Fundamentals of Accounting I

Credit Units: 6 Units

CARD-MRI Development Institute, Inc.
Basic Financial Accounting
Concepts
 Accounting Concepts, Conventions and Principles

Accounting Concepts
• Important ideas which accountants assume in recording
business transactions
• Serve as the bedrock of accounting and also known as
“postulates” or “accounting assumptions”
• Examples: separate entity, going concern, time period, accrual
and monetary value
Accounting Concepts, Conventions and Principles

Limitations of Accounting Concepts

– There is no complete set of concepts available.
– These are not universally accepted in the use of their terms as
principles, conventions, postulates, assumptions, etc.
– Even in the application of these concepts, there is no absolute
uniformity.
 Accounting Concepts, Conventions and Principles

Accounting Conventions
• Accounting practices that practitioners accept because of their
long existence and use
• Examples: “debit and credit” and “dual aspect concept”
 Accounting Concepts, Conventions and Principles

Accounting Principles
• Doctrines which are the basis of all other rules, procedures,
and methods used in the accounting practice
• Continually evolving and developing to meet the changing
needs and conditions
 Generally Accepted Accounting Principles (GAAP)

• Principles used uniformly by accountants in measuring,

recording, and reporting financial activities of an entity
• Developed based on experience, research and careful study
• Main objective – Expressed in the auditor’s report “To fairly
present the financial statements… in conformity with
generally accepted accounting principles”
• GAAPs used in the Philippines – PAS and PFRS, which are
adopted by FRSC from IAS and IFRS of IASB
 Conceptual Framework for Financial Reporting

• Establishes the ideas that bring about financial reporting

• Coherent concept of systems that flow from an accounting
objective which identifies the purpose of financial reporting
• Harmonizes varying accounting concepts to achieve a coherent
set of accounting standards that are more useful and
consistent
• Lends credibility to financial reports and provide clear
understanding and confidence in financial reporting
 Conceptual Framework for Financial Reporting

Common Ground Established by Conceptual Framework

– Identifying boundaries of financial reporting
– Selecting the transactions, other events, and circumstances
to be represented
– Recognizing and measuring
– Summarizing and reporting transactions and events
 Basic Accounting Assumptions
Accounting Assumptions
– Foundation for the rational and systematic formulation of principles and the
development of procedures and methods used to perform accounting services
Underlying Assumptions
• Accrual Basis Assumption
• Going Concern Assumption
Inherent or Implicit Assumptions
• Economic Entity or Separate Entity Assumption
• Periodicity or Time Period Assumption
• Monetary Unit Assumption
 Basic Accounting Assumptions
Economic Entity Assumption
– Accountant regard business enterprise as a separate and distinct entity
from the person or people who own and run it
– Business must keep its own record from the point of view of a business
and not be merged with the personal transactions of the owners
– Main Purpose: To properly account the real transactions of the business in
order to report the true and fair picture of the business financial affairs
– Other Terms: separate entity concept, entity concept, accounting entity or
business entity concept
 Basic Accounting Assumptions
Going Concern Assumption
– Assumes that the business entity will continue operating indefinitely for a period
of time sufficient to carry out its contemplated objectives, plans, contracts, and
commitments unless the liquidation of the entity is imminent
– Values of accounting elements in the financial statements should be based on
the accounting conventions of objectivity and historical cost
• Objectivity – accounting measurement must be both definite and verifiable
• Historical Cost – considering only the purchase price as the value of an asset
– Liquidating Concern – business has the intention to liquidate and the valuation
of accounting elements in the financial statements is valued at their fair market
value
 Basic Accounting Assumptions
Monetary Unit Assumption
– Assumes that money is the common denominator in measuring
economic activity
– Assumes that the monetary unit remains stable regardless of
fluctuation in money value (inflation or deflation)
– Supports the going concern assumption
 Basic Accounting Assumptions
Periodicity or Time Period Assumption
– Assumes that the life of the enterprise is divided into several periods
(normally at equal lengths of time)
– Usually called accounting period
• Calendar Year – twelve-month period starting January 1 and ending
December 31
• Fiscal Year – twelve months starting from any month other than January
• Interim Period – business period within an accounting period
– Financial Reporting Time Line – when a particular financial statement could
be reported and as to what the scope of the period of reporting is
 Basic Accounting Assumptions
Accrual Basis Assumption
– Net profit of a business enterprise is the difference between the revenues
and expenses for an accounting period
– Financial statements, except Statement of Cash Flows, are prepared on the
accrual basis
– Income – includes income earned but not yet received
– Expenses – includes expenses incurred but not yet paid
Cash Basis Accounting – business entity records revenue or expenses only when
cash is received or paid ; not allowed under IFRS because it violates the revenue
and expense recognition principle
 Basic Principles of Accounting
Measurement Principles
– Guide accountants that are used to record and report business
transactions
1. Cost Principle or Historical Cost Principle
• business entities should account for and report many assets and
liabilities on the basis of acquisition cost
• Adheres to the fundamental; qualities of faithful representation
and establishes verifiable benchmark for measuring historical
trends
 Basic Principles of Accounting
Measurement Principles
2. Fair Value Principle
• Amount for which an asset could be exchanged, a liability could be settled, or an
equity instrument granted could be exchanged between knowledgeable and willing
parties in arm’s length transaction
• Market-based valuation and is currently increasing because it provides more
relevant information
Particulars Valuation
Financial instruments, including derivatives Fair Value
FS of brokerage and mutual funds companies Fair Value
Long-lived assets w/ significant decline in value Fair Value
Agricultural industry/biological assets Net Realizable Value
 Basic Principles of Accounting
Revenue Recognition Principles
– Income is recognized when earned or has been substantially
completed, generally at the point of sale
Revenue – synonymous to income and measured at the fair value of
the consideration received or receivable
Income – increases in economic benefits during the accounting period
in the form of inflows or enhancements of assets or decreases of
liabilities that result in increases in equity, other than those relating to
contributing from equity participants
 Basic Principles of Accounting
Revenue Recognition Principles
Exceptions to Recognition of Revenue at Point of Sale
1. Earlier Recognition
– At the point of completed production. Products have ready market or
established price so revenue is recognized before sale by valuing
inventory of products on hand at market value (ex. Mining of certain
precious metals)
– At a certain percentage of completion. Production or performance of
service to complete an advanced contract extends for more than one
year (ex. Construction of roads and buildings)
 Basic Principles of Accounting
Revenue Recognition Principles
Exceptions to Recognition of Revenue at Point of Sale
2. Later Recognition – refers to point of collection (ex. Installment sales)
– Cash or profit recovery method. Recognizes first the profit upon
collection and later collection applies to cost of the product sold
– Cost recovery method. Recognition is made only when the related costs
or expenses of sale are fully recovered
– Installment or hybrid method. Applied on cash basis and installment
sales
 Basic Principles of Accounting
Expense Recognition Principles
– Expense is recognized when income is earned or synonymous with
matching principle
Matching Principle – all costs that were incurred to generate the
revenue appearing on a given period’s statement of comprehensive
income should appear as an expense on the same statement
Expenses – outflows of assets or incurring of liabilities during a period
as a result of delivering or producing goods and/or services
 Basic Principles of Accounting
Expense Recognition Principles
Application of Expense Recognition
1. Associating cause and effect or direct matching principle. Clear and
direct relationship exists between expense and associated revenue
2. Systematic and rational allocation. Cost of assets that are useful and
can provide benefits over several years are expensed over the years
they provided services
3. Immediate recognition. Have no discernible future benefit and they
are expensed immediately as incurred
 Basic Principles of Accounting
Full Disclosure Principle
– Requires that financial statements should report all relevant information
bearing on the economic affairs of a business enterprise, including
subsequent events
Ways of Disclosing Supplemental Information
– Parenthetical comments or modifying comments placed on the face of the
FS.
– Disclosure notes conveying additional insights.
– Supplemental financial statements that report more detailed information
than is shown in the primary FS.
 Qualitative Characteristics of Accounting Information

1. Decision usefulness. To choose which accounting method could provide the most
useful information for decision making and this serves as the criterion in the
making of financial reports.
2. Relevant disclosure. To determine the amount and types of accounting information
to disclose.
3. Reporting format. To use the appropriate presentation and contents of reporting
consistent to the financial reporting objective.
 Fundamental Qualities of Accounting
1. Relevance – capable of influencing or making a difference in economic
decision
2. Predictive Value – has inputs to increase their ability to forecast the
outcome of future events
3. Confirmatory Value – Validating, making updates, adjustments or
corrections to past predictions
4. Faithful Representation – contain factual transactions and other events it
purports to represent to achieve public trust and confidence in the financial
statements
– Faithfully represented if complete, neutral and free from material error
 Fundamental Qualities of Accounting
5. Completeness – contain all necessary information
6. Neutrality – fair or free from bias toward a desired result or behaviour ;
application of principle of fairness
7. Free from error – must be free from error to faithfully embody the
representation contained therein
 Enhancing Qualities of Accounting
1. Understandability – presenting data that can be understood by users of the
information and financial statements should be expressed in a form
properly classified and with terminologies adapted to the user’s range of
understanding
2. Verifiability – information could be checked and corroborated to prove their
faithful representation
3. Timeliness – available on time when needed if it is to influence decisions
4. Comparability – enables users to identify similarities and differences
between two or more sets of economic circumstances
 The Basic Financial Statements and their Definition

Financial Statements – formal reports prepared by accountants

• Statement of Financial Position (SFP) – shows the financial condition of the business entity
at any given time; known as balance sheet; contains assets, liabilities and equity
• Statement of Comprehensive Income – shows the operating performance of the business
for a given period; known as income statement; contains revenues and expenses
• Statement of Changes in Equity – shows the movements in the various elements of the
owner’s equity or capital for a certain period
• Owner’s investments to the business
• Profit or loss for the period
• Owner’s personal withdrawals
• Prior period adjustments
 The Basic Financial Statements and their Definition

• Cash Flow Statement - explains the changes of cash and cash equivalents during an
accounting period
Cash Equivalent – short-term, highly liquid investment that is easily convertible to cash
• Operating – from normal operating activities of the business
• Investing – from sale or purchase of assets other than inventory
• Financing – from the owners and creditors of the enterprise
• Notes to Financial Statements – parenthetical disclosures and notes to the financial
statements
 Elements of Financial Statements (FS)
1. Assets – resources owned or controlled by an entity resulting from past events
and from them, future economic benefits are expected to flow to the entity
2. Liabilities – existing obligations of the entity arising from past events and their
settlements are expected to result in an outflow of assets from the entity
3. Equity – residual interest in the assets of the entity after deducting all its
liabilities
4. Revenues – increases in assets or decreases in liabilities arising from business
operation that result to increase in equity
5. Expenses - decreases in assets or increases in liabilities arising from business
operation that result to decrease in equity
 Recognition of Elements of FS
Recognition – process of recording an item in the books of accounts or reporting
the elements of financial statements; involves the description of an item
including its total amounts in the SFP and SCI
1. Probability of Future Benefit – probable that any future economic benefit
associated with the item will flow to or from the entity
2. Reliability of Measurement – item has a cost or value that can be
measured with reliability
Note: If an item fails to meet the recognition criteria but is considered relevant,
it may be reported as a subsequent event or a disclosure to the financial
statements.
Relationships among the Financial Statements
 Accounts
• Real Accounts – accounts reported in the SFP and are not
closed at the end of the accounting period
• Nominal Accounts – accounts reported in the SCI and are
closed at the end of the accounting period
 The Accounting Equation

Assets Liabilities Equity

 Assets
• Recorded in the books of accounts with a normal debit balance
Criteria to be Recorded as Current Assets
• Cash or cash equivalent which is not restricted for current use.
• Expected to be realized, or is held for sale or consumption in the normal course of
the enterprise’s operating cycle.
• Held primarily for trading purposes or for short term, and is expected to be
realized within 12 months of the SFP date.
Realization – assets are expected to be converted into cash, sold, or disposed after a
certain time, through the passage of time
Noncurrent Assets
• All other assets which are not current
• Expected to be realized in more than 12 months
 Current Assets
1. Cash
– Any item with monetary value that a bank will accept for deposit
and all amounts currently on deposit with the bank in the name of
the business
– Includes coins and currencies, personal checks, money orders,
traveller's checks made payable to the business, bank drafts, and
any funds currently deposited at a bank and readily available as
checking and savings account
Money – everything composed of bills and coins, considered as legal
tender or legal tenders of other nations
 Current Assets
2. Accounts Receivable
– Debtor’s oral promises to the entity to pay a certain amount to the
business and the right of the business to collect that certain amount
Trade Receivables - arise from the normal course of business
Non-Trade Receivables – do not arise fro the normal course of business
(other receivables)
 Current Assets
3. Notes Receivable
– Promissory note received by the business from its debtors and/or
customers
Promissory Note – written promise to pay a certain amount on
specified or determinable date
 Current Assets
4. Accrued Interest Receivable
– Interest earned on note receivable but not yet received in cash
 Current Assets
5. Short-Term Investments
– Investments in low-risk, highly liquid assets such as bonds and
stocks, which are expected to be liquidated in less than a year
– Most often, these are entered to make the most income out of its
idle cash
 Current Assets
6. Inventories
– Assets held for sale in the normal operation of the business to be
consumed in the production process or in rendering the service
– Includes raw materials, work-in-process items, finished goods and
supplies
Raw Materials – inputs for producing other materials
Work-In-Process Items – raw materials entered into production but awaiting
completion
Supplies – do not serve as input for a product but are used in the production
Finished Goods – end products upon completing production
 Current Assets
7. Prepayments
– Paid in advance for goods or services anticipated to be received by
the entity in the future
– Would only cease to be as such when they are finally used up
 Noncurrent Assets
1. Investments
– Most liquid of the noncurrent assets
– Investments which are not expected to be realized within 1 year
 Noncurrent Assets
2. Fixed Assets
– Most tangible, longest-serving assets
– Expected to not be converted into cash immediately and regularly
placed as a means of production
– Not usually consumable and are only used through utilization
Depreciation – deterioration with the passage of time, through usage,
normal wear-and-tear, and obsolescence (except land)
 Noncurrent Assets
3. Intangible Assets
– Lack physical substance and yet are similarly realizable over long
periods of time
– Value and assets are harder to measure and evaluate
– Includes patents, copyrights, franchises, goodwill, trademarks and
licenses
– Often are represented by written documents or certificates stating
their description and ownership status
 Noncurrent Assets
4. Other Assets
– All remaining assets which do not fall into any of the accounts
mentioned
– Catch-all for assets which are usually very much unique or hard to
classify
 Contra-Valuation Accounts (Contra-Assets)
1. Allowance for Doubtful Accounts
– Amount estimated uncollectible on receivable in compliance with
the conservatism principle
– Credited to serve as a contra account for the related receivable
– Other terms: “allowance for uncollectible accounts” and “allowance
for bad debts”
2. Accumulated Depreciation
– Aggregate periodic costs of using a depreciable asset
 Liabilities
• Present obligations to pay cash or cash equivalents by an entity
• Claims against the assets of the business
Criteria to be Recorded as Current Liability
• Expected to be settled in the normal course of the business’ operating
cycle
• Due to be settled within 12 months of the SFP date
Noncurrent Liability
• does not meet the criteria of a current liability
• Comprises the portion payable beyond one year of a long-term liability
 Current Liabilities
1. Accounts Payable
– Obligation or debt to creditors for money borrowed or merchandise
and other assets bought on credit
– Opposite of accounts receivable
 Current Liabilities
2. Notes Payable
– Written promises of the entity to pay sum certain in a future
determinable time
– Can also arise from the regular borrowings
– Opposite of notes receivable
– Pay interest regularly and may be paid in lump sum or installments
 Current Liabilities
3. Accrued Liabilities
– All other accounts which the company should pay, arising from the
normal course of business
– Company has already received benefits from certain events yet still
been unable to pay for it
 Current Liabilities
4. Current Portion of Long-Term Debts
– Portion of the remaining debt that is due many years from now
5. Other Payables
– All other due from the entity outside the normal course of the
business
– Catch-all classification
 Noncurrent Liabilities
1. Bonds Payable
– Degree more formal than notes payable
– Have stated interest rates
– Usually issued by the government, banks and huge corporations
seeking huge financing sources
Bond Indenture – agreement of a long-term debt, often in huge sums
Term Bonds – Have principal maturing in a single date
Serial Bonds – Have principal maturing in multiple dates
 Equity
• Residual amount after deducting liabilities from assets
• Comprises the capital contribution and withdrawals by the owners
• Owner’s Capital (sole proprietorship), Partners’ Capital (partnership) and
Shareholders’ Equity (Corporation)
Drawing – temporary account used to record initially the
amount taken by the owner from the business
 Stockholder’s Equity
1. Common Stock
– Security which represents ownership in a corporation
Common Stockholders – those who own common stocks
Rights of a Common Stockholder:
• Right to vote in the stockholder’s meetings
• Right to receive dividends
• Pre-emptive right which is the right to be offered first to buy
additional shares in the event of future issuance
Par Value– legal nominal value assigned to stocks
 Stockholder’s Equity
2. Preferred Stock
– Also a security which represents ownership in a corporation
– Has preference as to corporate dividends and/or liquidation
Preferred Stockholders – those who own preferred stocks
Treasury Shares – shares bought by the corporation itself and have the
effect of decreasing total shareholder’s equity
 Stockholder’s Equity
3. Additional Paid-in Capital
– Also called share premium
– Excess over par value contributed by the company’s shareholders in a
stock issue
– Arises from the selling of the stock at higher price than the par value
 Stockholder’s Equity
4. Retained Earnings
– Accumulated net income from operations over several periods
– Measure of how much the company earned since day one of its
operations
 Increases in Equity
Revenues – amounts received by a business earned as a result of selling
something or rendering a service
1. Operating Revenue – originate from main business operations
a. Sales Revenue – main source of revenue for businesses that sells
products
b. Service Revenue - main source of revenue for businesses that
render services
 Increases in Equity
2. Non-Operating Revenue – result of some side activities
a. Interest Revenue –earned as a result of investment in debt
securities or receivables from other entities
b. Dividend Revenue – earned as a result of dividend declaration of
a company where in a business has invested stocks
c. Contributions Revenue – earned by not-for-profit organizations
usually in the form of donations by outside parties
 Increases in Equity
Gains – result of non-recurring activities or the increase in value of
investments
Capital Contributions – result of transactions with owners and may be
in the form of cash or non-cash assets for the use in the business
 Decreases in Equity
- Result of expenses, losses and distribution to owners
Expenses – amounts consumed by the business to operate and the
result of attempting to generate revenues
1. Cost of Goods Sold – incurred by the company to make the inventory sell or
buy them
2. Utility Expense – water and electricity
3. Depreciation Expense – use of building and equipment
4. Office Supplies Expense – use of office supplies
5. Insurance Expense – insurance paid for, expiring over time
6. Salaries Expense – salaries and benefits of employees
 Decreases in Equity
7. Bad Debts Expense – estimate of how much accounts receivable the
company will not be able to collect
8. Interest Expense – incurred as a result of borrowing money

Losses – direct opposite of gains

Distribution to Owners – assets given to owners, usually in cash
Liquidating Dividends – originate from some other equity account
 Chart of Accounts
– Listing of all accounts used by a company in its operations
– Classified according to the five major accounts and includes
reference numbers so they can be traced to the ledger
 Chart of Accounts
Ref. No. Assets Ref. No. Revenues
101 Cash 400 Sales
111 Accounts Receivable 405 Interest Revenue
121 Inventories 411 Dividend Revenue
141 Land
145 Furniture Ref. No. Expenses
150 Equipment 600 Cost of Goods Sold
611 Salaries Expense
Ref. No. Liabilities 621 Utility Expense
201 Accounts Payable 640 Depreciation Expense
212 Notes Payable 650 Office Supplies Expense
221 Accrued Liabilities
250 Other Payables

Ref. No. Equity

301 Common Stock
305 Preferred Stock
311 Additional Paid-in Capital
320 Retained Earnings
Accounting Processes and Accounting Cycle
 Books of Accounts
– Finance records, ledgers, and journals that compose the company’s
accounts
– Serve as company’s financial memory and comprise of every single
business transactions and financial information of a company
– Crucial in ensuring regulatory compliance as they serve as proof of
the business transactions reflected in the financial statements
 Journals
– Chronological record of all company’s transactions listed by date
– Often referred as the book of original entry
Journalizing – recording of financial information into the journal
Kinds of Journal
1. General Journal – all business transactions are recorded in chronological
order
2. Special Journal – used by large companies for recurring transactions such as
sales on account and purchases of merchandise on account
 General Journal
– Most basic type of journal
– Typically displays the transaction’s date, account titles and
explanations, references and respective amounts of corresponding
accounts
Date Account Title and Explanation Ref Debit Credit
2016
January 1 Cash 101 200,000
Shayne, Capital 301 200,000
Owner’s investment of cash in the business
 Special Journal
– Used to record typical and similar types of transactions
 Sales Journal
– Used in journalizing all sales of merchandise on account
 Cash Receipts Journal
– Used in journalizing all cash received, including cash sales
CASH RECEIPTS JOURNAL CR1
Date Account Ref Dr. Cash Cr. Accounts Cr. Sales Cr. Other Accounts
Credited Receivable
2016
January 1 Love, Capital 200,000 200,000
3 Hope & Co, 750,000 750,000
8 Peace Co. 30,000 30,000
980,000 30,000 750,000 200,000
 Purchases Journal
– Used in journalizing all purchases of merchandise on account

PURCHASE JOURNAL P1
Date Account Credited Terms Ref Dr. Merchandise Inventory
Cr. Accounts Payable
2016
January 1 Love, Inc. 2/10,n/30 213 20,000
3 Hope & Co, 4/15,n/30 203 10,000
8 Peace Co. 1/20,n/30 206 5,500
35,000
 Cash Payments Journal
– Used in journalizing all cash paid, including cash purchases
CASH PAYMENTS JOURNAL CP1
Date Check Account Credited Ref Dr. Accounts Payable Dr. Other Accounts Cr. Cash
No.
2016
January 1 1071 Love, Capital 40,000 40,000
3 1072 Hope & Co, 34,000 34,000
8 1073 Property, Plant & 120,000 120,000
Equipment
74,000 120,000 194,000
 Ledgers
– Grouping of all counts of a company showing its respective
outstanding balances
– Referred as the book of final entry
Posting – transferring of journal entries to the ledger accounts
Kinds of Ledger
1. General Ledger– all business transactions are recorded in chronological
order
2. Subsidiary Ledger – used by large companies for recurring transactions such
as sales on account and purchases of merchandise on account
 General Ledger
– Contains all accounts of the company
– Grouped according to their chart of accounts and arranged according to
the order of how they appear on the financial statements
– Shows the amount outstanding on each of the company’s accounts as of
a certain date

CASH
Date Explanation Ref Debit Credit Balance
January 1 Investment of capital by owner J1 200,000 200,000
3 Purchase of inventories from supplier J1 20,500 179,500
12 Sale of inventories to customer J1 60,000 239,500
 Subsidiary Ledger
– Group of accounts with a similar characteristic
– Additional record to the general ledger to track the pre-individual
accounts of the customers or creditors
 Accounts Receivable Subsidiary Ledger
– Used in tracking individual accounts receivable balances of company’s
customers

RYANBEAR & CO.

Date Ref Debit Credit Balance
January 1 J1 40,000 40,000
3 J1 60,000 100,000
12 J1 20,000 80,000
 Accounts Payable Subsidiary Ledger
– Used in tracking individual accounts payable balances of company’s
creditors

RYANBEAR & CO.

Date Ref Debit Credit Balance
January 1 J1 40,000 40,000
3 J1 60,000 100,000
12 J1 20,000 80,000
 Source Documents
– documents, such as cash slips, invoices, etc. that form the source of
(and serve as proof for) a transaction
– first documents that exist relating to a transaction
– evidence of the transaction taking place, on what days and at what
amounts
 Source Documents
1. Invoices
- documents listing goods or services provided,
as well as their prices
- normally relate to credit transactions
 Source Documents
2. Receipts
- documents confirming that cash or
goods have been received
- normally relate to payment that has been
made by cash or through a debit or credit
card
 Source Documents
3. Deposit Slips
- documents serving as proof that cash has been deposited in a bank
account
 Source Documents
4. Statement
- report showing the amount owed by one
business to another, as well as
details of transactions between the two
businesses
 Source Documents
5. Payment Confirmations
- documents serving as proof that
payment has been made, often used
as proof of electronic transfers