Module 2 - Accounting PDF

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BASIC ACCOUNTING WITH CORPORATEACCOUNTINGModule 2: The Accounting Equation and the Double-Entry SystemFINANCIAL STATEMENTSThe financial statements are the end products of the accounting cycle. They provide financial information about an entity to meet the needs of various users. The financial statem...

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BASIC ACCOUNTING WITH CORPORATE ACCOUNTING

Assets -

Module 2: The Accounting Equation and the Double-Entry System FINANCIAL STATEMENTS The financial statements are the end products of the accounting cycle. They provide financial information about an entity to meet the needs of various users. The financial statements include the following:

Liabilities -

Income Statement -

The Income Statement shows the results of operations or operating performance of the entity for a given time period (e.g., year or month).

Balance Sheet or Statement of Financial Position -

The Balance Sheet or Statement of Financial Position reports the entity’s financial position as of a given date (e.g., as of December 31, 2019).

Statement of Changes in Equity/Capital -

The Statement of Changes in Equity/Capital shows changes in owner’s equity or capital for a given time period.

Cash Flow Statement -

The Cash Flow Statement summarizes sources and uses of cash for a given time period

Are what the entity OWNS. They represent present economic resources controlled by the entity as a result of past events. An economic resource is a right that has the potential to produce economic benefits. Examples of assets are cash, amounts due from customers, and equipment used in the business.

Are what the entity OWES. They are present obligations of the entity to transfer economic resources as a result of past events. Examples of liabilities are amounts payable to suppliers, banks, and utility companies.

Capital or Equity -

Represents the OWNER’s CLAIM on the entity’s assets. It is the residual interest in the assets of the entity after deducting all its liabilities.

Financial Performance: Income -

is increases in assets or decreases in liabilities, that result in increases to in equity. Other than those relating to contributions from holders of equity claims. Ex: Receipts from customers for services rendered and interest earned from bank deposit

THE ELEMENTS OF THE FINANCIAL STATEMENT The elements of financial statements as defined in the 2018 Conceptual Framework are: Financial Position

Expenses

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Are decreases in assets or increases in liabilities; that result in decreases in capital/equity, other than those relating to distributions to holders of equity claims. Ex: amounts paid for employee salaries, office supplies, rent

THE ACCOUNTING EQUATION The basic accounting equation relates the elements of Financial position:

owner’s equity. The equation also explains why liabilities and owner’s equity follow the same rules of debit and credit. ACCOUNTING EVENTS AND TRANSACTIONS Accountants observe many events that they identify, and measure in financial terms. Accounting event -

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Assets = Liabilities + Capital Variations of the basic equation are as follows: Assets – Liabilities = Capital Assets – Capital = Liabilities

Financial statements tell how a business is performing. They are final product of the accounting process. The most common tool of accounting is the accounting equation. The logic of debiting and crediting is related to the accounting equation; the equality must always be maintained.

Note that the assets are on the left side of the equation opposite the liabilities and owner’s equity. This explains why increases and decreases in assets are recorded in the opposite manner (“mirror image”) as liabilities and

Is an economic occurrence that causes changes in an enterprise’s assets, liabilities and/or equity. Accounting events may be internal actions, such as the use of equipment for the production of goods or services. It can also be an external event, such as purchase of raw materials from supplier.

Transaction -

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is a particular kind of event that involves the transfer of something of value between two entities Transactions include acquiring assets from owner/s, borrowing funds from creditors, and purchasing or selling of goods or services.

THE ACCOUNT The account is the basic summary device of accounting. A separate account is maintained for each class of transactions affecting an element appearing in the balance sheet (assets, liabilities, and capital/equity) and income statement (income and expenses). An account serves as a detailed record of the increases, decreases, and balance of each class of transactions. Examples of accounts are as follows:

Asset accounts: Cash, accounts receivable, prepaid expenses, equipment Liability accounts: Accounts payable, notes payable

STATEMENT OF FINANCIAL POSITION Assets should be classified into two: -

Current Assets, and Non-current Assets

Capital/equity accounts: Owner’s capital, drawing

Assets are classified as current, when:

Income accounts: Professional fees, Rent income

It expects to realize the asset, or intends to sell or consume it, in its normal operating cycle;

Expense accounts: Salaries expenses, Supplies expense

It holds the asset primarily for the purpose of trading;

The simplest form of the account is the Taccount, so named since it looks like a letter “T”.

It expects to realize the asset within twelve months after the reporting date; or The asset is cash or cash equivalent (as defined in PAS No. 7) unless the asset is restricted from being exchanged or used to settle a liability for at least twelve months after the reporting date. All other assets should be classified as noncurrent assets.

THE T-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 expenses).

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. Current Assets Cash -

Is 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.

Cash Equivalents -

TYPICAL ACCOUNT TITLES USED

Are short terms, highly liquid investments that are readily convertible to known amounts of cash and which

are subject to an insignificant risk of changes in value.

Property, Plant and Equipment -

Notes Receivable -

A written pledge that the customer will pay the business a fixed amount of money on a certain date,

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Accounts Receivable -

Are claims against customers arising from sale of services or good on credit. This type of receivable offers less security than promissory note.

Accumulated Depreciation -

Inventories -

Are assets which are (a) held for sale in the ordinary course of business; (b) in the process of production for such sale; or (c) in the form of materials or supplies to be consumed in the production process or in the rendering of services.

Prepaid Expenses -

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Are expenses paid for in advance by the business. It is an asset because the business avoids having to pay cash in the future for a specific expense. These include insurance and rent. These prepaid items (Insurance and rent) represent future economic benefits (asset), until the time these start to contribute to the earning process, these then become expenses.

Non-current Assets

are tangible assets that are held for use of the enterprise in the production or supply of goods or services, or for rental to others, or for administrative purposes and which are expected to be used during more than one period. Included are such items as land, building, machinery and equipment, furniture and fixtures, motor vehicle and equipment.

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Is a contra account that contains the sum of the periodic depreciation charges. The balance in this account is deducted from the cost of the related asset such as building or equipment to obtain book value.

Intangible Asset -

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Are identifiable, nonmonetary assets without physical substance held for use in the production or supply of goods or services, for rental to others, or for administrative purposes. These include goodwill, patents, copyrights, licenses, franchises, brand names, secret processes, subscription lists and non-competition agreements.

Liabilities should be classified into two: -

Current Liabilities, and Non-current Liabilities

Liabilities are classified as current, when:

It expects to settle the liability in its normal operating cycle;

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It holds the liability primarily for the purpose of trading;

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The liability is due to be settled within twelve months after the reporting period; or The entity does not have an unconditional right to defer settlement of the liability for at least twelve months after the reporting period.

Are payments received by the entity in advance before providing its customers with goods or services. The amounts received as advance payment from customers are recorded in the unearned revenue account (liability method). When the goods or services are provided to the customer, the unearned revenue account is reduced and income is recognized.

Current Portion of Long-Term Debt All other liabilities should be classified as noncurrent liabilities.

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Current Liabilities Accounts Payable -

Represents the reverse of account receivable. By accepting the goods or services, the buyer agrees to pay for them in the near future.

Non-current Liabilities Mortgage Payable -

Notes Payable -

Is like note receivable but in a reverse sense. In the case of note payable, the business entity is the maker of the note, that is the business entity is the party who promises to pay the other party a specified amount of money on a specified future date.

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Accrued Liabilities

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Are amounts owed for unpaid expenses. These include salaries payable, utilities payable, interest payable and taxes payable.

Unearned Revenues

Records long-term debt of the business entity for which the business entity has pledge certain assets as security to the creditor. In the event that the debt payments are not made, the creditor can foreclose or cause the mortgage asset to be sold to enable the entity to settle the claim.

Bonds Payable -

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Are portions of mortgage notes, bonds and other long-term indebtedness which are to be paid within one year from the balance sheet date.

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Is a contract between the issuer and the lender specifying the terms of repayment and the interest to be charged. Business organizations often obtain substantial sums of money from lender to finance the acquisition of machinery and other needed assets. They obtain these funds by issuing bonds.

Owner’s Equity

Cost of Sales

Capital -

is used to record the original and additional investments of the owner of the business entity. It is increased by the amount of profit earned during the year or is decreased by a loss. Cash or other assets that the owner withdraw from the business ultimately reduce it. This account title bears the name of the owner.

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Salaries or Wages Expense -

Withdrawals -

Is an account used to record drawings of the owner rather than directly reducing the owner’s equity account.

Income Summary -

Is a temporary account used at the end of the accounting period to close income and expenses. This account shows the profit or loss for the period before closing to the capital account.

Service Income -

Are revenues earned by performing services for a customer or client. Example, accounting services by a CPA firm, legal services by a lawyer and laundry services by a laundry shop.

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Are revenues earned as a result of sale of merchandise. Example, sale of building materials by a construction supplies firm.

EXPENSES

are related to the use of telecommunication facilities, consumption of electricity, fuel and water.

Rent Expense -

Is for the use of space, equipment or other asset rentals.

Supplies Expense -

Is the cost of supplies used in the conduct of daily business.

Insurance Expense -

Sales -

Includes all payments as a result of an employer-employee relationship. These include salaries or wages, 13th month pay, cost of living allowance and other related benefits.

Telecommunications, Electricity, Fuel and Water Expenses

INCOME STATEMENT INCOME:

Are costs incurred to purchase or to produce the products sold to customers during the period. It is also called Cost of Goods Sold.

Is the portion of premiums paid on insurance coverage (on motor vehicle, building, fire, typhoon or flood, health, or life) which has expired.

Depreciation Expense -

Is the portion of the cost of tangible assets allocated or charged as expense during the accounting period.

Uncollectible Accounts Expense

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Is the amount of receivables estimated to be doubtful of collection and charged as expense during an accounting period.

Interest Expense -

Is an expense related to borrowed funds.

THE DUAL EFFECTS OF TRANSACTION The dual effect principle -

Is the foundation or basic principle of accounting. It provides the very basis for recording business transactions into the records of a business. This concept states that every transaction has a dual or double effect and should therefore be recorded in two places. This is the beginning of the double entry book keeping system.

ACCOUNTING FOR BUSINESS TRANSACTIONS Financial Transaction Worksheet -

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Can be analyzed by means of a financial transaction worksheet. It is a form of analyzing increases and decreases in the assets, liabilities or owner’s equity of a business entity. A business transaction is the occurrence of an event or a condition that affects financial position and can be reliably recorded.

Financial Transaction Worksheet

Illustration: Galicano Del Mundo decided to open a sole proprietorship business and named it as Del Mundo Graphics Design. During March, 2019, the first month of operations, various financial transactions took place. These transactions are described and analyzed as follows: Mar. 1 Del Mundo started his business by depositing P350,000 in a bank account in the name of Del Mundo Graphics Design at BPI Poblacion Branch.

Mar. 5. Computer equipment costing P145,000 is acquired on cash basis. The effect of the transaction on the basic equation is:

Mar. 9. Computer supplies in the amount of P25,000 are purchased on account.

Mar. 11 Del Mundo Graphics Design collected P88,000 in cash for designing interactive websites for two exporters based inside the Ortigas Ecozone

Mar. 19 Del Mundo made a partial payment of P17,000 for the Mar. 9 purchase on account.

Mar. 20 Checks totaling P25,000 were received from clients for billing dated Mar. 17 Mar. 16 Del Mundo paid P18,000 to Ceradoy Bills Express, a one-stop bills payment service company, for the semi-monthly utilities

Mar. 21 Del Mundo withdrew P20,000 from the business for his personal use. Mar. 17 The entity has service agreements with several Netpreneurs to maintain and update their websites weekly. Del Mundo billed these clients P35,000 for services already rendered during the month.

Mar. 27 Warlito Blanche Publishing submitted a bill to Del Mundo for P8,000 worth of newspaper advertisements for this month. Del Mundo will pay this bill next month.

Accounting is based on a double-entry system which means that the dual effect of business transaction is recorded. A debit side entry must have a corresponding credit side entry. Each transaction affects at least two accounts. The total debits for a transaction must always equal the total credits. -

An account is debited when an amount is entered on the left side of account. Credited when the amount is entered on the right side of the account.

The Rules of Debit and Credit Mar. 31 Del Mundo paid his assistant designer salaries of P15,000 for the month.

The account determines how increases or decreases in it are recorded

THE DOUBLE-ENTRY SYSTEM The logic of debiting and crediting is related to the accounting equation, the equality must always be maintained. The Normal Balance of Accounts The normal balance of any account refers to the side of the account – debit or credit – where increases are recorded. Asset and expense accounts normally have debit balances; liability, capital, and income accounts normally have credit balances. This is so because increases in an account are usually greater than or equal to

decreases. The following table summarizes normal account balances:

ACCOUNTING FOR BUSINESS TRANSACTIONS T-Account 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. Illustration: The rules of debit and credit will be applied to the Del Mundo Graphics Design illustration for comparison.

THE DRAWING ACCOUNT A special type of account maintained by sole proprietorships and partnerships is the drawing or withdrawals account. It is used to record and keep track of an owner’s or a partner’s fund withdrawals during the year in anticipation of profits. Thus, maintenance of this account is done to ensure that such withdrawals do not exceed the expected level of profits. The drawing account is a contra-capital or contra-equity account as its balance constitutes a deduction from the capital/equity account balance. Being a contra-capital account, increases and decreases in the drawing account are recorded in a manner opposite to those of entries to the capital account. Hence, increases are recorded as debits to the drawing account, while decreases are recorded as credits. Accordingly, the normal balance of the drawing account is debit.

Mar. 1 Del Mundo started his business by depositing P350,000 in a bank account in the name of Del Mundo Graphics Design at BPI Poblacion Branch.

Mar. 2. Computer equipment is acquired by issuing P50,000 note payable (liabilities, credit) to Maribeth Buenviaje Office Systems. The note is due in six months is acquired on cash basis (assets, debit). The effect of the transaction on the basic equation is:

Mar. 3 Del Mundo paid P15,000 to RF Refozar Suites for rent on the office studio for the months of March, April, and May.

Mar. 5 Computer equipment costing P145,000 is acquired on cash basis

Mar. 9 Computer supplies in the amount of P25,000 are purchased on account.

Mar. 20 Received checks totaling P25,000 from clients for billings dated Mar. 17

Mar. 21 Del Mundo withdrew P20,000 from the business for his personal use.

Mar. 11 Del Mundo Graphics Design collect...