Republic of the Philippines

POLYTECHNIC UNIVERSITY OF THE PHILIPPINES

San Pedro Campus
United Bayanihan, City of San Pedro, Laguna

Instructional Material
for Accounting
Principles

Compiled by:
LEA CATHERINE M. LAUS, CPA
 TABLE OF CONTENTS
Page
Module 1: Introduction to Accounting 1-20
Accounting as Language of Business - Definition
The Development of Accounting
The Role of Accounting in Business
Specialized Accounting Fields
Forms of Business Organizations
Types of Business
The Generally Accepted Accounting Principles (GAAP)
Basic Financial Statements of Business Organizations
Qualitative Characteristics of Financial Statements
Users of Financial Information
Elements of Financial Statements (Basic Classification of Accounts)

Module 2: Analyzing Business Transactions 21-50

Accounting Information System
Business Transactions
The Accounting Equation

Module 3: The Accounting Process of A Service Concern 51-89

Journalizing
Posting
Preparing a Trial Balance
Correction of Errors

Module 4: The Adjusting Process 90-131

Cash Versus Accrual Basis of Accounting
The Adjusting Process
Adjusting Entries for Accrued Expenses or Accrued Liabilities
Adjusting Entries for Accrued Revenues or Accrued Assets
Adjusting Entries for Prepaid Expenses or Deferred Expenses
Adjusting Entries for Unearned Revenues or Deferred Revenues
Adjusting Entries to take up Depreciation of Property, Plant and Equipment
 Adjusting Entry To Take Up Provision For Uncollectible Accounts

Module 5: Completion of the Accounting Cycle for a Service Business 132-164

Work Sheet
Preparing Financial Statements From The Work Sheet
Journalizing and Posting the Adjusting Entries
The Closing Process
Post-Closing Trial Balance
Reversing Entries
 MODULE 1: INTRODUCTION TO ACCOUNTING

Overview:
In this module, you will be able to have an introductory knowledge regarding the course subject,
Fundamentals of Accounting 1. Nowadays, Accounting has been a great help to our everyday life
– from analyzing which meal you will buy for lunch up to computing how much savings would you
have from your daily allowance. A successful business establishment cannot stand for years
without proper and systematized use of Accounting. You will appreciate the importance,
foundation and basics of Accounting in this module.

Module Objectives:
After successful completion of this module, you should be able to:

1. Define Accounting
2. Understand the Development of Accounting
3. Understand the Role of Accounting in Business
4. Differentiate the Specialized Accounting Fields
5. Identify the Forms of Business Organizations
6. Determine the Types of Business
7. Understand the Generally Accepted Accounting Principles (GAAP)
8. Determine the Basic Financial Statements of Business Organizations
9. Enumerate the Qualitative Characteristics of Financial Statements
10. Enumerate the Users of Financial Information
11. Determine the Elements of Financial Statements

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Course Materials:

Discussion

I. Accounting as Language of Business – Definition

The Accounting Standards Council (ASC) defines accounting as follows: “Accounting is a service
activity. Its functions is to provide quantitative information, primarily financial in nature, about
economic entities, that is intended to be useful in making economic decisions, in making reasoned
choices among alternative courses of action.” Accounting is also defined as the art of recording,
classifying and summarizing, in significant manner and in terms of money, transactions and
events which are in part at least of a financial character and interpreting the results thereof.

Accounting Phases

Recording or Bookkeeping is the process of systematically maintaining a record of all business

transactions. The recording of transactions either manually or electronically is usually done in
chronological order or according to the date of occurrence.
Classifying is the sorting or grouping of similar and interrelated transactions in their respective
class.
Summarizing is the preparation of financial
statements which include the Statement of
Financial Position (Balance Sheet),
Statement of Comprehensive Income,
Statement of Cash Flows, and Statement of
Changes in Owner’s Equity.

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II. The Development of Accounting

•Middle East Region - tradesmen use clay objects o represent commodities

•Ancient Civilization of Babylon, Greece, and Egypt - used clay tablets and
8500 BC papyri on later years

•Friar Luca Pacioli wrote a book which contains discussions on the double-
entry bookkeeping system. - Father of Double-Entry Bookkeeping.
1494 •Summa de Arithmetica, Geometria, Proportioni et Proportionalita (Everything
about Arithmetic, Geometry, Proportions and Proportionality)

•Corporate form of business organization was created to accomodate the

Mid-18th need for increasing large amounts of funds which was required to finance the
to Mid- expansion of businesses.
19th
Centuries

III. The Role of Accounting in Business

In general, accounting as an information system, provides reports about economic activities and
condition of a business. Accounting provides the necessary information essential in the
formulation and execution of business and non-business policies. Accounting reports
summarizing the profitability of a product help management decide whether to continue selling a
product or not. An accounting system allows them to develop financial records that can be used
to prepare reports on the financial state of the business. Business establishments and the
government acknowledge accounting as an essential tool of management.

IV. Specialized Accounting Fields

A. Public Accounting – accountants and their staff who render services for a fee are said to be
engaged in public accounting. In this field, an accountant may practice as an individual or as a
member of an accounting firm. Certified Public Accountants (CPAs) are public accountants who
have met the required education, experience and have passed the CPA licensure examination.
The services being rendered by CPAs in public practice include:

• Auditing – this involves the independent examination of financial statements for the
purpose of expressing an opinion on the fairness of the said statements prepared by the
company under audit.

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 • Tax Services – CPAs who specialize in tax accounting prepare income tax returns and
advise clients on tax matters.
• Management Advisory Services – involve providing services to clients on matters relating
to the design and maintenance of a company’s accounting system, budgeting, cost
accounting, production, organizational planning and other business matters.

B. Private Accounting – accountants employed by business firms or by a not-for-profit

organization are said to be engaged in private accounting. The scope of activities and duties of
private accountants widely varies. These accountants may be hired as accounting clerk,
bookkeeper, management accountant, cost accountant, internal auditor, vice-president for
finance or budget director. The chief accountant in a business is called the controller or
comptroller.
C. Government Accounting – accountants who are employed in any governmental units are
said to be in the field of government accounting.
D. Accounting Education – accountants employed as instructors, professors, reviewers or
researchers are in the field of accounting education. Only CPAs can engage in this field of
endeavor.

V. Forms of Business Organizations

is a business owned by only an individual called
the proprietor. It is the form of business easiest to
Single or Sole organize since there are only minimal
Proprietorship requirements to follow. It is less complicated to
operate and decisions are made faster since only
one owner decides.

is an association of two or more persons who

bind themselves to contribute money, property
or industry to a common fund, with the intention
Partnership of dividing the profits among themselves. The
partners draw up and sign a formal business
engagement called the Articles of Co-
Partnership.

is an artificial being created by operation of law

having the rights of succession and the powers
and attributes expressly authorized by law or
Corporation incident to its existence. A corporation gets its
capital from issuing shares of stocks to
individuals and to other businesses who
become owner or stockholders of the
corporation.

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 VI. Types of Business

Merchandising Business Manufacturing

Services Business
or Trading Business

this type makes

this kind of finished goods from
this business business buys raw materials or
renders services to goods or unassembled parts.
customers or clients commodities and A manufacturing
for a fee. sells them at a business produces
profit. the goods that is
sells.

Examples of
service type of
business are: public
transport
Examples are:
companies, beauty Examples are: shoe
grocery stores,
parlors, security factories, garment
supermarkets,
agencies, repair factories, car
hardware stores,
shops, laundry assembler, and
drugstores, car
shops, schools, food processing
dealers, real estate
medical or health plants.
dealers, and
clinics, event
appliance stores.
coordinators, law
offices, accounting
firms, and
advertising firms.

VII. The Generally Accepted Accounting Principles (GAAP)

Generally Accepted Accounting Principles (GAAP) defines what is accepted in accounting
practice and they are like laws that must be followed in financial reporting. It encompasses the
conventions, rules, procedures, practice and standards followed in that accumulation, preparation
and presentation of accounting data in the financial statements.
The Financial Reporting Standards Council (FRSC) is the accounting standard setting body
created by the Professional Regulations Commission (PRC) upon recommendation of the Board

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of Accountancy (BOA). The FRSC aims to develop a single set of high quality, understandable
and enforceable accounting standards that require high quality, transparent and comparable
information in financial statements and other financial reporting to help participants in the various
capital markets and other users of information in making economic decisions.

1. Business Entity Concept – business entity is treated as separate and distinct from its
owner/s and from other business units. This accounting concept is important because it
limits the economic data in the accounting system to data related to the activities of the
business. The personal transactions of the owner should not be merged with that of the
business he owns.
2. Going Concern or Continuity Assumption – this assumes that unless there is evidence
to the contrary, the business entity will continue to operate for an indefinite period.
3. Time Period Assumption – this assumption requires that the indefinite life of the
business be divided into time periods or accounting periods for the purpose of preparing
financial reports on the performance and financial position of the business.

Financial statements may be prepared on a monthly basis (the shortest accounting

period), at the end of every three months (quarterly basis), six months (semi-annual basis)
or one year (annually). The annual accounting period of a company may be a calendar
year, a fiscal year or a natural business year. A calendar year begins on January 1 and
ends on December 31 of the same year. A fiscal year begins on any month (except
January) and will end on the twelfth month of the following year. A natural business year
is a twelve-month period that ends on any month when the business is at the lowest point
or is experiencing slack season.
4. Unit of Measurement Assumption – this specifies that accounting should measure and
report the results of a business’ economic activities in terms of a monetary unit such as
the Philippine Peso. This assumption recognizes that the use of a standard monetary unit
throughout all the financial statements is an effective means for aggregating and
communicating accounting information. It is a standard practice to ignore changes in the
purchasing power of a peso.
5. Accrual Basis – requires that revenue or income should be recognized when earned
regardless of when collection is received; and expense should be recognized when
incurred regardless of when payment is made.

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 In contrast, revenues and expenses may be accounted for on a ‘cash received or cash
paid basis’. This method of recognizing revenue and expense is known as the cash basis
of accounting.
6. Matching Principle – relates to the expense recognition principle which requires that
costs and expenses incurred in generating the revenue should be properly matched
against the related revenue in determining the net income or net loss for the period.

VIII. Basic Financial Statements of Business Organizations

Financial Statements is the end product of the accounting process. They are the means by which
financial information about an economic entity is communicated to the various users of financial
information. Year-end financial statements must be prepared, although interim statements of less
than one year may be prepared for internal purposes.

1. Statement of Comprehensive
Income (Income Statement) – the
financial statement that shows the
summary of the company’s revenue and
expenses for a given period. The result
of a company’s business operation is
reported in this financial statement.
2. Statement of Financial Position
(Balance Sheet) – the financial
statement which shows the list of a company’s asset, liabilities, and owner’s equity as of
a specific date, usually at the close of the last day of a month or a year. It shows the
financial position or condition of an enterprise as of a particular date.
3. Statement of Changes in Owner’s Equity (Capital Statement) – the summary of
changes in the owner’s equity that have occurred during a specific period of time, such as
a month or a year.
4. Statement of Cash Flows – the financial statement that provides information about the
cash receipts and cash payments of an entity for a given period of time. Reported in the
cash flow statement are the sources of cash and the uses or disbursements made by the
company.

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 5. Notes to the Financial Statements – to make the financial statements more useful and
meaningful to those who might have an interest in the business, the notes to the financial
statements are added as one of the basic financial statements companies are required to
prepare. This statement presents in narrative form the significant accounting policies and
other related explanatory notes that have affected the preparation of the financial
statements. Other relevant information which cannot be shown in the face of the financial
statements is reported in the Notes to the Financial Statements.

IX. Qualitative Characteristics of Financial Statements

1. Relevance – information has the quality of relevance when it would influence a decision
by helping users form predictions about the outcome of past, present and future events,
or confirm and correct prior expectations.
2. Reliability – information has the quality of reliability when it is free from errors and bias
and can be depended upon by users to represent faithfully what it purports to represent.
Financial statements are reliable if they represent faithfully the actual economic effects of
transactions, are neutral, prudent and complete in all material aspects. An omission can
cause misleading and false information and therefore unreliable.
3. Understandability – information provided in the financial statements must be presented
in a form and expressed in terminology that a user understands. Understandability is very
essential because even if the financial information is relevant and reliable it may prove to
be useless if it is not understood by the users of the information or decision-makers.
4. Comparability – means the ability to bring together for the purpose of noting points of
likeness and differences. Users must be able to compare the financial statements of an
entity through time in order to identify trends in its financial position and performance from
one accounting period to the next. Knowing the past trends, users can reasonably make
more accurate predictions and decisions. Comparability also allows comparisons between
two or more enterprise engaged in the same industry.

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X. Users of Financial Information

1. Management – for planning and controlling the operation of the business.

2. Creditors and suppliers – in
order to evaluate a borrower’s
ability to pay and in deciding
whether to extend credit to a debtor.
3. Owner/s of the firm – need
to know if the business is operating
at a profit or loss.
4. Investors – to determine if
their investment is profitable and safe and in deciding whether to invest in the business or
not. Also, whether they should buy, hold or sell their shares of stocks.
5. Employees – employees are interested in information regarding the profitability and
stability of an enterprise so they can assess
their employment status, and whether the
company has the ability to provide better
remuneration and additional benefits.
6. Government and their Agencies – these users
require financial information to regulate the
activities of the enterprise, determine taxation
policies and as basis for national income statistics.
7. Customers – use financial
statements as basis for evaluating the
possibility of price changes and
identifying other sources of cheaper
services and commodities.
8. Financial Analysts and Advisors –
use financial information as basis in
evaluating the position of the business in
the industry and render an opinion on the business’ potentials regarding profitability risks
and opportunities.

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 9. Trade Associations – use financial data to report industry statistics; industry comparisons
and analysis in order that firms belonging to the same industry can make relevant
economic decisions.
10. Others – lawyers, media or press and the general public.

Managerial Accounting is the area of accounting that is focused on the accumulation and
preparation of financial reports for the use of management, while the area of accounting that
focuses on developing and reporting financial information intended for the external users is called
Financial Accounting.

XI. Elements of Financial Statements (Basic Classification of Accounts)

1. Assets – are defined as resources controlled by the enterprise as a result of past

transactions and events and from which future economic benefits are expected to flow to
the enterprise. Assets are the properties owned by the business.

Examples:

Cash Furniture & Fixtures

Accounts Receivable Store Equipment
Notes Receivable Automobiles
Merchandise Inventory Machineries
Office Supplies Land
Store Supplies Building
Office Equipment
Prepaid Expenses (like Prepaid Rent and Prepaid Insurance)
Intangible Assets (like Franchise. Copyright, Patent, Trademarks)

Cash – is any medium of exchange that a bank will accept at face value. It includes coins and
currencies, checks, money orders and bank drafts.

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Accounts Receivable – are claims against debtors or customers arising from services rendered
on account and sale of merchandise on account.

Notes Receivable – are claims supported by promissory note.

Merchandise Inventory – are goods on hand and are available for sale.

Office/Store Supplies – are supplies being used by the business. Like papers, pens, pencils,
folders, staplers, etc.

Prepaid Expenses – are expenses paid by the business. Examples are: six months rental paid
in advance (Prepaid Rent) or one year insurance premiums paid in advance (Prepaid Insurance).
Office/Store Equipment – includes computers, air-conditioning units, electric fans, freezers,
refrigerators, display cabinets, etc.

Furniture and Fixtures – includes offices tables, chairs, filing cabinets, etc.

Intangible Asset – is an identifiable non-monetary asset without physical substance. Intangible

assets do not have physical appearance but are expected to provide future economic benefits to
the company.

Franchise – is a right granted by one party (called franchisor) to another party (called franchisee)
for a specified period. When the franchisor is a private entity, it permits the franchisee to use the
franchisor's trademark or process. Example is, Jollibee Corporation grants Mr. Aga Muhlach a
right to operate a Jollibee food store in Alabang.

Copyright – is an exclusive right or protection granted to an author for literary, musical or artistic
work.

Patent – is an exclusive legal right granted by the government for an invention to enable its holder
to manufacture, sell and control an item or process.

Trademarks – are words, names, symbols, or other devices used in trade to indicate the source
of a product and to distinguish it from the products of others.

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Computer Software or Software – is a general term primarily used for digitally stored data such
as computer programs and other kinds of information read and written by computers. Examples
are: Microsoft word, windows XP, video games, and websites.

2. Liabilities – are defined as present obligations of an enterprise arising from past

transactions or events, the settlement of which is expected to result in an outflow from the
enterprise of resources embodying economic benefits. Liabilities are the financial
obligation or debts of the business. It is also described as the claim or equity of the
creditors on the assets of the enterprise.

Examples:

Accounts Payable Taxes Payable

Notes Payable Utilities Payable
Mortgage Payable Unearned Revenue
Salaries Payable (like Unearned Rent Revenue)

Accounts Payable – are amounts due to creditors for assets acquired on account.

Notes Payable – are amounts due to creditors evidenced by written promise to pay.

Mortgage payable – are long term debts secured by a collateral.

Salaries Payable – are unpaid salaries of employees at the end of an accounting period.

Interest Payable – are interest due on borrowed funds.

Utilities Payable – examples are unpaid electric and water bills.

Unearned Revenue – is revenue collected by the business in advance. When a business

receives payments before providing services to customers, there is an obligation created on the
part of the business to provide services. Generally Accepted Accounting Principles requires that

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revenue received in advance be treated as liability. Once the business has provided the services,
the advance collection will become earned and will be recognized as income.

3. Capital – represents the equity or claim of the owner on the assets of the business. It is
the residual interest in the assets of the business after deducting all its liabilities. The capital
account of a proprietorship type of business consists of the following:

Owner's Capital (Investment)

Owner's Drawing or Owner's Withdrawal

Charged to the owner's drawing account are cash or other asset withdrawn or taken by the owner
from the business for personal use.

4. Revenue or Income – is the gross inflow of economic benefits during the period in the
form of inflows or enhancements on assets or decrease in liabilities that result in increase
in equity, other than those relating to contributions from the owner or owners.

Examples:

Sales Interest Income

Service Revenue Fees Earned
Professional Fees Subscription Revenue
Rent Income Commissions Earned

The use of appropriate revenue account title depends upon the source of the revenue. Example
is, if the revenue relates to rental the appropriate revenue account to use is rental income, if it
relates to interest, then interest income. The commonly used revenue account by merchandising
companies is Sales.

5. Expenses – is defined as the gross outflow of economic benefits during the period in the
course of ordinary activities when these outflows result in decrease in equity other than
those relating to distribution to owners. Expenses are costs incurred to produce revenue.

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Examples:

Salaries & Wages Expense Transportation Expense

Taxes and Licenses Expense Supplies Expense
Rent Expense Utilities Expense
Advertising Expense Repair & Maintenance
Insurance Expense Uncollectible Accounts Expense
Depreciation Expense or Bad Debts Expense
Miscellaneous Expense

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Activities/Assessments:

Self-Assessment

I. Based on the discussion, how can you apply Accounting in our daily lives? What is the
importance of Accounting in personal financial decision making?

II. Out of the 3 Forms of Business Organizations, what do you think is the most effective
type and which one is the most likely to succeed?

Practical

III. Encircle the letter of your answer.

1. The primary function of accounting is

a. to provide quantitative, primarily financial information about economic entities that is
useful in making economic decisions
b. to provide information that the creditors of an entity can use in deciding whether to make
additional loans to the entity
c. to measure the resources owned by economic entities and the financial obligations of
the entities
d. to provide the information that managers of an entity need to control its operations

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2. Accountants who are engaged in public accounting generally work in one or more of the
following fields
a. internal auditing tax services, and management advisory services
b. tax services, management advisory services, and auditing
c. government accounting, private accounting, and auditing
d. tax services, cost accounting, and budgeting

3. The financial statements usually presented to the owner of a business and to other outside
parties are the
a. Balance Sheet, Statement of cash flows, Income Statement, and Statement of changes
in owner's equity
b. Income Statement, Statement of changes in owner's equity, and Balance Sheet
c. Income Statement, Balance Sheet and Statement of Cash Flows
d. Income Statement and Balance Sheet

4. Presented below are the advantages of a partnership over a sole proprietorship. Select
the exception:
a. better decision making
b. personal involvement in the business
c. larger capacity to raise capital
d. none of these

5. The statement which presents the financial picture of a company as of a specific date is
the
a. statement of owner's equity
b. income statement
c. statement of cash flows
d. balance sheet

6. The economic resources that a business owns and expects to be useful to the enterprise
are called
a. owner's equity
b. liabilities
c. receivable

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 d. assets

7. Equities are legal and economic claims to the assets of a business. The owner's claims
on the business assets are also known as
a. accounts payable
b. liabilities
c. outsider claims
d. capital

8. The statement of financial position is another name for the

a. statement of owner's equity
b. income statement
c. statement of cash flows
d. balance sheet

9. Which type of business organization is owned by stockholders?

a. Proprietorship
b. Corporation
c. Partnership
d. all are owned by stockholders

10. Which of the following statements regarding accounting career is the least valid?
a. The principal function of internal auditors is to issue reports on the "fairness” of their
company's financial statements.
b. A background in accounting may serve as a useful “stepping-stone" positions in top
management.
c. Managerial accountants, CPAs, and the SEC all participate in the process of financial
reporting.
d. Careers in accounting education often involve research and consulting

11. The income statement reports

a. financial position on a specific date
b. financial position for a specific period
c. results of operations on a specific date

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 d. results of operations for a specific period

12. One of the following is not a part of the phases of accounting.

a. classifying
b. auditing
c. journalizing
d. interpreting

13. The branch of accounting that is concerned primarily with providing information for internal
users.
a. auditing
b. income tax accounting
c. financial accounting
d. managerial accounting

14. Which of the following is an internal user of a company's financial information?

a. board of directors
b. regulatory agencies
c. stockholders of the company
d. long-term creditors of an enterprise

15. All the following are external users of accounting information except
a. regulatory agencies
b. management
c. trade associations
d. labor union

16. In accounting, an economic entity may be defined as

a. business enterprise
b. a division within a business enterprise
c. an individual
d. any of these
17. The objectives of financial accounting for business enterprises are based on
a. generally accepted accounting principles

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 b. the need for conservatism
c. reporting on management's stewardship
d. the needs of the users of the information

18. These are structured financial representation of the financial position of and the
transactions undertaken by an enterprise during a particular reporting period.
a. financial reports
b. financial statements
c. annual reports
d. financial plans

19. Which is not a component of a complete set of financial statements?

a. balance sheet
b. cash flow statement
c. statement of changes in equity
d. statement of cost of goods manufactured and sold

20. An information possesses this characteristic if it is relatively free from error and represents
what it claims to represent
a. relevance
b. understandability
c. reliability
d. comparability

IV. Classify the following as to: Asset (A), Liability (L), Capital (C). Revenue (R), and
Expense (E).

_____ 1. Accounts Payable _____16. Interest expense

_____ 2. Accounts Receivable _____17. Interest payable

_____ 3. Automobile _____18. Land

_____ 4. Advertising expense _____19. Machineries

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_____ 5. Bonds Payable _____20. Merchandise inventory

_____ 6. Building _____21. Mortgage payable

_____ 7. Cash _____22. Notes payable

_____ 8. Commissions income _____23. Notes receivable

_____ 9. Depreciation expense _____24. Office Supplies

_____10. Equipment _____25. Office Supplies expense

_____11. Fees earned _____26. Prepaid insurance

_____12. Franchise _____27. Prepaid rent

_____13. Furniture and Fixtures _____28. Professional fees

_____14. E. Dela Cruz, Capital _____29. Rent expense

_____15. E. Dela Cruz, Drawing _____30. Rent income

_____31. Salaries expense _____33. Sales

_____32. Salaries payable _____34. Taxes payable

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