Review of the Previous Lesson Week 2 ACCOUNTING

Review of the Previous Lesson

Week 2 ACCOUNTING EQUATION & THE DOUBLE-ENTRY SYSTEM ACCOUNTING INFORMATION SYSTEM

Learning Objectives • • Differentiate the elements of financial statements Explain the meaning of the account Discuss the accounting equation Explain the nature of debits and credits – the double-entry system • Discuss accounting events and transactions • Identify and differentiate typical account titles used – Balance Sheet & Income Statement • Explain the accounting procedures for business transactions

ELEMENTS OF FINANCIAL STATEMENTS • The elements of financial statements refer to the quantitative information shown in the statement. 1. Assets 2. Liabilities 3. Owner’s Equity 4. or Capital 4. Income or Revenue 5. Expenses

ACCOUNT T-ACCOUNT A detailed record of the increases, decreases & balance of each element that appears in an entity’s financial statements. The simplest form of the account. It has 3 parts: account title, debit side & credit side. Account Title Left side or Debit side Right side or Credit Side

ASSET ACCOUNTS - Debit Current Assets Cash Petty Cash Fund Non-Current Assets Property, Plant & Equipment Cash Equivalents Land Notes Receivable Building Accounts Receivable Equipment Allowance for Bad Debts Furniture & Fixtures Accrued Interest Income Accumulated Depreciation Advances to Employees Intangible Assets Inventories Prepaid Expenses Unused Supplies

LIABILITIES ACCOUNTS - Credit Current Liabilities Accounts Payable Notes Payable (short-term) Accrued Expenses or Accrued Liabilities Unearned Revenues or Unearned Income SSS Premium Payable Philhealth Premium Payable Pag-ibig Premium Payable Withholding Tax Payable Pre-collected or Unearned Income Non-Current Liabilities Mortgage Payable Bonds Payable Notes Payable (Long-term) Accounts Payable

OWNER’S EQUITY ACCOUNTS - The Capital (Credit) original and additional investments of the owner of the business entity. - Increased by net income - Decreased by net loss Withdrawals (Debit) When the owner of a business entity withdraws cash or other assets

INCOME OR REVENUE ACCOUNTS - Credit Sales Service Income or Service Revenue Professional Income Accounting or Auditing Fees Income Legal Fees Income Dental Fees Income Medical Fees Income Rental Income Interest Income Miscellaneous Income or revenue derived from the sale of merchandise. Income or revenue derived from rendering services.

EXPENSES ACCOUNTS - Debit Cost of Sales or Cost of Goods Sold Salaries or Wages Expense Bad Debts or Uncollectible Accounts Expense SSS Contribution Philhealth Contribution Pag-ibig Contribution Insurance Expense Utilities Expense Supplies Expense Depreciation Expense Miscellaneous Expense Taxes & Licenses CHART OF ACCOUNTS – list of account titles or account name.

ACCOUNT T-ACCOUNT A detailed record of the increases, decreases & balance of each element that appears in an entity’s financial statements. The simplest form of the account. In every transaction, there is a value received, we call Debit and value parted with, we call a Credit. It has 3 parts: account title, debit side & credit side. Account Title Left side or Debit side (Dr. ) Right side or Credit Side (Cr. ) Value received Value parted with Debit balance Credit balance

Account titles are identifications or brief descriptions of items that fall to same kind, class or nature. In other words, are assigned names to various accounts. Account Title DEBIT ENTRY: An amount entered on the left-hand side of the account. CREDIT ENTRY: Left side or Debit side (Dr. ) Right side or Credit An amount entered Side (Cr. ) Value received Value parted with Debit total Credit total on the right-hand side of the account. = account balance ACCOUNT BALANCE the difference between the debit total & credit total of an account. DEBIT BALANCE if the debit total exceeds credit total. CREDIT BALANCE if the credit total exceeds debit total. IN BALANCE or CLOSED ACCOUNT if the debit total equals credit total.

Example of Chart of Accounts CHART OF ACCOUNTS – list of account titles or account name. Account titles are identifications or brief descriptions of items that fall to same kind, class or nature. In other words, are assigned names to various accounts.

THE NATURE OF DEBITS AND CREDITS – The double-entry system • A double-entry system means that the dual effects of a business transaction is recorded. A debit side entry must have a corresponding credit side entry. Dual effects Business transactions Each transaction affects at least two accounts. The total debits for a transaction must always equal the total credits.

THE RULES OF DEBIT & CREDIT Rule 1 – Asset: Rule 2 - Liabilities: Rule 3 – Owner’s Equity: Rule 4 – Drawing: Rule 5 – Income: Rule 6 – Expenses: debit to increase credit to decrease credit to increase debit to decrease debit to increase credit to decrease

NORMAL BALANCE OF THE ELEMENTS OF FINANCIAL STATEMENTS DEBIT BALANCE Assets CREDIT BALANCE Liabilities Owner’s Equity Expenses Income or Revenue

BASIC ACCOUNTING EQUATION Assets = Liabilities + Capital Income – Expenses = Net Income

EXPANDED ACCOUNTING EQUATION

PHASES OF ACCOUNTING 1. Identifying transactions and events – source documents 2. Journalizing transactions – the journal 3. Posting to the ledger – general ledger 4. Trial balance preparation 5. Adjusting journal entries 6. Preparing the worksheet 7. Preparing financial statements 8. Closing entries NOTE: Steps 1 to 10 is the ACCOUNTING CYCLE. 9. Post-closing trial balance 10. Reversing entries Profitability – How much is the increase in capital as a result of business operation? Liquidity – Are there available funds to finance the business operation? Solvency – Can the business pay its long-term obligations to others?

PHASE 1 - RECORDING Steps 1 of the ACCOUNTING CYCLE. 1. Identifying transactions and events – source documents a) Identification of business transaction what transactions are considered as accountable and what are not. RULE: Only transactions & events which are of financial character to the business are being recognized. SOURCE DOCUMENTS or SUPPORTING BUSINESS DOCUMENTS the basis of identifying transactions. b) Analysis of business transactions Business transactions are analyzed from the view point of the business. “Always consider yourself as the business” when making the analysis. By analyzing, we have to ask: What is the value received and value parted with in this particular transactions? c) Measuring of business transaction the peso is our financial denominator.

Example of Source Documents (under Servicing Activities) 1. 2. 3. 4. Customers’ & suppliers’ sales invoices Official receipts Cash or Check Vouchers Service Order Slip

PHASE 1 - RECORDING is the 1 st phase of accounting. This involves the writing down of business transaction in a systematic manner and in order of their occurrence in the book of original entry called Journal. Steps 2 of the ACCOUNTING CYCLE. 2. Journalizing transactions – the journal JOURNALIZING is the process of recording the effects of economic transaction in the journal. the act of recording business transactions in the journal. JOURNAL ENTRY the accounting record written in the journal which consists of debit account and credit account with their respective values.

ANALYSIS OF BUSINESS TRANSACTION Transaction: Bought a car for cash, P 650, 000. Questions guide: 1. Identifying: Who bought the car? The business. 2. Analyzing: What is the value received? Car. What is the value parted with? Cash. 3. Measuring: What is the amount involved? P 650, 000. 4. Journalizing: 1. Debit, value received – car P 650, 000. 00 2. Credit, value parted with – cash 650, 000. 00

To illustrate the analyzing process of accounting, consider the transactions of Valrox, a servicing business. Cash on hand Cash in bank Accounts Receivable Office equipment Notes Payable Valrox, Capital Utility expense Bank charge expense SSS Premium Payable Service Income Withholding tax payable Salaries expense Supplies expense Owner’s drawing

Financial Statements Objective: To provide financial information useful to the users. The formal reports prepared by accountants The information that accumulated and processed in financial accounting The final products of the accounting process. 1. Statement of Financial Position Shows the financial position of a business entity as of a particular date. 2. Income Statement Shows the performance of the business entity for a given period. 3. Statement of Changes in Equity Shows the movement or changes in owner’s capital or equity in a certain period. 4. Cash Flow Statement Shows and explains the changes of cash during an accounting period. 5. Notes to the Financial Statement Part of the financial statements in a parenthesis form, to achieve proper understanding of the financial reports.

Relationships Among the Financial Statements

Example of Income Statement Example of the Statement of Owner’s Equity

Example of Statement of Financial Position Report Form – in vertical order Account Form – in horizontal order

Example of Statement of Cash Flows

Example of Notes to Financial Statement

ELEMENTS OF FINANCIAL STATEMENTS • The elements of financial statements refer to the quantitative information shown in the statement. 1. Assets 2. Liabilities 3. Owner’s Equity 4. or Capital 4. Income or Revenue 5. Expenses Real accounts are not closed at the end of the accounting period. Nominal accounts are temporary accounts that are closed or put to zero balance at the end of the accounting period.

ELEMENTS OF FINANCIAL STATEMENTS 1. Assets – are resources controlled by the entity as a result of past transactions or events and from which future economic benefits are expected to flow to the entity. Asset accounts have a normal debit balance. 1. Is a leased lot or rented machines considered an asset of the entity? 2. Is a machine that can not be repaired and owned by the entity considered an asset? 3. Is buying a machine in the future transactions considered an asset? 4. Is a machine bought by the entity for the personal use of the owner considered an asset?

ELEMENTS OF FINANCIAL STATEMENTS 2. Liabilities – are present obligations of the entity arising from past transactions or events the settlement of which is expected to result in an outflow from the entity of resources embodying economic benefits. Liability accounts have normal credit balance. a. Is the debt of the owner considered a liability of the entity? b. Is a bank loan in the future transaction, thus a future obligation considered a liability?

ELEMENTS OF FINANCIAL STATEMENTS 3. Equity – is the residual interest in the assets of the entity after deducting all of its liabilities (asset – liabilities = equity). Equity accounts have normal credit balance. 4. Income or Revenue – represents the earnings of the business from sales of goods or service rendered. Revenue accounts have a normal credit balance. 5. Expenses – are costs incurred in conducting the business activities. Expense accounts have normal debit balances.

ELEMENTS OF FINANCIAL STATEMENTS RECOGNITION OF ELEMENTS Recognition means the process of reporting the elements of financial statements of an entity. 1. Probability of future benefit When the item has any future economic benefit that will flow to or from the entity. 2. Reliability of measurement When the item has a cost or value that can be measured with reliability. MEASUREMENT OF ELEMENTS Measurement is the process of determining the monetary amounts at which the elements of financial statements are recognized. 1. Historical cost 2. Current cost 3. Realizable value 4. Present value

MEASUREMENT OF ELEMENTS 1. Historical cost is the amount paid when an asset was acquired. 2. Current cost is the amount to be paid if the asset (already acquired) was acquired today. 3. Realizable value or settlement value is the amount to be received if the asset is to be sold. 4. Present value the amount that a future sum of money is worth today given a specified rate of return. 5 years from now P 1, 000. 00 P 620. 00 10%

ACCOUNTING CONCEPTS & PRINCIPLES • Accounting concepts are important assumptions or ideas which accountants observe in recording business transactions in the books of accounts. • Accounting conventions are the means of implementing accounting principles. They are the rules, procedures & methods used in accounting practice. They comprise the large body of practices that prescribe definitely how to do the accounting process. • Accounting principles refers to a doctrine which is the basis of accounting conventions. • GAAP Generally Accepted Accounting Principles – Guide accountants in the accounting process of an enterprise. – Are developed based on experience, research, & careful study. – Become generally accepted by agreement among accounting practitioners. – OBJECTIVE: to fairly present the financial statements…in conformity with GAAP.

IMPLICIT ASSUMPTIONS 1. Entity concept ACCOUNTING PRINCIPLES 2. Periodicity concept 3. Stable monetary unit concept 1. Objectivity principle UNDERLYING ASSUMPTIONS 3. Revenue recognition principle 2. Historical cost 4. Expense recognition principle 5. Adequate disclosure 1. Accrual basis 6. Materiality 2. Going concern 7. Consistency principle Assignment: Give the description of each concepts & principles (except implicit assumptions).