PART I – INTRODUCTION

Accounting Concepts and it’s Environment

Why Do We Need Accounting?

So why do we need accounting? Asking that question of an accountant is like asking a farmer why
we need rain. We need accounting because it’s the only way for business to grow and flourish.
Accounting is the backbone of the business financial world. After all, accounting was created in
response to the development of trade and commerce during the medieval times.

Accounting is the conscious of the business world. When handled with care and with respect, it
performs as expected. When abuse occurs, and the system is circumvented or overridden because
of dishonesty and greed, it doesn’t work correctly. Accounting is much like all other systems in
place, they are only as good as the people using them.

ACCOUNTING is a service activity. It’s function is to provide quantitative information, primarily

financial in nature, about economic entities that is intended to be useful in making economic
decisions.
“Language of business”
Accounting as science and art
 Accounting is a social science with a body of knowledge which has been systematically
gathered, classified, and organized. It is influenced by, and interacts with, economic, social and
political environments.
 Accounting is a practical art which requires the use of creative skill and judgment.
Accounting as an information system
Accounting identifies and measures economic activities, processes information into
financial reports and communicates these reports to decision makers.
Economic Activities and their classification:
a. Production – the process of converting economic resources into outputs of goods and
services that are intended to have greater utility than the required inputs.
b. Exchange – the process of trading resources or obligations for other resources or
obligation.
c. Income distribution – the process of allocating rights to the use of output among
individuals and groups in society.
d. Consumption – the process of using the final output of the production process.
e. Investment – the process of using current inputs to increase the stock of resources
available for output as opposed to immediately consumable output.
f. Savings – the process by which individuals and groups set aside rights to present
consumption in exchange for rights to future consumption.
BASIC PURPOSE OF ACCOUNTING: To provide quantitative information about economic entities
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
3. Financial information – expressed in terms of money

ECONOMIC ENTITY VS BUSINESS ENTITY

Economic entity – is a separately identifiable combination of persons and property that uses or
controls economic or scarce resources to achieve certain goals or objectives. Scarce resources
have no significant characteristics.
 Not-for-profit or non-profit entity is one that carries out some socially desirable needs of the
community or its members whose activities are not directed towards making profit.
 Business entity is an entity that produces and distributes goods or services primarily for
profit.
FUNCTIONS OF ACCOUNTING
1. Identification. The accounting process of recognition or non- recognition of business
activities as accountable events or whether has accounting relevance.
 One that is quantifiable and has an effect on assets, liabilities and equity. This also
known as economic activity, which is the subject matter of accounting.
Criteria for accountable event
 It must affect a financial element of accounting (increasing or decreasing asset,
liability or equity)
 It is a result of a past activity
 Its cost can be measured reliably.
2. Measurement. The accounting process of assigning of peso amounts or numbers to the
economic transactions and events. The unit of measure of accounting is money, expressed
in prices.
3. Communication. The accounting process of preparing and distributing accounting reports
to potential users of accounting information and interpreting the significance of this
processed information.
a. Recording. the process of systematically committing to writing business transactions
and events after they have been identified and measured, in books of account in a
systematic and chronological manner according to accounting rules.
b. Classifying. The grouping of similar and interrelated items into their respective classes.
c. Summarizing. Putting together or expressing in condensed or brief form the recorded
and classified statements in financial statements.

BRANCHES OF ACCOUNTING/AREA OF SPECIALIZATION

 1. Financial Accounting. The recording of transactions, preparation of financial statements and
communication of financial information to external user groups. Focuses on general purpose
reports.
2. Auditing. The examination of financial statements by independent certified public accountant
for the purpose of expressing an opinion on the fairness of presentation of financial statements.
3. Management Accounting. Incorporates cost accounting data and adapts them for specific
decisions which management may be called upon to make. A management accounting system
incorporates all types of financial and non-financial information from a wide range of sources.
4. Financial Management. Relatively new branch of accounting that has been grown rapidly over
the last 35 years. Financial managers are responsible for setting financial objectives, making
plans based on those objectives, obtaining the finance needed to achieve the plans, and
generally safeguarding all the financial resources of the entity.
5. Taxation / Tax accounting. Involves the preparation of tax returns and rendering of tax advice,
such as determination of tax consequences of certain proposed business endeavors.
6. Government Accounting. Accounting for the national government and its instrumentalities,
focusing attention on the custody of public funds and the purpose or purposes to which such
funds are committed.
7. Fiduciary Accounting. Handling of accounts managed by a person entrusted with the custody
and management of property for the benefit of another.
8. Social Responsibility. Reporting of programs and projects that have to do with the upliftment
of the welfare of the people of a community or of the nation.
9. Environmental Accounting. The area of accounting that focuses on programs, activities and
projects that are focused care for Mother Earth.
10. Price-level Accounting. Otherwise known as Accounting for Hyperinflationary Economies –
simply defined, is accounting that recognizes in the financial statements changes in the
purchasing power of money.
USERS OF ACCOUNTING INFORMATION
 Internal Users are those who make decisions directly affecting the internal operations of the
business.
 Managers are directly involved in operation of the business. They need accounting data to
improve the efficiency and effective of the organization.
 Employees use financial data to assess whether they are receiving the right compensation and
to check if they bargain for higher remuneration, retirement benefits and employment
opportunities.
 Officers, also called as the company executives who are interested to know if the company is
doing well in its operation so they can plan for possible expansion or branching out to widen its
geographical and demographic market.
 Internal Auditors, there role is to protect and safeguard the resources of the company against
fraud or irregularities.

 External users are individuals or enterprises that have financial interest in the business but they
are not involved in the day activities of the organization. These are:
  Investors (The providers of risk capital) are interested in information which enables them to
assess the ability of the enterprise to pay dividends. They need information on whether they
should buy, hold or sell their shares in.
 Lenders are interested in information that enables them to determine whether their loans, and
their interest attaching to them will be paid when due.
 Suppliers and other trade creditors are interested in information that enables them to
determine whether amount owing to them will be paid when due.
 Customers are interested in the quality of goods and services that they are getting from the
entity.
 Government and their agencies require information in order to regulate the activities of the
enterprise, determine taxation policies and as a basis for national income and similar activities,
 Public are assisted by information through Financial statements about the trend and recent
developments in the prosperity of the enterprise and the range of its activities.
FUNDAMENTAL CONCEPTS
Entity Concept
The most basic concept in accounting is the entity concept. An accounting entity is an organization or a
section of an organization that stands apart from other organizations and individuals as a separate
economic unit. Simply put, the transactions of different entities should not be accounted for together.
Each entity should be evaluated separately.
Periodicity Concept
An entity’s life can be meaningfully subdivided into equal time periods for reporting purposes.
For the purpose of reporting to outsiders, one year is the usual accounting period. Luca Pacioli, the
first author of an accounting text, wrote in 1494: “Books should be closed each year, especially in a
partnership, because frequent accounting makes for long friendship.”
Calendar Year – starts in January and ends in December.
Fiscal Year – starts in any month and ends after 12 months.
Stable Monetary Unit Concept
The Philippine Peso is a reasonable unit of measure and that its purchasing power is relatively stable.
This is the basis for ignoring the effects of inflation in the accounting records.
BASIC PRINCIPLES
Accounting practices follow certain guidelines. The set of guidelines and procedures that constitute
acceptable accounting practice at a given time is GAAP, which stands for generally accepted
accounting principles. In order to generate information that is useful to the users of financial
statements, accountants rely upon the following principles.
Objectivity Principle. Accounting records and statements are based on the most reliable data
available so that they will be as accurate and as useful as possible. Reliable data are verifiable when
they can be confirmed by independent observers.
Historical Cost. This principle states that acquired asset should be recorded at their actual cost and
not at what management thinks they are worth as
Revenue Recognition Principle. Revenue is to be recognized in the accounting period when goods
are delivered or services are rendered or performed.
Expense Recognition Principle. Expenses should be recognized in the accounting period in which
goods and services are used up to produce revenue and not when the entity pays for those goods and
services.
Adequate Disclosure. Requires that all relevant information that would affect the user’s
understanding and assessment of the accounting entity be disclosed in the financial statements.
Materiality. Financial reporting is only concerned with information that is significant enough to affect
evaluations and decisions. Materiality depends on the size and nature of the item judged in the
particular circumstances of its omission.
Consistency Principle. The firms should use the same accounting method from period to period to
achieve comparability over time within a single enterprise. However, changes are permitted if justifiable
and disclosed in the financial statements.
UNDERLYING ASSUMPTIONS
Accrual Basis
Financial Statements are prepared on the accrual on the accrual basis of accounting and not as cash
or its equivalent is received or paid. Under this assumption, the effects of transactions and other
events are recognized when they occur and they are recorded in the accounting records and reported
in the financial statements of the periods to why they relate.
In short, transactions are recognized when “Revenue as they earned, even not yet received and;
Expenses as they incurred, even not yet paid.
In cash basis accounting, however, does not record a transaction until cash is received or paid.
Generally, cash receipts are treated as revenues and cash payments as expenses.
Going Concern
Financial statements are normally prepared on the assumption that an enterprise is a going concern
and will continue in operation for a foreseeable future. It is assumed therefore that the enterprise has
neither the intention nor the need to liquidate its operations.

BUSINESS ORGANIZATION
FORMS OF BUSINESS ORGANIZATIONS
1. Sole Proprietorship. This business organization has a single owner called the proprietor who
generally is also manager. It tends to be small service-type (e.g. physicians, lawyers and
accountants) business and retail establishments. The owner receives all profits, absorbs all
losses and is solely responsible for all debts of the business. From the accounting viewpoint,
 the sole proprietorship is distinct from its proprietor. Thus, the accounting records do not
include proprietor’s personal financial records.
2. Partnership. A business owned and operated by two or more persons who bind themselves to
contribute money, property or industry to a common fund, with the intention of dividing the
profits among themselves. Each partner is personally liable for any debt incurred by the
partnership, except limited partner.
3. Corporation. A business owned by its stockholders. It is an artificial being created by operation
of law, having the rights of succession and the powers, attributes and properties expressly
authorized by law or incident to its existence. The stockholders are not personally liable for the
corporation’s debt.
PURPOSE OF BUSINESS ORGANIZATIONS
 Service companies perform services for a fee (e.g. law firms, accounting and law firms, stock
brokerage, beauty salons and recruitment agencies)
 Merchandising companies purchase goods that are ready for sale and then sell these to
customers (e.g. car dealers, clothing stores and supermarkets)
 Manufacturing companies buy raw materials, convert them into products and then sell the
products to other companies or to final consumers (e.g. paper mills, steel mills, car
manufacturers and drug manufacturers)
MICRO, SMALL AND MEDIUM ENTERPRISES (MSME)
Micro Enterprises are those with assets, before financing of P 3 million or less and employ not more
than nine (9) workers.
Small Enterprises are those with assets, before financing of above P 3 million to P 15 million and
employ 10 to 99 workers.
Medium Enterprises are those with assets, before financing of above P15 million to P100 million and
employ 100 to 199 workers.
ACTIVITIES IN BUSINESS ORGANIZATIONS
Operating Activities are the principal activities of the enterprise. They are the transactions and events
that enter into the determination of profit and loss. E.g.
 Sale of services
 Purchase of supplies
 Payment of various expenses like salaries and other benefits to employees, utilities, taxes and
repairs and maintenance, insurance, transportation and gasoline expense.
Investing Activities are the acquisition and disposal of long-term assets and other investments. E.g.:
 Purchase of equipment, furniture, automobile and land
 Cost of developing and constructing office or building
 Sale of used fixed assets
 Loans and advances to other parties
 Investments in equity or debt instruments
Financing Activities are activities that result in charges in the size and composition of the contributed
equity and borrowings of the enterprise. E.g.:
 Cash proceeds from issuing shares of stocks by a corporation
  Cash proceeds and repayment of bank loans and other long-term barrowings.

FINANCIAL STATEMENTS
Objectives
Provide information about the financial position, performance and changes in financial position of an
entity that is useful to a wide range of users in making economic decisions.
Financial statements prepared for this purpose:
 Meet the common needs of most users
 Also show the results of the stewardship* of management, or accountability of management for
the resources entrusted to it.
 Do not, however, provide all the information that users may need to make decisions since they
largely portray the financial effects of past events and do not necessarily provide non- financial
information.

QUALITATIVE CHARACTERISTICS OF FINANCIAL STATEMENTS

A. Fundamental qualitative characteristics
a. Relevance
b. Faithful Representation

B. Enhancing Qualitative characteristics

a. Comparability
b. Verifiability
c. Timeliness
d. Understandability
Relevance
Relevant financial information is capable of making a difference in the decision made by users,
influences the economic decisions of users by helping them to evaluate, past, present, or future events
or confirming, or correcting, their past evaluations.
a. Predictive value. Financial information has predictive value if it can be used as input to
processes employed by users to predict future outcomes. For e.g. information about financial
position and past performance is frequently used in predicting wages payments, and the ability
of the entity to meet maturing obligations.
b. Confirmatory value (or feedback). Financial information has confirmatory value if it provides
feedback about (confirms or changes) previous evaluation. Information with feedback value
enables users to confirm or correct expectations.
Faithful Representation
To be useful, financial information must not only represent relevant phenomena, but it must also
faithfully represent the phenomena that it purports to represent.
 a. Completeness. A complete depiction includes all information necessary for a user to
understand the event or information being presented, including all necessary descriptions and
explanations.
b. Neutrality. A neutral presentation is one without bias.
c. Freedom from error. Means there are no errors or omissions in the description of the
phenomenon, and the process used to produce the reported information has been selected and
applied with no errors in the process.
ENHANCING QUALITATIVE CHARACTERISTICS
a. Comparability. It enables the users to identify and understand similarities in, and differences
among, items. Consistency, although related to comparability, is not the same.

b. Verifiability. Means that different knowledgeable and independent observers could reach
consensus, although not necessarily complete agreement, that a particular depiction is a
faithful representation.

c. Timeliness. Means having information available to decision-makers in time to be capable of

influencing their decisions.

d. Understandability. Means classifying, characterizing, and presenting information clearly and

concisely.
THE ELEMENTS OF FINANCIAL STATEMENTS
The financial statements portray the financial effects of transactions and other events by grouping
them into broad classes according to their economic characteristics. These termed the elements of
financial statements. Elements directly related to measurement of financial position are:
Elements directly related to measurement of financial position are:
 Assets
 Liabilities
 Equity

Elements directly related to measurement of performance are:

 Income
 Expense

RECOGNITION OF THE ELEMENTS OF FINANCIAL STATEMENTS

Recognition is the process of incorporating in the balance sheet or income statement an item that
meets the definition of an element and satisfies the criteria for recognition. An item that meets the
definition of an element should be recognized if:
 It is probable that any future economic benefit associated with the item will flow to or from the
enterprise; and
 The item has a cost or value that can be measured with reliability.

MEASUREMENT OF THE ELEMENTS OF FINANCIAL STATEMENTS

Measurement is the process of determining the monetary amounts at which the elements of financial
statements are to be recognized and carried in the balance sheet and income statement. This involves
the selection of a particular basis of measurement. A number of these are used to different degrees
and in varying combinations in financial statements. They include the following:
HISTORICAL COST. Assets are recorded at the amount of cash or cash equivalents paid or the
fair value of the consideration given to acquire them at the time their acquisition.
CURRENT COST. Assets are carried at the amount of cash or cash equivalents that would have to
be paid if the same or an equivalent asset was acquired currently.
RELIAZABLE (SETTLEMENT) VALUE
Reliazable value. Assets are carried at the amount of cash or cash equivalents that could
currently be obtained by selling an asset in an orderly disposal.
Settlement value. Liabilities are carried at the undiscounted amounts of cash or cash
equivalents expected to be paid to satisfy the liabilities in the normal course of business.
Present Value. Assets/liabilities are carried at present discounted value of the future net cash
inflows/outflows that the item is expected to generate/settle in the normal course of business.
GUIDELINES IN THE PRESENTATION OF FINANCIAL STATEMENTS
Philippine Accounting Standard 1 (PAS) gives us the following guidelines in the presentation of
financial statements.
1. Each component of the financial statements shall be clearly identified and the following
information shall be emphasized for a proper understanding of the information presented:
a) The name of the reporting entity;
b) Whether the financial statements cover the individual entity or a group of entities.

2. The period covered by the financial statement shall be specified.

Note: For Balance Sheet, use As of (date). For Income Statement, Statement of Changes in
Owner’s Equity and Statement of Cash flows, use For the month/year ended (date).

FINANCIAL POSITION
The financial position of an enterprise is affected by the economic resources it controls, its financial
structure, it liquidity and solvency, and its capacity to adapt to changes in the environment in which it
operates. This is primarily provided in the Statement of Financial Position or Balance Sheet.
It answers the following questions:
 What assets does entity own?
 What does it owe?
 What are the residual equity interests in the entity’s net assets?

Other important information provided by the statement of financial position is as follows:

 Financial structure – is the source of financing for the assets of the enterprise. It indicates what
amount of assets has been financed by creditors, which is borrowed capital, and what amount of
assets has been financed by owners, which is invested capital.
Significance:
1. Useful in predicting future borrowing needs and how future profits and cash flows will be
distributed among those with an interest in the enterprise.
2. Useful in predicting how successful the enterprise is likely to be raising further finance.

 Liquidity – refers to the availability of cash in the near future after taking account of financial
commitments over this period.
Significance:
1. Useful in predicting the ability of the enterprise to meet its short-term financial commitments
as they fall due.

 Solvency – refers to the availability of cash over the longer term to meet financial commitments
as they fall due.
Significance:
1. Useful in predicting the ability of the enterprise to meet its long-term financial commitments
as they fall due.

 Capacity for adaption – the ability of the enterprise to use its available cash for unexpected
requirements and investment opportunities. This is also known as financial flexibility.

1. Information about the economic resources controlled by the enterprise and its capacity for
adaptation is useful in predicting the ability of the enterprise to generate cash and cash
equivalents in the future.

COMPOSITION OF A STATEMENT IN FINANCIAL POSITION

ASSETS
These are resources controlled by the enterprise* as a result of past events** and from which
future economic benefits*** are expected to flow to the enterprise.
For example, an asset may be:
 Used singly or in combination with other assets in the production of goods or services to be
sold by the enterprise;
 Exchanged for other assets;
 Used to settle a liability;
 Distributed to the owners of the enterprise.
Assets are should be classified only in two: current assets and non- current assets. Operating
Cycle is the time between the acquisition of assets for processing and their realization in cash or cash
equivalents. When the entity’s normal operating cycle is not clearly identifiable, it is assumed to be
twelve months.
*Controlled by the enterprise – control is the ability to obtain the economic benefits and to restrict the
access of others (e.g. an entity being the sole user of its plants and equipment or by selling idle assets)
**Past events – The event must be past before an asset can rise. (E.g. equipment will only become an
asset when there is the right to demand delivery or access to the asset’s potential. Dependent on the
terms of the contract, this may be on acceptance of the order or on delivery.
***Future economic benefits – These are evidenced by the prospective receipt of cash. This could be
cash itself, an account receivable or any item which may be sold. Although, for example, a factory may
not be sold for it houses the manufacturing facility for the goods. When these goods are sold, the
economic benefit resulting from the use of the factory is realized as cash.
Current Assets
An entity shall classify assets as current when:
a. It expects to realize the asset, or intends to sell or consume it, in its normal operating cycle;
b. It holds the asset primarily for the purpose of trading;
c. It expects to realize the asset within twelve months after the reporting period;
d. The asset is cash or cash equivalent unless the asset is restricted from being exchanged or
used to settle a liability for at least months after the reporting period.

1. Cash any medium of exchange that a bank will accept for deposit at face value. It includes
coins, currency, checks, money orders, bank deposits and drafts.

2. Cash Equivalents these are short-term, highly liquid investments that are readily convertible to
known amounts of cash and which are subject to an insignificant risk of changes in value.

3. Accounts Receivable. These are claims against customers arising from sale of services or
goods on credits. This type of receivable offers less security than a promissory note.

4. Notes Receivable. A note receivable is a written pledge that the customer will pay the
business a fixed amount of money on a certain date.

5. Inventory or Merchandise. Inventory these are assets which are (a) held for sale by the
company, (b) in the process of production for such sale, (c) in the form of materials (raw
materials) or supplies to be consumed in the production.

6. Supplies this may be office supplies like bond papers, paper clips and the like or can be also
store supplies like boxes, bags, packaging tapes and other related materials.

7. Prepaid Expenses. These are expenses paid for by the business in advance. It is an asset
because the business avoids, having to pay cash in the future for a specific expense. This
includes insurance and rent.
Non-current Assets
All other assets not classified or does not fall under the criteria of current assets are called non-current
assets.
1. Property, Plant and Equipment (PPE) these are tangible assets that are held by an enterprise
for use in the production or supply of goods or in rendering services, or for rental to other, or
for administrative purposes and which are expected to be used during more than one period.
These are:
 Land
 Building
 Office Equipment
 Furniture and Fixtures
 Delivery Equipment
 Store Equipment
 Service Vehicle

2. Accumulated Depreciation applies to property, plant and equipment except land as a contra
account that contains the sum of periodic depreciation charges. The reflected amount is
deducted from the cost of the related asset to obtain book value.
To illustrate:
The Company has an office equipment worth P500,000 with a useful life of 10 years acquired
last June 1, 2013. (from june 1 2013 to june 1 2015)
Office Equipment P 500,000
Accumulated Depreciation – O/E (100,000)
Net book value P 400,000

Formula:
Cost of the PPE−salvage value∗(if any)
Annual Depreciation=
Life(n)

Accumulated Depreciation = Annual depreciation x age of the PPE

*Salvage value is the value of an asset if sold for scrap and also called as Residual or scrap
value.
To compute:
500,000
¿ =50,000 annual depreciation
10
= 50,000 x 2 years = 100,000 Accumulated Depreciation
3. Intangible
These are identifiable, nonmonetary assets without physical substance held for use in the production
or supply of goods or services, for rentals to others or for administrative purposes. These are:
 Goodwill  Copyrights
 Patents  Licenses
 Franchises  Brand names
 Trademarks

LIABILITIES
A present obligation of the enterprise arising from past events, the settlement of which is expected to
result in an outflow from the enterprise of resources embodying can be measured benefits
 Obligation – These maybe legal or not. A duty to do something or a debt.
 Transfer economic benefits – This could be a transfer of cash, or another property, the provision
of a service or the refraining from activities which would otherwise be profitable.
The settlement of a present obligation involving outflow of resources may take the form of:
a. Payment of cash
b. Transfer of other assets
c. Provision for services
d. Replacement of the present obligation with another obligation
e. Conversion of the obligation to equity
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 months after the reporting period; or
d.The entity does not have an unconditional right to defer settlement of the liability for at least
twelve months after the reporting period.
1. Accounts payable. This account represents the reverse relationship of the accounts receivable.
Due to suppliers of goods and other assets purchased on credit.

2. Notes Payable. A note payable is like a note receivable but in a reverse sense. The business
entity is the maker of the note; that is, the entity is the party who promises to pay in a specified
amount of money on specified future date.

3. Accrued Liabilities. Amounts owed to others for unpaid expenses. This account includes:
a. Salaries payable
b. Utilities payable
c. Interest payable
d. Taxes payable

4. Unearned Revenues. When the business entity receives payment before providing its customers
with goods or services, the amounts received are recorded in the unearned revenue account
(liability method). When the goods or services are provided to the customer, the unearned revenue
is reduced and income is recognized.

5. Current portion of Long-term debt. These are portions of long-term liabilities which are to be
paid within one year from the balance sheet date.
Non-current liabilities
All other liabilities not classified or does not fall under the criteria of current liabilities are called non-
current liabilities.
1. Mortgage payable. This account records long-term debt of the business entity for which the
entity has pledged certain assets as security to the creditor.

2. Bonds payable is an obligation in connection with the bond, a contract between the issuer and
the lender specifying the terms of repayment and the interest to be charged.
OWNER’S EQUITY

Equity is defined as the residual interest in the asset of an entity that remains after deducting all its
liabilities.
1. Capital this account is used to record original and additional investment of the owner of the
business entity. In partnership, Partners’ Capital is use as its capital account while in
corporation is Shareholders’ Equity.
2. Withdrawals When the owner of a business entity withdraws cash or other assets, such are
recorded in the drawing or withdrawal account rather than directly reducing the owner’s equity
account.
3. Income Summary It is a temporary account used at the end of the accounting period to close
the income and expenses. This account shows the profit or loss for the period before closing to
the capital account.

FINANCIAL PERFORMANCE reflected by accrual accounting*

Performance of an enterprise – comprise its revenue, expenses, net income or loss for a period of
time. It is the level of income earned by the enterprise through efficient and effective use of its
resources. Information about performance is primarily provided in an Income Statement or Statement
of Financial Performance or Statement of Comprehensive Income or Statement of Income and
Expenses.
*Accrual Accounting recognizes transactions and other events of a reporting entity in the periods in
which those effects occur, even if the resulting cash receipts and payments occur in a different period.

COMPOSITION OF STATEMENT OF FINANCIAL PERFORMANCE

REVENUE OR INCOME
These are increases in economic benefits during the accounting period in the form of inflows or
enhancements of assets or decrease of liabilities from delivery or production of goods, rendering of
services, or other activities that constitute the enterprise’s major operations.
1. Service Income Revenues earned by performing services for a customer or client, for e.g.
accounting services by a CPA firm, laundry services by a laundry shop.
 2. Sales Revenues earned as a result of sale of merchandise; for e.g. sale of merchandise by
General Merchandise Store.
EXPENSES
These are decrease in economic benefits during the period in the form of outflows or using up of
assets or incurrence of liabilities that result in decreases in equity, other than relating to distributions to
equity participants.
1. Cost of Sales The cost incurred to purchase or to produce the products sold to customers
during the period; also called as cost of goods sold.

2. Salaries and Wages Expense includes all payments as a result of an employer-employee

relationship such as salaries and wages, 13th month pay, cost if living allowances, other related
benefits.

3. Utilities Expense expenses related to use of telecommunications facilities, consumptions of

electricity, fuel and water.

4. Rent Expense expense for space, equipment or other asset rentals.

5. Supplies Expense expense of using supplies in the conduct of daily business.

6. Insurance Expense portion of premiums paid on insurance coverage which has expired.

7. Depreciation Expense portion of the cost of a tangible asset allocated or charged as expense
during an accounting period.

8. Uncollectible Accounts Expense the amount of receivables estimated to be doubtful of

collection and charged as expense during an accounting period.

9. Interest Expense An expense related to use of borrowed funds.

CHANGES IN FINANCIAL POSITION

It refers to the changes in the economic resources and obligation of an enterprise. In constructing a
statement of changes in Owner’s Equity, funds can be defined in various ways, such as all financial
revenues, working capital, liquid assets or cash.
THE ACCOUNT
The basic summary device of accounting is the account. A separate account is maintained for each
element that appears in the balance sheet (assets, liabilities, and equity) and in the income statement
(income and expense). Thus, an account may be defined as a detailed record of the increases,
decrease and balance of each element that appears in an entity’s financial statements.
The simplest form of the account is known as the “T” account because of its similarity to the letter T.
the account has three parts as shown on the next page.

Account Title
Left side or debit side Right side or credit side

THE ACCOUNTING EQUATION and DEBITS AND CREDITS-THE DOUBLE ENTRY SYSTEM

ASSET = LIABILITIES + EQUITY

Balance

The basic tool of accounting is the accounting equation. The left side of the equation shows how
much the business owns, and the right side of the equation shows how much resources do the
outside creditor and owner supplied to the business.
The logic of debiting and crediting is related to the accounting equation. Transactions may require
addition to both sides (left or sides), subtractions from both sides (left and right sides), or an addition
and subtraction on the same side (left or right sides). But in all cases the equality must be
maintained as shown above.
The definitions of a debit and credit are:
A debit is that portion of an accounting entry that either increases an asset or expense account or
decreases a liability or equity account. It is positioned to the left in an accounting entry.
A credit is that portion of an accounting entry that either increases a liability or equity account or
decreases an asset or expense account. It is positioned to the right in an accounting entry.
ASSETS = LIABILITIES + EQUITY (ALE)
This formula shall be the foundation of all entries. Why? Because if you stick to this principle, you will
minimize your errors in making entries.
Accounting is based on a double-entry system which means that the dual effects of business are
recorded. A debit side entry must have a corresponding credit side entry. For every transaction,
there must be one or more accounts debited and one or more accounts credited and must be equal
both sides. Each transaction affects at least two accounts.
The rules of debit and credit in accounts.

ACCOUNT DEBIT CREDIT

Assets + -
Liabilities - +
Capital or Equity - +
Revenue or Income - +
Expenses + -
(+) increase; (-) decrease
Normal Balances:
 Assets = Debit
 Contra Assets = Credit
 Liabilities = Credit
 Equity = Credit
 Income = Credit
 Expense = Debit
Sample scenarios:
An Increase in ASSET will result to either one of the following:
 A decrease in ASSET
 An increase in LIABILITY
 An Increase in EQUITY
 An Increase in INCOME
A Decrease in ASSET will result to one of the following:
 Increase in ASSET
 Decrease in LIABILITY
 Decrease in EQUITY
 Increase in EXPENSE
An Increase in LIABILTY will result to one of the following:
 Increase in ASSET
 Decrease in LIABILITY
 Decrease in EQUITY
 Increase in EXPENSE
A Decrease in LIABILITY will result to one of the following:
 Decrease in Asset
 Increase in Liability
 Increase in Equity
  Increase in Income
 Decrease in Expense
ACCOUNTING EVENTS AND TRANSACTIONS
An accounting event is an economic occurrence that causes changes in an enterprise’s assets,
liabilities, and/or equity. A transaction is a particular kind of event that involves the transfer of
something of value between two entities.
Accountants observe many events that they identify and measure in financial terms. A business
transaction is the occurrence of an event or a condition that affects financial position and can be
reliably recorded.
Financial transaction worksheet
Every financial transaction can be analyzed or expressed in terms of its effects on the accounting
equation. The financial transactions will be analyzed by means of a financial transaction worksheet
which is a form used to analyze increases and decreases in the assets, liabilities or owner’s equity of a
business entity.
When a specific asset, liability or owner’s equity item is created by a financial transaction, it is listed in
the financial transaction worksheet using the appropriate accounts.

To illustrate:
Mr. Balan Sy wants to open an accounting firm this year. The following transactions are made
during the month.

May 1. Mr. Sy invested P100,000 to start an accounting office.

B. Sy Accounting Firm
Financial Transaction Worksheet
Month of May 2015

ASSET = LIABILITIES + OWNER'S EQUITY

May Accounts Office Office Accounts Notes
Cash = + B. Sy Capital
2015 Receivable Supplies Equipment Payable Payable
1 100,000 = 100,000

The financial transaction is analyzed as follows:

 An entity separate and distinct from Sy’s personal financial affairs is created.
 An economic resource – cash of P 100,000 is invested in the business entity. The
source of this asset is the contribution made by the owner, which represents owner’s
equity. The owner’s equity account is B. Sy, Capital.
  The dual nature of the transaction is that cash is invested and owner’s equity created.
The effects of this transaction on the accounting equation are as follows: increase in
asset – cash from zero to P 100,000 and increase in owner’s equity from zero to P
100,000.

May 3. Purchased office supplies worth P20,000 on account.

ASSET = LIABILITIES + OWNER'S EQUITY

May Accounts Office Office Accounts Notes
Cash = + B. Sy Capital
2015 Receivable Supplies Equipment Payable Payable
Bal. 100,000 = 100,000
3 20,000 = 20,000 0 +
Bal. 100,000 0 20,000 0 = 20,000 0 + 100,000
120,000 120,000

Analysis: The effect of transaction is increase in asset and increase in liabilities. Take note
that the equality of the two sides of the equation is maintained.

May 5. Purchased additional office supplies for cash, P10,000.

ASSET = LIABILITIES + OWNER'S EQUITY

May Accounts Office Office Accounts Notes
Cash = + B. Sy Capital
2015 Receivable Supplies Equipment Payable Payable
Bal. 100,000 20,000 = 20,000 100,000
5 (10,000) 10,000 = 0 +
Bal. 90,000 0 30,000 0 = 20,000 0 + 100,000
120,000 120,000

Analysis: The effect of transaction is increase in asset and decrease in another asset form of
asset. After posting the transaction, total asset amounts to P120,000 and total liabilities and
capital amount to P120,000.

May 6. Paid the accounts payable in full.

ASSET = LIABILITIES + OWNER'S EQUITY

May Accounts Office Office Accounts Notes
Cash = + B. Sy Capital
2015 Receivable Supplies Equipment Payable Payable
Bal. 90,000 30,000 = 20,000 100,000
6 (20,000) = (20,000) 0 +
Bal. 70,000 0 30,000 0 = 0 0 + 100,000
100,000 100,000
 Analysis: Transaction reduces both sides of the equation by P20,000 resulting to the equality
of the equation after posting.

May 8. Purchased 2 units of computer with printer for P50,000, 30 days.

ASSET = LIABILITIES + OWNER'S EQUITY

May Accounts Office Office Accounts Notes
Cash = + B. Sy Capital
2015 Receivable Supplies Equipment Payable Payable
Bal. 70,000 0 30,000 0 = 0 0 100,000
8 50,000 = 50,000 0 +
Bal. 70,000 0 30,000 50,000 = 50,000 0 + 100,000
150,000 150,000

May 10. Rendered accounting services for cash, P25,000.

ASSET = LIABILITIES + OWNER'S EQUITY

May Accounts Office Office Accounts Notes
Cash = + B. Sy Capital
2015 Receivable Supplies Equipment Payable Payable
Bal. 70,000 0 30,000 50,000 = 50,000 0 100,000
10 25,000 = + 25,000
Bal. 95,000 0 30,000 50,000 = 50,000 0 + 125,000
175,000 175,000

May 15. Rendered accounting services on account, P 30,000.

ASSET = LIABILITIES + OWNER'S EQUITY

May Accounts Office Office Accounts Notes
Cash = + B. Sy Capital
2015 Receivable Supplies Equipment Payable Payable
Bal. 95,000 0 30,000 50,000 = 50,000 0 125,000
15 30,000 = + 30,000
Bal. 95,000 30,000 30,000 50,000 = 50,000 0 + 155,000
205,000 205,000

May 15 Paid Meralco bills, P 3,500.

 ASSET = LIABILITIES + OWNER'S EQUITY
May Accounts Office Office Accounts Notes
Cash = + B. Sy Capital
2015 Receivable Supplies Equipment Payable Payable
Bal. 95,000 30,000 30,000 50,000 = 50,000 0 155,000
15 (3,500) = + (3,500)
Bal. 91,500 30,000 30,000 50,000 = 50,000 0 + 151,500
201,500 201,500

May 15 Paid salaries for the period, P15,000.

ASSET = LIABILITIES + OWNER'S EQUITY

May Accounts Office Office Accounts Notes
Cash = + B. Sy Capital
2015 Receivable Supplies Equipment Payable Payable
Bal. 91,500 30,000 30,000 50,000 = 50,000 0 151,500
15 (15,000) = + (15,000)
Bal. 76,500 30,000 30,000 50,000 = 50,000 0 + 136,500
186,500 186,500

May 20 Collected P10,000 from customer.

ASSET = LIABILITIES + OWNER'S EQUITY

May Accounts Office Office Accounts Notes
Cash = + B. Sy Capital
2015 Receivable Supplies Equipment Payable Payable
Bal. 76,500 30,000 30,000 50,000 = 50,000 0 + 136,500
20 10,000 (10,000) =
Bal. 86,500 20,000 30,000 50,000 = 50,000 - + 136,500
186,500 = 186,500

May 22 A Short term loan from a local bank was granted in the amount of P50,000, less P5,000
financing charges. Mr. B. Sy issued 1-year promissory note.

ASSET = LIABILITIES + OWNER'S EQUITY

May Accounts Office Office Accounts Notes
Cash = + B. Sy Capital
2015 Receivable Supplies Equipment Payable Payable
Bal. 86,500 20,000 30,000 50,000 = 50,000 0 + 136,500
22 45,000 = 50,000 + (5,000)
Bal. 131,500 20,000 30,000 50,000 = 50,000 50,000 + 131,500
231,500 = 231,500
 May 25 Paid telephone bill amounting to P 6,000.

ASSET = LIABILITIES + OWNER'S EQUITY

May Accounts Office Office Accounts Notes
Cash = + B. Sy Capital
2015 Receivable Supplies Equipment Payable Payable
Bal. 131,500 20,000 30,000 50,000 = 50,000 50,000 + 131,500
25 (6,000) = + (6,000)
Bal. 125,500 20,000 30,000 50,000 = 50,000 50,000 + 125,500
225,500 = 225,500

May 27 Mr. Sy withdrew P20,000 for personal use.

ASSET = LIABILITIES + OWNER'S EQUITY

May Accounts Office Office Accounts Notes
Cash = + B. Sy Capital
2015 Receivable Supplies Equipment Payable Payable
Bal. 125,500 20,000 30,000 50,000 = 50,000 50,000 + 125,500
27 (20,000) = + (20,000)
Bal. 105,500 20,000 30,000 50,000 = 50,000 50,000 + 105,500
205,500 = 205,500

May 30 At the end of the month, physical count of the office supplies revealed that P 5,000 had
been consumed.

ASSET = LIABILITIES + OWNER'S EQUITY

May Accounts Office Office Accounts Notes
Cash = + B. Sy Capital
2015 Receivable Supplies Equipment Payable Payable
Bal. 105,500 20,000 30,000 50,000 = 50,000 50,000 + 105,500
27 (5,000) = + (5,000)
Bal. 105,500 20,000 25,000 50,000 = 50,000 50,000 + 100,500
200,500 = 200,500

Summary of B. Sy in tabular Form

B. Sy Accounting Firm
Financial Transaction Worksheet
Month of May 2015
 ASSET = LIABILITIES + OWNER'S EQUITY
May Accounts Office Office Accounts Notes
Cash = + B. Sy Capital
2015 Receivable Supplies Equipment Payable Payable
1 100,000 100,000
3 20,000 20,000
5 (10,000) 10,000
6 (20,000) (20,000)
8 50,000 50,000
10 25,000 25,000
15 30,000 30,000
15 (3,500) (3,500)
15 (15,000) (15,000)
20 10,000 (10,000)
22 45,000 50,000 (5,000)
25 (6,000) (6,000)
27 (20,000) (20,000)
30 (5,000) (5,000)
Bal. 105,500 20,000 25,000 50,000 = 50,000 50,000 + 100,500
200,500 = 200,500

USE OF T-ACCOUNTS
Analyzing and recording transactions using the accounting equation is useful in conveying a basic
understanding of how transactions affect the business. However, it is not an efficient approach once
the number of accounts involved increases. Double-entry system provides a formal system of
classification and recording business transactions.
May 1. Mr. B. Sy invested P100,000 to start an accounting office.
Cash B. Sy, Capital
5/1 100,000 100,000 5/1

May 3. Purchased office supplies worth P20,000 on account.

Office Supplies Accounts Payable
5/3 20,000 20,000 5/3

May 5. Purchased additional office supplies for cash, P 10,000.

Office Supplies Cash
5/3 20,000 5/1 100,000 10,000 5/5
5/5 10,000
May 6. Paid the accounts payable in full, P20,000
Accounts Payable Cash
5/6 20,000 20,000 5/3 5/1 100,000 10,000 5/5
20,000 5/6

May 8. Purchased 2 units of computer with printer for P50,000, 30 days.

Accounts Payable Office Equipment
5/6 20,000 20,000 5/3 5/8 50,000
50,000 5/8
May 10. Rendered accounting services for cash, P25,000.
Cash Professional Fees
5/6 20,000 20,000 5/3 25,000 5/10
5/10 25,000 50,000 5/8
May 15. Rendered accounting services on account, P30,000.
Accounts Receivable Professional Fees
5/15 30,000 25,000 5/10
30,000 5/15
May 15. Paid Meralco bills, P3,500.
Cash Utilities Expense
5/6 20,000 20,000 5/3 5/15 3,500
5/10 25,000 50,000 5/8
3,500 5/15
May 15. Paid salary of office staffs, P15,000
Cash Salaries Expense
5/6 20,000 20,000 5/3 5/15 15,000
5/10 25,000 50,000 5/8
3,500 5/15
15,000 5/15
May 20. Collected P 10,000 from customer.
Cash Accounts Receivable
5/6 20,000 20,000 5/3 5/15 30,000 10,000 5/20
5/10 25,000 50,000 5/8
5/20 10,000 3,500 5/15
15,000 5/15
May 22. A short term loan from a local bank was granted in the amount of P50,000, less
P5,000 finance charges. B. Sy issued 1 year promissory note.
Cash Notes Payable
5/6 20,000 20,000 5/3 50,000 5/22
5/10 25,000 50,000 5/8
 5/20 10,000 3,500 5/15 Interest Expense
5/22 45,000 15,000 5/15 5,000 5/22
May 25. Paid telephone bill amounting to P6,000.
Cash Telephone Expense
5/6 20,000 20,000 5/3 5/15 30,000 10,000 5/20
5/10 25,000 50,000 5/8
5/20 10,000 3,500 5/15
5/22 45,000 15,000 5/15
6,000 5/25
May 27. B. Sy withdrew cash P20,000 for her personal use.
Cash B. Sy drawing
5/6 20,000 20,000 5/3 5/27 20,000
5/10 25,000 50,000 5/8
5/20 10,000 3,500 5/15
5/22 45,000 15,000 5/15
6,000 5/25
20,000 5/27

May 30. At the end of the month, physical count of the office supplies revealed that P5,000 had
been consumed.
Office Supplies Supplies Expense
5/3 20,000 5,000 5/30 5/30 5,000
5/5 10,000