFICE EQUIPMENT, COMPUTER
EQUIPMENT, FURNITURE AND FIXTURES
13. ACCUMULATED DEPRECIATION-EQUIPMENT- TOTAL AMOUNT OF DEPRECIATION EXPENSES
RECOGNIZED SINCE THE EQUIPMENT WAS ACQUIRED AND MADE AVAILABLE FOR USE

LIABILITIES
1. ACCOUNTS PAYABLE- OBLIGATIONS SUPPORTED BY ORAL OR INFORMAL PROMISES TO PAY
2. NOTES PAYABLE- SUPPORTED BY PROMISSORY NOTES
3. INTEREST PAYABLE- INTEREST INCURRED BUT NOT YET PAID
4. SALARIES PAYABLE- EARNED BY EMPLOYEES BUT NOT YET PAID BY THE BUSINESS
5. UTILITIES PAYABLE- UTILITIES (ELECTRICITY, WATER,ETC) ALREADY USED BUT NOT YET PAID
6. UNEARNED INCOME- COLLECTED IN ADVANCE BEFORE THEY ARE EARNED.

EQUITY
1. OWNER’S CAPITAL (OR OWNER’S EQUITY)- THE RESIDUAL AMOUNT AFTER DEDUCTING
LIABILITIES FROM ASSETS. INCREASED BY CONTRIBUTIONS, PROFITS. DECREASED
BY WITHDRAWALS, DISTRIBUTIONS, LOSSES.
2. OWNER’S DRAWINGS- TEMPORARY WITHDRAWALS OF
THE OWNER. CLOSED TO THE OWNER'S CAPITAL ACCOUNT.

INCOME STATEMENT ACCOUNTS

INCOME
1. SERVICE FEES- EARNED FROM RENDERING SERVICES
2. SALES- EARNED FROM SALE OF GOODS
3. INTEREST INCOME- EARNED FROM ISSUANCE OF INTEREST- BEARING RECEIVABLES
4. GAINS- EARNED FROM SALE OF ASSETS OF ENHANCEMENT OF ASSETS OR DECREASES IN
LIABILITIES THAT ARE NOT CLASSIFIED AS REVENUE.

EXPENSES

1. COST OF SALES/COST OF GOODS SOLD- VALUE OF INVENTORIES SOLD DURING THE

PERIOD
 2. FREIGHT-OUT- SELLERS’ COST OF DELIVERING GOODS.
DELIVERY EXPENSE, TRANSPORTATION-OUT, CARRIAGE OUTWARDS
3. SALARIES EXPENSE- SALARIES EARNED BY EMPLOYEES
4. RENT EXPENSE- RENTALS USED UP DURING THE PERIOD
5. UTILITIES EXPENSE- COST OF UTILITIES EARNED DURING THE PERIOD
6. SUPPLIES EXPENSE- COST OF SUPPLIES USED UP
7. BAD DEBT EXPENSE- ESTIMATED LOSSES FROM UNCOLLECTIBLE ACCOUNTS (DOUBTFUL
ACCOUNTS EXPENSE)
8. DEPRECIATION EXPENSE- DEPRECIATION FOR THE PERIOD
9. ADVERTISING EXPENSE- COST PROMOTIONAL OR MARKETING ACTIVITIES
10. INSURANCE EXPENSE- COST OF INSURANCE DURING THE PERIOD
11. TAXES AND LICENSES- COST OF BUSINESS AND LOCAL TAXES REQUIRED BY THE GOVERNMENT
(PARTNERSHIPS AND CORPORATIONS- INCOME TAX EXPENSE)
12. TRANSPORTATION EXPENSES- COST OF EMPLOYEES GETTING FROM ONE WORKPLACE TO
ANOTHER (REIMBURSABLE)
13. TRAVEL EXPENSES- BUSINESS TRIPS
14. INTEREST EXPENSE- COST OF BORROWING MONEY
15. MISCELLANEOUS EXPENSE- SMALL EXPENDITURES
16. LOSSES- EXPENSES WHICH MAY OR MAY NOT ARISE FROM THE ORDINARY COURSE OF THE
BUSINESS (SELLING ASSETS LESS THAN THE CARRYING AMOUNT, DECREASE IN THE VALUE OF ASSETS
BECAUSE OF DESTRUCTION, DAMAGES,ETC.)
 Chapter 5
Books of Accounts and Double Entry System

The Books of Accounts

Journal – “book of original entries”, the accounting record where business transactions are first
recorded. The recording process is called journalizing.

1. Special Journal – to record transactions of a similar nature. It simplifies the recording

process, an efficient way of recording and retrieving information.
Examples:
a. Sales Journal – is used to record sales on account
b. Purchases journal – to record purchases of inventory on account
c. Cash receipts journal – to record all transactions involving receipts of cash
d. Cash disbursements journal – to record transactions involving payments of cash
2. General journal – if it can’t be recorded in the special journal then record it in the general
journal

Ledger – “book of secondary entries” or “book of final entries”

a. General Ledger – all accounts appearing in the trial balance

b. Subsidiary Ledger – provides a breakdown of the balances of the controlling accounts

Controlling account – one that consists of a group of accounts with similar nature. Not all accounts
in the general ledger though are controlling accounts. Only those whose balances necessarily need
a breakdown are considered controlling accounts.

Double-entry – under this system, each transaction is recorded in two parts – debit and credit. This
is in order for the accounting equation to be balanced at all times.

Concepts of Duality and Equilibrium

a. Concept of Duality – views each transaction as having a two-fold effect on values – a value
received and a value parted with, and each transaction is recorded using at least two
accounts.
b. Concept of Equilibrium – requires that each transaction is recorded in terms of equal debits
and credits.

Normal Balances of accounts

TYPE OF ACCOUNT Normal balance Normal balance

(increase) (decrease)
ASSET DEBIT CREDIT
LIABILITY CREDIT DEBIT
EQUITY CREDIT DEBIT Assets + Expenses =
Liabilities + Equity +
INCOME CREDIT DEBIT
Income
EXPENSE DEBIT CREDIT
*Dr - Left side; Cr- right side

Contra and Adjunct accounts

a. Contra accounts are presented in the financial statement as deduction to their related
accounts.
b. Adjunct accounts are presented in the financial statements as addition to their related
accounts.

Net Carrying amount – the sum of the balances of an account and its related contra or adjunct
account.
 Chapter 6
Business transactions and their analysis

Business transactions and their analysis

The accounting cycle – represents the steps or procedures used to record transactions and
prepare financial statements.

STEPS;
1. Identifying and analyzing – the accountant gathers information from source documents
and determines and determines the effect of the transactions of the accounts.
2. Journalizing – The identified accountable events are recorded in the journals.
3. Posting – information from the journal are transferred to the ledger
4. The unadjusted trial balance – the balances of the general ledger accounts proved as to
equality of debits and credits. Serves as a basis for adjusting entries.
5. Adjusting entries – the accounts are updated as of the reporting date on an accrual basis by
recording accruals, expiration of deferrals, estimations, and other events often not
signaled by new source documents.
6. Adjusted trial balance – the equality of debits and credits are rechecked after adjustments are
made. Serves as the basis for the preparation of the financial statements.
7. Financial statements – these are the means by which the information processed is
communicated to users.
8. Closing the books – this involves journalizing and posting closing entries and ruling the ledger.
Temporary accounts are closed and the resulting profit or loss is transferred to an equity account.
9. Post-closing trial balance – the equality of debits and credits are again rechecked after the closing
process.
10. Reversing entries – reversing entries are usually made at the beginning of the beginning of the
next accounting period to simplify the recording of certain transactions in that period.

Source Documents

a. Sales invoices – are used for the sale of goods

b. Official receipts – are used for the rendering of services
c. Purchase orders – a document issued by a buyer to a seller indicating the types, quantities and
agreed prices for products and services that the buyer intends to purchase. Purchase orders
are prepared as internal control over purchases.
d. Delivery receipts – is a document signed by the receiver of a shipment acknowledging the
receipt of the goods.
e. Bank deposit slips – evidences a deposit to a bank account it shows the date of deposit, the
bank account name and number, and amount deposited
f. Bank statements – a report issued by the bank that shows the deposits and withdrawals during
the period and the cumulative balance of a depositor’s bank account.
g. Checks -
 h. Statements of account – a report a business sends to its customer listing the transactions with
the customer during the period, the payments made by the customer and any remaining balance due
from the customer. It also serves as a notice of billing.
Types of events

External events – are transactions that involve the business and another external party.

Internal events – are events that do not involve an

external party. “the business only”

Simple and compound journal entries

a. Simple journal entry – one that contains a single debit and a single credit
b. Compound journal entry – one that contains two or more debits or credits
 CHAPTER 7
POSTING TO THE LEDGER
POSTING
- The third step in the accounting cycle
- The process of transferring data from the journal to the appropriate accounts in the ledger is
done by transferring amounts of debits and credits in a recorded journal entry to the ledger
accounts.

Purpose: Classify the effects of transactions on specific asset, liability, equity, income, and expense
accounts to provide more meaningful information.

Note: Accounts in the ledger resemble a "T-account.”

The ending balance of an account is the difference between the total debits and credits in that
account.

Overview of the Recording Process

Example: On March 31, 20x1, the business pays employee salaries for the current month amounting to
P30,000. Step 1: Transaction analysis

Identify the accounts affected by the transaction and the effects of the transaction on these accounts
(increase or decrease).

Accounts Affected “Salaries expense” (expense) and “Cash”

(asset)

Effects on Accounts Expenses have increased. Cash is

decreased.

Debit/Credit Expenses are increased through debit.

Assets are decreased through credit.

Step 2: Journalizing

Transaction is recorded in debit/credit form (journal entry) in the journal.

Mar. 31,20x1 Salaries expense 30,000

Cash 30,000

To record salaries expense

Step 3: Posting
The debit(s) and credit(s) of the journal entry are transferred to the affected accounts in the ledger.

Cash Salaries expense

30,000 March March 30,000

31. 31.

TRIAL BALANCE
A list of general ledger accounts and their balances
- Checks the equality of total debits and credits in the ledger
O Created a starting point for the preparation of the financial statements
O Although optional, a trial balance shall be prepared because it helps in revealing some errors

Types:

a) Unadjusted trial balance – prepared before

adjusting entries are made

Note: Adjusting entries and financial statements can’t be prepared unless total debit and credit is equal

b) Adjusted trial balance – prepared after adjusting entries but before the financial statements
are prepared

c) Post-Closing trial balance – prepared after the closing process

Another way of setting up the “Owner’s capital” and “Owner’s drawings” accounts is by using the name
of the business owner. Heading of trial balance

1. Name of business (Who?) 2. Title of the report (What?) 3. Date of the report (When?)

Order of account titles in the unadjusted trial balance

 o Assets, Liabilities, Equity, Income, Expenses

CHAPTER 8
ADJUSTING ENTRIES
Adjusting Entries
- Entries made before the preparation of financial statements to update certain
accounts so that they reflect correct balances as of the designated time
Purpose:
1. Take up unrecorded income and expense of the period
2. Split mixed accounts into their real and nominal
elements
Accruals of Income and Expenses (NO CASH INVOLVED)

 Accrual means to recognize an

o Income that is already earned but not yet collected
o Expense that is already incurred but not yet paid
 Gives rise to both income and receivable (or both payable and expense)
Note: (1) All adjusting entries involve at least one balance sheet account and one income
statement/statement of comprehensive income account
(2) All adjusting entries affect the profit or loss (or comprehensive income) for the
period
Recognition of Depreciation Expense

The Concept of Systematic and Rational Allocation

- States that costs that provide economic benefits over several accounting periods but
cannot be directly associated with the earning of revenues are
recognized as expenses over the periods where the economic benefits are consumed
- Example is the recognition of depreciation expense.
The equipment is initially recorded as an asset. But
since the expense can’t be directly associated with
sales (as opposed to the cost of inventories sold), the expense is recorded over the
periods the equipment
is used.
The Concept of Immediate Recognition
- States that a cost that produces no future economic benefits or an asset that ceases to
provide future economic benefits is recognized immediately as expense
- Example is the recognition of bad debts expense since accounts receivables that are
doubtful for collection will not provide future economic benefits anymore.
The Concept of Matching
- Costs that are directly associated with the earning of revenue are recognized as
expenses in the same period in which the related revenue is recognized
 - Example: The cost of inventory is initially recognized as an asset and charged as
expense (COGS) when inventory is sold.

Real, Nominal, and Mixed Accounts

1. Real/Permanent accounts – not closed at the end of the accounting period. These are
extended to the next accounting period. Includes all balance sheet accounts except
Owner’s drawings
2. Nominal/Temporary accounts – closed at the end of the accounting period. Includes
all income statement
accounts, drawings account, clearing accounts,
and suspense accounts.

- Clearing account – used temporarily to store amounts that will eventually be transferred to
another account. Example is income summary -> closed to Owner’s capital account

- Suspense account – used temporarily to store discrepancies in the accounts pending

their analysis and permanent classification. Example is cash shortage (closed to
receivable/loss

3. Mixed accounts – have both real and nominal account components. Subject to
adjustment.
- Include unadjusted prepayments (prepaid assets) and deferrals (unearned income) that have
both expired and unexpired components

The expired portion is the nominal account component while the unexpired portion is the real
account component
These are separated because the nominal account should be in income statement wile the
real account is in balance sheet

Methods of Initial Recording of Income and Expenses

Income

1. Liability Method – advanced collections of income are initially credited to a liability

account. At end of period, the “earned portion” is recognized as income while the
“unearned” remains as liability
2. Income Method – advanced collections of income are initially credited to an income
account. At end of the period, the “unearned portion” is recognized as liability while the
“earned” remains as income.

*Earned (‘used up’) portion is recognized as income for the period

*Unearned (‘unused’) portion is recognized as liability. Will be recognized as income in the
next accounting period.
Expenses
 1. Asset Method – prepayments of expenses are initially debited to an asset account.
At end of period, the incurred (expired or used up) portion is recognized as expense
while unused portion remains as asset
2. Expense Method – prepayments of expenses are initially debited to an expense
account. At end of period, the unused (not yet incurred/ unexpired) portion is
recognized as assets while the expired portion remains as expense

Incurred portion is recognized as an expense for the period.

*Not yet incurred portion is recognized as an asset. Will be recognized as an expense in
the next accounting period.
Note: The recording of items of income that were collected in advance and items of expense
that were paid in advance is referred to as deferrals. (defer means to postpone the
recognition)

Accrual Deferral

- To recognize income that is already earned -To postpone the income recognition of an
but not yet collected advance collection. It is treated as liability until
- To recognize expense that is already incurred earned
but not yet paid - To postpone the expense recognition of the
prepayment. It is treated as an asset until
incurred.
 CHAPTER 9

Accounting Cycle of a Service Business

Service Business- one that offers services as its main product rather than physical goods.

Worksheet- an analytical device used to facilitate the gathering of data for adjustments, the
preparation of financial statements and closing entries.

Heading of the worksheet

1. Name of the business

2. Title of the report
3. Date discovered by the report (i.e. for the period ended Dec. 31, 20x2)

Consistency Concept- applying the policy consistently in the current and succeeding accounting periods

Adjusting entries (identifying the needed adjustments)

1. Accruals of income and expenses

2. Recognition of depreciation expense and bad debts expense
3. Deferrals of income and expenses (splitting of ‘mixed accounts’)

Adjustments columns - where you place the debits and credits of the adjusting entries

Rules of debits and credits

1. Debit and Debit- Add

2. Credit and Credit- Add
3. Debit and Credit or vice versa- Subtract

Cross-footing – adding or subtracting amounts horizontally in accounting reports.

- Procedure to compute for the adjusted balances of accounts in the adjusted trial
balance.
Footing- adding or subtracting amounts vertically in accounting reports.

- Procedure to compute the “total” of the columns.

Double Rule- two lines underneath an amount.

 - Use to connote a total or the end of a computation.
Financial Statements- end products of the accounting process means by which information are
summarized and communicated to users.

Statement of Financial Position (Balance Sheet)- shows the assets, liabilities and equity of a business.

Statement of Profit or Loss (Income Statement)- shows the income and expenses, and consequently,
the profit or loss of a business.

Income Statement*

 Profit- credits exceeds debit

 Loss- debits exceeds credit
 Profit or Loss is closed to the “Owner’s Capital”.

*Balance Sheet*

 Profit- debits exceeds credit

 Loss- credits exceeds debit

Profit or Loss for the period - Balancing figure in the

Income Statement and Balance Sheet

*Closing Entries- entries prepared at the end of the accounting period to “zero out” all nominal
accounts
in the ledger. Also referred to as “closing the BOOKS

 Income Summary- clearing account

 Credit Balance- profit
 Debit balance- loss
 Income summary is closed to the “owner’s Capital”
 Owner’s Drawings is closed to the “Owner’s Capital”

Post-Closing Trial Balance- prepared to check the equality of the debits and credits in the
general ledger after the closing entries are made. Contains real accounts.
 Closed account- an account that has no balance
 Open account- an account that has a balance.

*Reserving Entries- entries usually made on the first day of the next accounting period to reverse
certain adjusting entries in the immediately preceding period.
 Adjusting entries that may be reversed
1. Accruals for income or expense
2. Prepayments (expense method)
3. Advance collections (income method)