1 Handout Accounting 1 - Partnership formation, operation, dissolution, liquidation PDF

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Note to Student:DISCLAIMER: This handout does not contain all information regarding the topics in FinancialAccounting and Reporting.This handout contains concepts and some practice problems hence you still need to solveproblems in different study materials.Study well!-JDCTHO1: OVERVIEW OF ACCOUNTING...

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Note to Student: DISCLAIMER: This handout does not contain all information regarding the topics in Financial Accounting and Reporting. This handout contains concepts and some practice problems hence you still need to solve problems in different study materials. Study well! -JDCT

HO1: OVERVIEW OF ACCOUNTING DEFINITION OF ACCOUNTING - ASC Accounting Standards Council (Service); its function is to provide quantitative information, primarily financial in nature, about economic entities that is intended to be useful in making economic decisions. - AICPA American Institute of Certified Public Accountants (Art); art of recording, classifying and summarizing in a 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. - AAA American Accounting Association (Process); process of identifying, measuring and communicating. BUSINESS ORGANIZATIONS By law all businesses must keep accounting records. Decisions are based on accounting information for profit and non-profit companies alike. There are different forms of business organizations:  Sole Proprietorship—owned by one person, called the Sole-Proprietor  Partnership—co-owned by two or more persons, in Philippine Law, there is no maximum number of partners.  Corporation—owned by investors called stockholders (The business —not the owners —are responsible for the company’s obligations.). Owned by 5 to 15 persons called shareholders There are different types of business organizations:  Service business— renders services e.g. doctors, lawyers, barber shop, etc.  Merchandising business —purchases goods for resale or buys and sells merchandise to the public  Manufacturing business—produces a product to sell or buys raw materials and converts them into finished goods to be sold to the public BOOKKEEPING v. ACCOUNTING Bookkeeping focuses on the recording of transactions and in the preparation of financial reports while in Accounting, it records the transactions, prepare and analyze financial reports, and users make decisions. BRANCHES OF ACCOUNTING 1. Financial accounting/ Financial Reporting – focuses on general purpose financial statements. It is primarily concerned with the recording of business transactions and the eventual preparation of financial statements 2. Management accounting – focuses on special financial reports geared towards the needs of an entity’s management. It is the preparation of financial reports and management research intended for management use and interpretation of these reports and researches. Examples of financial reports are Sales reports, Cost of Production reports, Budgets etc. Example of management research is evaluation of a business process and management consulting. 3. Cost accounting – the systematic recording and analysis of the costs of materials, labor, and overhead incident to production. It is primarily concerned with proper accumulation of costs such as materials, labor and overhead, proper costing of inventories and study of different costing methods. 4. Auditing – a systematic process of objectively obtaining and evaluating evidence regarding assertions about economic actions and events to ascertain the degree of correspondence between these assertions and established criteria and communicating the results to interested users. It basically deals with the examination of the financial statements by an independent party (auditor) to ascertain whether such financial statements are in conformity with Philippine Accounting Standards. 5. Tax accounting – the preparation of tax returns and rendering of tax advice, such as determination of tax consequences of certain proposed business endeavors. It deals with the study of provisions of the law with regard to Philippine taxation system and proper computation of taxes such as income tax, value-added tax, withholding tax and other taxes.

6. Government accounting – the 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. SECTORS IN THE PRACTICE OF ACCOUNTANCY 1. Practice of Public Accountancy - involves the rendering of audit or accounting related services to more than one client on a fee basis. 2. Practice in Commerce and Industry - refers to employment in the private sector in a position which involves decision making requiring professional knowledge in the science of accounting and such position requires that the holder thereof must be a certified public accountant. 3. Practice in Education/Academe – employment in an educational institution which involves teaching of accounting, auditing, management advisory services, finance, business law, taxation, and other technically related subjects. 4. Practice in the Government – employment or appointment to a position in an accounting professional group in government or in a government–owned and/or controlled corporation, including those performing proprietary functions, where decision making requires professional knowledge in the science of accounting, or where a civil service eligibility as a certified public accountant is a prerequisite. GENERALLY ACCEPTED ACCOUNTING PRINCIPLES (GAAP)  The GAAP of the Philippines are represented by the Philippine Financial Reporting Standards (PFRSs).  GAAP refers to rules, procedures, practice and standards followed in the preparation and presentation of financial statements,  Philippine Financial Reporting Standards (PFRSs) o These are Standards and Interpretations adopted by the Financial Reporting Standards Council (FRSC). They comprise of:  Philippine Financial Reporting Standards (PFRSs);  Philippine Accounting Standards (PASs); and  Interpretations o PFRSs, PASs, and PICs have equal authority. o PFRSs sets out the recognition, measurement, presentation and disclosure requirements dealing with accountable events. o PFRSs apply to all general purpose financial statement and these statements are directed towards the common information needs of a wide range of users  FRSC is the council that establishes and improves accounting standards that will be generally accepted in the Philippines. o FRSC (Financial Reporting Standards Council)  Established by the Board of Accountancy through R.A. 9298 to promulgate accounting standards in the Philippines  Composed of a chair and 14 members (BOA, COA, SEC, BIR, BSP, FINEX, 8 PICPA)  FUNCTION: Establishment and Approval of PFRSs and Philippine Interpretations (GAAP) Accounting as “Language of Business” The primary objectives of the business are: 1. To generate profits 2. To properly manage limited and scarce resources With these objectives, a business must prepare financial reports and interpret these reports as an aid in decision-making. In making decisions, accounting is used as a tool for communication. PURPOSE OF ACCOUNTING The basic purpose of accounting is to provide information about economic activities intended to be useful in making economic decisions. TYPES OF INFORMATION PROVIDED BY ACCOUNTING

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Quantitative information – expressed in numbers, quantities or units Qualitative information – expressed in words or descriptive form Financial information – expressed in terms of money

TYPES OF INFORMATION CLASSIFIED AS TO USERS’ NEEDS  General purpose accounting information - designed to meet the common needs of most statement users. This information governed by the Philippine Financial Reporting Standards (PFRSs).  Special purpose accounting information - designed to meet the specific needs of particular statement users. This information is provided by other types of accounting, e.g., managerial accounting, tax basis accounting, etc. USERS OF ACCOUNTING INFORMATION According to the Conceptual Framework:  Primary Users – Potential and Existing Investors or Owners, and Potential and Existing Lenders or Creditors  Other Users – Any other user not a primary user. As to whether the user is External or Internal:  Internal Users – Management and Employees  External Users – Investors, Creditors / Lenders, Suppliers / Vendors, Government, and Public BASIC ACCOUNTING CONCEPTS 1. Entity Concept  Separate Entity Concept / Accounting Entity Concept  Under this concept, the business enterprise is viewed as separate from the owners, managers, and employees of the business. 2. Time period  This concept requires that the indefinite life of an enterprise is subdivided into time periods which are usually of equal length or the life of the business is divided into series of reporting periods. o

Accounting time periods (a month, a quarter, a year)  Monthly and Quarterly – Interim Periods  Year – Annual Periods  Calendar Year – starts January ends December  Fiscal Year – 12-month period not starting on January

3. Monetary Unit  This concept assumes that financial transactions be measured in terms of money or currency of the Philippines; and changes in purchasing power are ignored. o Stability of Peso - and changes in purchasing power are ignored o Quantifiability of Peso - financial transactions be measured in terms of money or currency of the Philippines 4. Historical Cost  Cost Principle  This concept requires that assets should be recorded initially at original acquisition cost 5. Adequate Disclosure  Full Disclosure Principle  This concept requires that all significant and relevant information leading to the preparation of financial statements should be clearly reported  That financial statements provide sufficient detail to disclose matters that make a difference to users, yet sufficient condensation to make the information understandable, keeping in mind the costs of preparing and using it. 6. Materiality

 This concept relates to the significance of an item to the overall presentation of the financial statements. Information is material if its omission could influence the economic decision of the users of the financial statements. 7. Accrual Basis  The effects of transactions are recognized when they occur (and not as cash or its equivalent is received or paid) and they are recognized in the accounting periods to which they relate. 8. Consistency  This concept requires that the accounting methods and practices should be applied on a uniform basis from one time period to another.  That financial statements are prepared on the basis of accounting principles which are followed consistently from one period to the next. 9. Comparability  There are 2 kinds of comparability: Comparability within an enterprise and Comparability between enterprises o Comparability within an enterprise is the quality of information that allows comparisons within a single enterprise from one time period to the next. o Comparability between enterprises is the quality of information that allows comparisons between two or more enterprises engaged in the same industry. 10. Going Concern  This concept assumes that business will operate indefinitely and there is no intention of liquidating or closing down the business. 11. Conservatism  Under this concept, when alternatives exist, the alternative which has the least effect on net income or owner’s equity should be chosen.  Conservatism is synonymous with Prudence. Prudence is the desire to exercise care and caution when dealing with the uncertainties in the measurement process such as assets or income are not overstated and liabilities or expenses are not understated. 12. Objectivity  This concept requires that financial transactions that were recorded be supported by business documents. 13. Matching Principle  Associating cause and effect  That costs are recognized as expenses when the related revenue is recognized. 14. Cost Benefit  That cost is the pervasive constraint in financial reporting and the cost of processing and communicating information should not exceed the benefits to be derived from it. THE ACCOUNTING PROCESS (according to the definition of AAA) - Identifying as the analytical component o Recognition of Accountable events  Criteria for Accountable Events / Recognition Criteria: Probable, Measurable, Meets the definition  There are 3 types of transactions:  Business transaction – transactions which are recorded in the financial books. Example is investment of the owner.  Personal transaction – transactions which are not recorded in the financial books. Example is purchase of house and lot of a business owner using his personal money.

Neither business nor personal transaction – Business events that are not recorded in the financial books. Examples are hiring of employees, death of the owner, entering into a contract etc. NOTE: We only account for transactions that pertain to the business and meets the definition of the elements. Events can be classified as:  External events – events which involve an entity and an external party. o Exchange (reciprocal transfer) – reciprocal giving and receiving o Non-reciprocal transfer – “one way” transaction o External event other than transfer – an event that involves changes in the economic resources or obligations of an entity caused by an external party or external source but does not involve transfers of resources or obligations.  Internal events – events which do not involve an external party. o Production – the process by which resources are transformed into finished goods. o Casualty – an unanticipated loss from disasters or other similar events. 

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Measuring as the technical component o Assigning of peso amounts or numbers to the economic transactions and events Communicating as the formal component o Process of preparing and distributing accounting reports to potential users of accounting information

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HO 2: THE ACCOUNTING CYCLE ACCOUNTING CYCLE - A series of well-defined steps leading to the communication of the effects of a business transaction. - The accounting cycle represents the steps or accounting procedures normally used by entities to record transactions and prepare financial statements.

STEPS IN ACCOUNTING CYCLE 1. Identifying and Analyzing  Selecting accountable events and analyzing its impact on the financial statements 2. Journalizing  Process of recording transactions to the journals. o Journals are book of original entry.  Two Kinds of Journals: General Journal and Special journal.  General Journal –used to record transactions other than those which are recorded in the special journals.  Special Journal – used to record transactions of a similar nature. 3. Posting  Process of transferring data from the journal to the appropriate accounts in the ledger o Account is used as a storage unit of information in a double entry system.  Real Account – those reported in the balance sheet, which is the summary of the assets, liabilities, and owners’ equities of a business. The label real refers to the continuous, permanent nature of this type of account. Real accounts are active from the first day of business to the last day.  Nominal Account – those reported in the income statement, which is the summary of the revenue and expenses of a business for a period of time. Balances in nominal accounts are cumulative over a period of time. o Ledgers are books of final entry. Ledgers are systematic compilation of a group of accounts.  Two Kinds of Ledgers: General Ledger and Subsidiary Ledger.  General ledger – contains all accounts appearing in the financial statements.  Subsidiary ledger – supporting ledger for controlling accounts in the general ledger. 4. Preparing the unadjusted trial balance  A list of accounts and their balances, prepared for the purpose of proving the mathematical accuracy of the monetary totals of debits and credits in the ledger.  Proves mathematical accuracy of accounts posted in the ledger  Reveals: Transplacement, Transpositions o Transposition – figures are interchanged o Transplacement – error in placing the decimal point  Does not reveal: Wrong Classification, Omissions, Double posting 5. Preparing adjusting entries  Adjusting entries ensure that the revenue recognition and expense recognition principles are followed.  To split mixed accounts into their real and nominal elements (Prepaid Expenses, Unearned or precollected income, Bad Debts, Inventory, Depreciation) 6. Preparing Adjusted trial balance  Facilitates gathering of data for adjustment, the preparation of FS and closing entries.

 After a company has journalized and posted all adjusting entries, it prepares another trial balance from the ledger accounts. This trial balance is called an adjusted trial balance. It shows the balances of all accounts, including those adjusted, at the end of the accounting period. 7. Preparing the FS  Financial statements are the means by which the information accumulated and processed in financial accounting is periodically communicated to the users.  A complete set of financial statements comprises the following: o Statement of financial position o Statement of profit or loss and other comprehensive income o Statement of changes in equity o Statement of cash flows o Notes o Additional statement of financial position required in certain cases (PAS 1) 8. Closing the Books  Is the process of preparing closing entries and ruling and balancing accounts.  Closing Entries are entries to bring to zero all nominal accounts in the ledger. 9. Preparing the post-closing trial balance  Contents: Real Accounts only  After a company has journalized and posted all closing entries, it prepares another trial balance from the ledger accounts. This trial balance is called post-closing trial balance. It shows the balances of all real accounts at the end of the accounting period. 10. Preparing Reversing entries  Entries made on the first day of the next accounting period to reverse certain adjusting entries.  Accruals, Prepayments recorded using the expense method, unearned income recorded using the income method

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HO 3: ANALYZING BUSINESS TRANSACTIONS ELEMENTS OF FINANCIAL STATEMENTS 1. Assets  Resource controlled by the enterprise as a result of past events and from which future economic benefits are expected to flow to the enterprise.  Physical form is not essential to the existence of the asset. Right of ownership is not essential. It is the capacity to control the economic benefits expected.  In basic accounting, Assets are items with money value that are owned by a business. Some examples are: cash, accounts receivable (selling goods or services on credit), equipment (office, store, delivery, etc.), and supplies (office, store, delivery, etc.). 2. Liabilities  Present obligation arising from past events, the settlement of which is expected to result in an outflow of economic benefits.  In basic accounting, Liabilities are debts owed by the business. 3.   

Equity Residual interest of owners is the assets of the enterprise. Also called as Capital Classification of Transactions: o Capital Transactions – represents direct contributions or withdrawals o Income-related Transactions – represent income statement transactions

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Income Increases in economic benefits Profit – measure of performance Revenue – arises from ordinary course of business Gains – represent other items that meet the definition of income and may, or may not, arise in the course of the ordinary activities of the enterprise.

5. Expense  Decreases in economic benefits THE RULE OF DEBIT AND CREDIT  Debit means left side. (Dr.)  Credit means right side. (Cr.) Debit

Credit

 The figure above is called a “T” ACCOUNT, it is so named because it looks like a capital T. Use this form of an account to help you determine whether the amount is placed on the left (debit) or right (credit) side of the account.  It is important that you think of debits and credits as only meaning left and right!  Debits and Credits can either be increases or decreases depending on the type of account. THE DOUBLE ENTRY SYSTEM  Under the Double-entry system, each transaction is recorded in two parts – debit and credit. The double-entry system makes use of the following concepts: o Duality – this concept ...