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FUNDAMENTAL OF ACCOUNTING 1 2015 EDITION LEEMON LOPEZ ARAZA DYCI - COA AC101 TABLE OF CONTENTS Session 1: Accounting Concepts and Its Consideration Session 2: Basic Consideration on Financial Statements Session 3: Preparation of Financial Statements Session 4: Adjusting the Accounts Session 5: Compl...

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FUNDAMENTAL OF

ACCOUNTING 1 2015 EDITION

LEEMON LOPEZ ARAZA

DYCI - COA

AC101

TABLE OF CONTENTS Session 1:

Accounting Concepts and Its Consideration

Session 2:

Basic Consideration on Financial Statements

Session 3:

Preparation of Financial Statements

Session 4:

Adjusting the Accounts

Session 5:

Completing the Accounting Cycle

Fundamentals of Accounting 1 SESSION 1 ACCOUNTING CONCEPTS AND ITS CONSIDERATION Desired Learning Outcomes  Understand and explain the definition, purpose, nature, functions and objectives of accounting.  Distinguish the branches of accounting, users of accounting information.  Understand the double entry bookkeeping concept and how it differs from single entry bookkeeping.  Appreciate the history of accounting, accounting variations among countries  Adopt the basic professional values and ethics

Instructor Leemon L. Araza 2015 Edition

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.

1|AC101 SESSION 1

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 Fixed, inflexible,  Accounting is a social science with a body of knowledge organized and which has been systematically gathered, classified, and systematic 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. Opinionated, flexible and subjective 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  Production – the process of converting economic resources into outputs of goods and services that are intended to have greater utility than the required inputs. 

Exchange – the process of trading resources or obligations for



Income distribution - the process of allocating rights to the



Consumption – the process of using the final output of the



Investment – the process of using current inputs to increase



Savings – the process by which individuals and groups set aside

other resources or obligation.

use of output among individuals and groups in society.

production process.

the stock of resources available for output as opposed to immediately consumable output.

rights to present consumption in exchange for rights to future consumption.

BASIC PURPOSE OF ACCOUNTING: To provide quantitative information economic entities intended to be useful in making economic decisions. TYPES 1. 2. 3.

about

OF INFORMATION PROVIDED BY ACCOUNTING Quantitative information – expressed in numbers, quantities or units. Qualitative information – expressed in words or descriptive form Financial information – expressed in terms of money

2|AC101 SESSION 1

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. o 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. o Business entity is an entity that produces and distributes goods or services primarily for profit. FUNCTIONS OF ACCOUNTING  Identification. The accounting process of recognition or nonrecognition 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 1. It must affect a financial element of accounting (increasing or decreasing asset, liability or equity) 2. It is a result of a past activity 3. Its cost can be measured reliably.  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.  Communication. The accounting process of preparing and distributing accounting reports to potential users of accounting information and interpreting the significance of this processed information. o

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.

o

Classifying. The grouping of similar and interrelated items into their respective classes.

o

Summarizing. Putting together or expressing in condensed or brief form the recorded and classified statements in financial statements.

3|AC101 SESSION 1

BRANCHES OF ACCOUNTING/AREA OF SPECIALIZATION 1. Financial Accounting. The recording of transactions, preparation financial statements and communication of financial information external user groups. Focuses on general purpose reports.

of to

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. One example of this is carbon accounting such as “Cap and Scheme”, which is a process of encouraging reductions in greenhouse gas emissions. 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.

4|AC101 SESSION 1

USERS OF ACCOUNTING INFORMATION 

Internal Users are those who make decisions directly affecting the internal operations of the business. o Managers are directly involved in operation of the business. They need accounting data to improve the efficiency and effective of the organization. o

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.

o

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. the act of making money Internal Auditors, there role is to protect and by making people believe safeguard the resources of the company against something which is not true. fraud or irregularities.

o



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: o

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.

o

Lenders are interested in information that enables them to determine whether their loans, and their interest attaching to them will be paid when due.

o

Suppliers and other trade creditors are interested in information that enables them to determine whether amount owing to them will be paid when due.

o

Customers are interested in the quality of goods and services that they are getting from the entity.

o

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,

5|AC101 SESSION 1

o

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.

a greater increase in the supply of money or credit than in the production of goods and services, resulting in higher prices and a fall in the purchasing power of money.

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. the total cost of Historical Cost. This principle states that acquired asset producing or buying an should be recorded at their actual cost and not at what item, which may management thinks they are worth as at reporting date. include, e.g., its price plus the cost of delivery or storage.

6|AC101 SESSION 1

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.

7|AC101 SESSION 1

BUSINESS ORGANIZATION FORMS OF BUSINESS ORGANIZATIONS 

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.



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.



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 accounting and law firms, stock 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)

for a fee (e.g. brokerage, beauty

law firms, salons and

MICRO, SMALL AND MEDIUM ENTERPRISES (MSME) 

Micro Enterprises are those with assets, before financing 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.

of

P

3

8|AC101 SESSION 1



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.: o Sale of services o Purchase of supplies o 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 assets and other investments. E.g.: o Purchase of equipment, furniture, automobile and land o Cost of developing and constructing office or building o Sale of used fixed assets o Loans and advances to other parties o 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.: o Cash proceeds from issuing shares of stocks by a corporation o Cash proceeds and repayment of bank loans and other long-term barrowings.

long-term

**End of Session 1**

References: Ballada, Win and Susan Ballada. (2009). Basic Accounting Made Easy 14th Edition. Manila: Domdane Publishers and Made Easy Books. Ledesma, Ester L.(2014).Financial Accounting Theory Review Booklets. Manila: CRC-Ace The Professional CPA Review School. Rante, Gloria Aradaniel.(2013). Accounting for Service Entities. Mandaluyong City: Millenium Books, Inc.

9|AC101 SESSION 1

NAME: COURSE:

YR.&SEC. DATE

ACTIVITY NO. 1 Multiple Choice 1. Accounting is a service activity. Its function is to provide a. Quantitative information b. Qualitative information c. Quantitative and qualitative information d. None of the above 2. The basic purpose of accounting is a. To provide the information that the managers of an economic entity need to control its operations. b. To provide information that the creditors of an economic entity can use in deciding whether to make additional loans to the entity. c. To measure the periodic income of the economic entity. d. To provide quantitative financial information about a business enterprise that is useful in making rational economic decision. 3. Which of the following best describes the attributes of a partnership a. Limited ability to raise capital; unlimited personal liability of owners. b. Limited ability to raise capital; limited personal liability of owners. c. Ability to raise large...