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QUALIFYING EXAM REVIEWER THEORIES FROM

FINANCIAL ACCOUNTING BY WEYGANDT ET AL Prepared by: Laron Yvette Vicente de Ocampo

ACTBAS1

I.

Introduction to Accounting 1.1 Financial Statements Financial Statements provide management, owners and other interested parties with relevant financial data. These are: Statement of Comprehensive Income – presents income and expenses and resulting profit or loss for a specific period of time. As permitted by the International Accounting Standards, an entity may present all items of income and expense recognized in a period in either a single statement of comprehensive income or in two statements: a. a separate Income Statement/Profit of Loss Statement – displays income and expenses resulting in a profit or loss - revenue is listed first followed by expenses before determining profit (or loss) for the period - expenses are listed in order or magnitude b. a Statement of Comprehensive Income – displays components of other comprehensive income which comprises other income and expenses that are not recognized in profit or loss Statement of Changes in Equity – summarizes the changes in owner’s equity for a specific period of time - time period is the same as that covered by the income statement - information in this statement indicated the reasons why owner’s equity has increased or decreased a. owner’s additional investments – assets that the owner puts into the business b. profits (or loss) – gross increase (decrease) in owner’s equity which is equal to the difference of revenue – arises

in the course of the ordinary activities of the business – and gains – include gains on disposal of non-current asses and unrealized gains on revaluing assets – (expenses) over the expenses – the cost of assets consumes or services used in the process of earning income (revenue and gains) c. owner’s drawings – withdraw cash or other assets for personal use Statement of Financial Position – reports the assets, liabilities and owner’s equity at a specific date or point in time - assets are listed at the top, followed by liabilities and owner’s equity - total assets must equal total liabilities and owner’s equity (capital) - snapshot of business’ financial condition at a specific moment in time usually month-end or year-end Statement of Cash Flows – summarizes information about the cash inflows (receipts) and outflows (payments) for a specific period of time - reports the cash effect of the following activities of an entity during a period: a. operating activities – include transactions that create income and expenses b. investing activities – include (a) acquiring and disposing of investments and plant, property and equipment and (b) lending money and collecting loans c. financing transactions – include (a) obtaining cash from issuing debt and repaying the amounts borrowed and (b) obtaining cash from shareholders and providing them with a return on their investment - reports the net increase or decrease in cash and the cash amount at the end of the period - this report is useful of investors and creditors because they would want to know what is happening to the company’s most liquid resource - answers the following questions: a. Where did cash come from? b. What was the cash used for? c. What was the change in the cash balance? Notes to Financial Statements – include summary of significant accounting policies used to prepare financial statements, and other explanatory notes and supporting schedules 1.2 Definition, Nature and Scope of Accounting Accounting – is an information system that identifies, records and communicates the economic events of an entity to interested users Identifying – selecting the economic activities/transactions relevant to a particular entity

Recording – provide a history of the entity’s financial activities - consists of keeping a systematic, chronological diary of events - classifies and summarizes economic events Communicating –through accounting reports of which the most common are the financial statements, financial information is communicated to interested users: a. Internal – managers who plan, organize and run a business 1. Marketing Managers 2. Production Supervisors 3. Chief Financial Officers 4. Other Employees b. External – there are types of external users and these are: 1. Investors (Owners) – use accounting information to make decisions to buy, hold or sell shares 2. Creditors (such as Supplier and Bankers) – use accounting information to evaluate risks of granting credit or lending money 3. Tax Authorities - want to know whether the company complies with the tax laws 4. Regulatory Agencies – want to know whether the entity is operating within the prescribed rules 5. Customers – interested in whether an entity will continue to honor product warranties and support its product lines 6. Employees and Labor Unions – want to know whether the entity can pay increased wages and benefits 7. Economists – use accounting information to forecast economic activity Analyzing- involves the use of ratios, percentages, graphs and charts to highlight significant financial trends and relationships Interpreting – involves explaining the uses, meaning and limitations of reported data - often referred to as the “language of business” – means of communication as it provides information that assist users to understand where the entity has been by looking at its past performance, to understand where it is now by looking at its current financial position, and to provide insight into what is likely future prospects are - its purpose is to assist people, whether internal or external to an entity, to make decisions about the allocation of scarce resources - means of measuring business activity and processing this information into reports to communicate results to decision makers

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may be divided into: a. Financial Accounting – provides economic and financial information for external users b. Management Accounting – provides economic and financial information for internal users has three major fields: a. Public Accounting – would offer expert services to the general public - involves the following major area/work: 1. Auditing – public accountants such as Certified Public Accountant (CPA) or Chartered Accountant (CA) examine the financial statements of entities and express on opinion as to the fairness/reliability of presentation 2. Taxation – includes tax advice and planning, preparing tax returns and representing clients before government agencies 3. Management Consulting – ranges from installing of basic accounting systems to helping entities determine whether they should use the space shuttle for high-tech research and development projects - also include activities such as developing business financial plans and outsourcing requirements for clients b. Private (or Management) Accounting – includes the following activities: 1. General Accounting – recording daily transactions and preparing financial statements and related information 2. Cost Accounting – determining the cost of producing specific products 3. Budgeting – assisting management in quantifying goals concerning revenue, costs of goods sold and operating expenses 4. Accounting Information Systems - designing both manual and computerized data processing systems 5. Tax Accounting – preparing tax returns and doing tax planning for the business 6. Internal Auditing – reviewing the business operations to see if they comply with the management policies and evaluating the efficiency of operations

c. Not-for-Profit Accounting – non-profit entities also need sound financial reporting and control because donors to such entities would want information about how well the entity has met its financial objectives and whether continued support is justified - entities must also make decisions about allocating funds - one area of Not-for-Profit Accounting is Government Accounting 1.3 Brief History of Accounting The origins of accounting are generally attributed to the work of Luca Pacioli, an Italian renaissance mathematician. In his 1494 text Summa de arithmetica, geometria, proportione et proportionalite, he described a system to ensure that financial information was recorded efficiently and accurately. The advent of the industrial age in the 19th century and later, the emergence of large entities, a separation of the owners from the managers of business took place. As a result, the need to report the financial status of the entity became more important, to ensure that the managers acted in accord with the owner’s wishes. Also, transactions between entities became more complex, making necessary improved approaches for reporting financial information Our economy has now evolved into a post-industrial age – the information age – in which many “products” are information services. The computer had been the driver of this age 1.3.1 Double-Entry Bookkeeping Double-Entry Bookkeeping – suggests that for every credit entered into a ledger, there must be corresponding debit. - one of the most beautiful discoveries of the human spirit 1.3.2 Harmonization of Accounting Reports Generally Accepted Accounting Principles (GAAP) – set of standards and rules for financial reporting - these principles, since they are ‘Generally Accepted’, have a substantial authoritative support from… 1.3.3 International Accounting Standards International Accounting Standards Board (IASB) – national accounting standard-setting bodies and/or regulatory and enforcement agencies 1.4 Relationship of Accounting to Other Fields of Discipline “How will the study of accounting help me?” General Management – make wise business decisions Marketing – develops strategies to help the sales Finance – examine and analyze statements Real Estate – agents must understand the numbers involved 1.5 Forms of Business Organization as to Ownership and Activity Proprietorship – a business owned by one person

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owner is often the manager/operator of the business, which is usually a small service-type one - only relatively small amount of money is necessary - owner receives any profits, suffers any losses and is personally liable for all debts of the business - although there is no legal distinction between the business and the owner, accounting records of the business activities are still kept separate from the personal records of the owner Partnership – business owned by two or more persons - like a proprietorship in most cases expect that there are more than one owner involve - partnership agreement which may either be oral or in writing sets forth terms such as initial investment, duties of each partner, division of profit (or loss) and settlement to be made upon death or withdrawal of a partner - each partner has unlimited personal liability for the debts of the partnership - partnership affairs must be kept separate from the personal activities of the partners - often used to organize retail and service-type business, including professional practices Company/Corporation – business organized as a separate legal entity under the corporation law and having ownership divided into transferable shares - shareholders enjoy limited liability or they are not personally liable for the debts of the company - shareholders may transfer all or part of their shares to other investors at any time - ease with ownership - has unlimited life since the ownership may be transferred without dissolving the company 1.6 Basic Professional Values and Business Ethics Ethics – standards of conduct which encompasses principles such as: a. acting in the public interest b. acting with integrity (i.e. with honesty, fairness and sincerity) c. avoiding conflicts of interest d. independence e. respect for confidentiality f. maintaining technical competence g. acting with due care h. behaving ethically II.

Measuring and Reporting Financial Position 2.1 Nature and Forms of Statement of Financial Position Statement of Financial Position presents:

Current Assets – cash and other resources that are reasonably expected to be realized in cash or sold or consumed in the business within 1 year of the reporting date or the business operating cycle - is the average time that is required to go from cash to cash in producing revenue – whichever is longer - Important in assessing the business’s short-term dept-paying ability Financial Assets – cash and accounts receivables are example of these. Financial Assets may also be: a. Current b. Non-Current – are long-term assets and are given meaningful descriptions, such as: 1. Property, Plant and Equipment – tangible resources of a relatively permanent nature that are used in the business and not intended for sale 2. Intangible Assets – are non-current resources that do not have physical substance and are recorded at cost which is expensed over the useful life of the intangible asset 3. Investment Property – investment of non-current assets other than financial assets Current Liabilities – are liabilities that are (1) expected to be settled in the business’ operating cycle, (2) held primarily for the purpose of trading, (3) due and to be settled within 12 month after the end of the reporting period. Liabilities are also current when the entity does not have an unconditional right to defer settlement of the liability for at least 12 months after the reporting period Non-Current Liabilities – obligations expected to be paid after 1 year or after an operating cycle Owner’s Equity/Capital – this varies with the form of business entity. a. Proprietorship: one capital account b. Partnership: capital for each partner c. Company: divided into three accounts which when combined comprise the shareholders’ equity 1. Share Capital – investment of assets 2. Reserves – increases in equity from sources other than contributed capital from the owners and retained earnings 3. Retained Earnings – profit retained for the use in the company Presentation of Financial Statements, as prescribed by the IAS that must at least include the following line items: (a) property, plant and equipment, (b) investment property, (c) intangible assets, (d) financial assets, (e) investments accounted for using equity method, (f) biological assets, (g) inventories, (h) trade and other receivables, (i) cash and cash equivalents, (j) the total assets classified as held for sale, and assets included in disposal groups classified as held for sale, (k) trade and other payables, (l) provisions,

2.2

2.3

2.4

2.5 III.

(m) financial liabilities, (n) liabilities and assets for current tax, (o) deferred tax liabilities and deferred tax assets, (p) liabilities included in disposal groups classified as held for sale, (q) minority interest, presented within the equity and (r) issued capital and reserves attributable to owners of the parent may be presented in either: 2.1.1 Report Form – assets are presented above the liabilities and equity 2.1.2 Account Form – assets and liabilities and equity are presented side by side with assets at the left and liabilities and equity at the right Related Accounting Concepts/Principles 2.2.1 Entity – activities of the company be kept separate and distinct from the activities of the owner 2.2.2 Monetary – only transaction data that can be expressed in terms of money may be included in the accounting records 2.2.3 Cost – assets should be recorded at cost – the value exchange at the time something is acquired Market (or Fair) Value – value determined by the market at the time 2.2.4 Objectivity or Reliability - information is free of error and bias 2.2.5 Going Concern – assumes that the entity will continue in operation long enough to carry out its existing objectives 2.2.6 Materiality – relates to an item’s impact on an entity’s overall financial condition and operations an item is said to be material when it is likely to influence user’s decisions 2.2.7 Disclosure – circumstances and events that make a difference to financial statement users be disclosed Accounting Equation The two basic elements of a business are what it owns and what it owes. Assets – resources controlled by an entity Liabilities – claims against assets or existing debts and obligations Owner’s Equity – ownership claim on total assets At all times, Assets of the entity MUST equal to its Liabilities and Owner’s Equity (Capital) – A=L+C Transactional Analysis: Assets, Liabilities and Owner’s Equity Transactions – are the economic events of an entity that are recorded, which may be identified as external – entity and some outside entity, or internal – within one entity Preparation of Statement of Financial Position

Measuring and Reporting Financial Performance 3.1 Nature and Forms of Income Statement 3.1.1 Natural Form – format where expenses are classified according to the nature of expense 3.1.2 Functional Form – expenses are subdivided into: c. Selling or Distribution Expenses – making sales

3.2

3.3 3.4 3.5

d. Administrative Expenses (General Expenses) – general operating activities e. Finance Cost – associated with the financing of the business’ operations and debt collection f. Other Expense Related Accounting Concepts/Principles 3.2.1 Time Period – division of economic life of a business into artificial time periods d. Interim Periods – monthly and quarterly time periods e. Annual Basis 1. Financial (or Fiscal) Year – starts months between January and December 2. Calendar Year – starts January 3.2.2 Income Recognition – revenue be recognized in the accounting period when an increase in future economic benefits has occurred 3.2.3 Matching or Expense Recognition – expenses be recognized in the accounting period when a decrease in future economic benefits has occurred 3.2.4 Accrual – determine profits means recognizing revenue when earned rather when cash is received and recognizing expenses when incurred rather than when paid 3.2.5 Consistency – entity uses the same accounting principles 3.2.6 Conservatism (Prudence) – not overstating assets and income and understating liabilities and expenses 3.2.7 Disclosure Expanded Accounting Equation Assets = Liabilities + Owner’s Capital - Owner’s Drawings + Revenue - Expenses Transactional Analysis: Revenues and Expenses Preparation of Natural Form Income Statement

IV.

Measuring and Reporting Changes in Equity 4.1 Nature and Form of Statement of Changes in Owner’s Equity 4.2 Transaction Analysis: Investments, Withdrawals, Net Income (Loss) 4.3 Preparation of Statement of Changes in Owner’s Equity

V.

Measuring and Reporting Cash Flows 5.1 Nature and Forms of Statement of Cash Flows Statement of Cash Flows – which helps creditors and investors to assess (a) the entity’s ability to generate future cash flows, (b) ability to pay dividends and meet obligations, (c) the reasons for the difference between profit and net cash provided (used) by operating activities and (d) the cash investing and financing transaction during the period may be presented using two methods:

Direct Method – provides major classes of gross cash receipts and gross cash payments which are determined from the accounting records of the entity or by adjusting sales, cost of sales and other items in the income statement for: a. changes during the period in inventories and operating receivables and payables b. other non-cash items, and c. other items for which the cash effects are investing or financing cash flows 5.1.2 Indirect Method – net cash from operating activities is determined by adjusting profit for the effect of: a. changes during the period in inventories and operating receivables and payables b. non-cash items such as depreciation, provisions, deferred taxes, unrealized foreign currency gains and losses, undistributed profits of associates, and minority interest, and c. all other items for which the cash effects are investing and financing cash flows 5.2 Components of Statement of Cash Flows 5.2.1 Operating Activities 5.2.2 Investing Activities 5.2.3 Financing Activities 5.3 Preparation of Statement of Cash Flows – Direct Method 5.1.1

VI.

The Accounting Cycle 6.1 Accounting Cycle and Business Documents Used Documents – pr...