Review on Basic Accounting 2020 Basic accounting refers to the process of recording a company\'s financial transactions. It involves analyzing, summarizing and reporting these transactions to regulators, oversight agencies and tax collection entities PDF

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Basic accounting refers to the process of recording a company's financial transactions. It involves analyzing, summarizing and reporting these transactions to regulators, oversight agencies and tax collection entities. ... Basic accounting is one of the key functions in almost all types of business....

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REVIEW ON BASIC ACCOUNTING 1.

DEFINITION OF ACCOUNTING a. A service activity. Its function is to provide quantitative information, primarily financial in nature, about economic entities that is intended to be useful in making economic decisions. b. A process of identifying, measuring, and communicating economic information to permit informed judgments and decisions by users of the information. c. 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.

2.

USERS OF ACCOUNTING INFORMATION EXTERNAL USERS LENDERS SHAREHOLDERS GOVERNMENTS CONSUMERS EXTERNAL AUDITORS CUSTOMERS SUPPLIERS

3.

INTERNAL USERS EXECUTIVES MANAGERS SALES STAFF BUDGET ANALYSTS INTERNAL AUDITORS CONTROLLERS HUMAN RESOURCES

BASIC ACCOUNTING CONCEPTS AND PRINCIPLES a. Generally Accepted Accounting Principles (GAAP) -Set of guidelines and procedures that constitute acceptable accounting practice at a given time. -Aims to make information relevant (affect users decision-making), reliable (Trusted by users), and comparable (Contrasting organizations). b.

Principles 1. Measurement/Cost Principle/Historical Cost – Acquired assets should be recorded at their actual cost. 2. Revenue recognition principle – Revenue is to be recognized in the accounting period when goods are delivered or services are rendered or performed, not when cash is collected. 3. Expense recognition principle/Matching principle - Expenses should be recognized in the accounting period in which goods and services are used up to produce revenue not when the entity pays for the goods or services. 4. Full disclosure- Requires that all relevant (not all) information that would affect the user’s understanding be disclosed in the financial statements. 5. Other principles: Objectivity principle – Accounting records and statements are based on the most reliable data available. Accounting records are based on information that flows from activities documented by objective evidence. Consistency principle - Firms should use the same accounting method from period to period to achieve comparability. c. Assumptions 1. Going concern – Accounting information reflects presumption that the business will continue operating instead of being closed or sold. 2. Monetary unit – We can express transactions and events in monetary units. 3. Time period – Life of a company can be divided into time periods, e.g. monthly, annually. 4. Business entity – A business is accounted for separately from other business, including its owner. d. Constraints 1. Materiality – prescribes that only information that influences decisions need be disclosed. 2. Benefit exceeds cost – prescribes that only information with benefits of disclosure greater than the costs of providing it need be disclosed.

4.

BUSINESS ENTITIES a. Sole proprietorship – a business owned by one person and accounted for separately. b. 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 intention of dividing profits among themselves. c. Corporation – A business owned by its stockholders. An artificial being created by operation of law, having rights of successions and powers authorized by law.

5.

ELEMENTS OF FINANCIAL STATEMENTS

a.

ASSETS – Resources controlled by the enterprise as a result of past events from which future benefits are expected to flow to the enterprise. CURRENT ASSETS: CASH

SUPPLIES ACCOUNTS RECEIVABLE NOTES RECEIVABLE MERCHANDISE INVENTORIES *PREPAID EXPENSES - costs that have been paid but are not yet used up or have not yet expired.

*ACCRUED REVENUES – revenues rendered but not yet collected NON-CURRENT ASSETS: PROPERTY PLANT AND EQUIPMENT (Land, Equipment, Machineries) INTANGIBLE ASSETS b.

LIABILITY – Present obligation of the enterprise to outside parties arising from past events, settlement of which is expected to result to an outflow from the enterprise. -Claims of the creditors from the assets of the company. CURRENT LIABILITIES: ACCOUNTS PAYABLE NOTES PAYABLE *ACCRUED EXPENSES – expenses incurred but not yet paid *UNEARNED REVENUES – money received from a customer for work that has not yet been performed. NON-CURRENT LIABILITIES: MORTGAGE PAYABLE BONDS PAYABLE

c.

CAPITAL/OWNER’S EQUITY/NET ASSETS – Residual interest in the assets of the enterprise after deducting all its liabilities. -Claims of the owners from the assets of the company a. b. c. d.

REVENUES – Sales, Service Revenue/Fees EXPENSES – Cost of Goods sold, Salaries expense, Utilities expenses, Rent expenses, Maintenance expenses etc. WITHDRAWALS – Withdrawal of assets by the owners. CAPITAL INVESTMENT – Investment of assets by the owners.

CHART OF ACCOUNTS – A listing of all the accounts and their account numbers in the ledger. 6.

ACCOUNTING EQUATION

Assets=Liabilities + Capital Liabilities= Assets – Capital Capital= Assets – Liabilities 7.

DOUBLE-ENTRY SYSTEM

-For every transaction, there must be at least 2 accounts affected -Debit and Credit should be equal RULES OF DEBIT AND CREDIT: -Debit (DR) is found on the left side of the T-account (Ledger); left most side of the journal entry -Credit (CR) is found on the right side of the T-account (Ledger); indented part of the journal entry -Debit is the normal balance (to record increase) of ASSETS -Credit is the normal balance (to record increase) of LIABILITIES AND CAPITAL -To decrease the balance of ASSETS, LIABILITIES AND CAPITAL, just use the opposite of the its normal balance

DR

NORMAL BALANCE/TO RECORD INCREASE

CR

CR

ASSETS = LIABILITIES + *CAPITAL CR

OPPOSITE BALANCE /TO RECORD DECREASE

DR

DR

*CAPITAL COMPOSITION: CAPITAL COMPOSITION REVENUES (+) EXPENSES (-) OWNER’S DRAWING (-) INVESTMENT (+)

ASSETS

NORMAL BALANCE (INCREASE) CR DR DR CR

ANALYSIS Revenue increases capital Expenses decreases capital Drawing decreases capital Investment increases capital

LIABILITIES

CAPITAL (INVESTMENT)

DEBIT

CREDIT

DEBIT

CREDIT

DEBIT

CREDIT

(+)

(-)

(-)

(+)

(-)

(+)

increase

decrease

decrease

increase

decrease

increase

REVENUES DEBIT

CREDIT

EXPENSES DEBIT

CREDIT

OWNER'S DRAWING DEBIT

CREDIT

(-)

(+)

(+)

(-)

(+)

(-)

decrease

increase

increase

decrease

increase

decrease

ACCOUNTING PROCESS

Steps in the Accounting Cycle – There are 9 basic steps in the accounting cycle, which includes 2 phases known as recording and summarizing. RECORDING PHASE 1.

Analyzing the transaction (business document)- This is where the accountant gathers information from source documents and determines the impact of the transaction on the financial position as represented by the equation “assets equals liabilities plus equity”.

2.

Journalizing – This is the process of recording the transactions in the appropriate journals. A journal is a chronological record of transactions also known as the book of original entry. Although all transactions could be recorded in the general journal, it is more efficient to use special journals in recording a large number of like transactions. Special journals that enterprises usually use are: 1. 2. 3. 4.

Sales Journal – Only sales of merchandise on account are recorded. Cash receipts journal – All types of cash receipts are recorded. Purchase journal – Used to record all purchases on account (merchandise, equipment and supplies). Cash disbursement journal – All payments of cash for any purpose are recorded.

Type of journal entries according to form: 1.

Simple journal entry – One which contains a single debit and a single credit element.

2.

Compound journal entry – One which has two or more elements and often representing two or more transactions.

Accounts are the storage units of accounting information and used to summarize changes in assets, liabilities and equity including income and expenses. The following are a broad classification of kinds of accounts: 1.

Real account – Statement of financial position or so called permanent accounts. These accounts are not closed and carryover to the next accounting period. (ex. Cash, AR and PPE)

2.

Nominal account – Income statement or temporary capital accounts. These accounts are closed at the end of the accounting period. (ex. Sales and expenses)

3.

Mixed account – A combination of real and nominal accounts. (ex. Prepaid expenses)

4.

Clearing account – Holds temporarily certain information pending transfer to other ledger accounts.

5.

Controlling account – The general ledger account that summarizes the detailed information in a subsidiary ledger.

6.

Suspense account – Is an account that holds temporarily certain information pending for disposition.

7.

Reciprocal account – Has a counterpart in another book with in the entity or in another ledger or another entity.

8.

Principal account – An account that is independent or can stand alone.

9.

Auxiliary account – An account that cannot stand alone and are technically neither assets, liabilities nor income and expenses.

10. Summary account 3.

Posting - It is the process of transferring data from the journal to the appropriate accounts in the general ledger and subsidiary ledger. This process classifies all accounts that were recorded in the journals. Kinds of ledgers 1.

General ledger – Includes all the accounts appearing on the financial statements.

2.

Subsidiary ledgers – Affords additional detail in support of certain general ledger accounts.

SUMMARIZING PHASE 4.

Preparing the unadjusted trial balance – A list of general ledger accounts with their respective debit or credit balance. The purpose of the unadjusted trial balance is to provide evidence that the total debits in the general ledger equal the total credits and prepares the accounts for adjustments.

5.

Preparing adjusting entries – To take up accruals, expiration of prepayments and deferrals, estimations and other events often not signaled by new source documents. Adjusting entries are made at the end of each accounting period. The concepts involved behind adjusting entries are ACCRUAL, MATCHING OF COSTS AGAINST REVENUE and ACCOUNTING PERIOD. Typical Adjusting Entries classified according to timing of cash flow.

1.

Prepayments and Deferrals – The cash flow precedes the revenue or the expense recognition. Prepaid Expenses

Asset Method

Prepaid expense (asset)

Expense Method

xx

Cash

Expense xx

xx

Cash

xx

Adjustment:

Expense

xx

Prepaid expense

Prepaid expense (asset) xx

xx

Expense

xx

Deferred or Unearned Revenue

Liability Method

Cash

Income Method

xx Unearned Income (liab.)

Cash xx

xx Income

xx

Adjustment:

Unearned Income Income

2.

3.

4.

xx

Income xx

xx

Unearned Income (liab.)

xx

Accruals – Income or expense recognition precedes the cash flow. a.

Accrued Income – Income earned but not yet received. A receivable is always debited and income is recognized (credited)

b.

Accrued expenses – Expenses incurred but not yet paid. An expense is recognized (debited) and a liability is always credited.

Estimates – Adjusting entries that do not involve cash flows. a.

Doubtful accounts – The expense to be matched against credit sales.

b.

Depreciation - Allocation of the cost of fixed assets as expense over its useful life

Ending inventory - An adjustment to set up the year-end physical count of the inventory. This only applies if the PERIODIC INVENTORY SYSTEM IS USED.

6.

Preparing the financial statements – The most important part of the summarizing phase, this is where the processed information is communicated to external users.

Basic financial statements a.

Statement of financial position

b.

Income statement or a statement of comprehensive income

c.

Statement of changes in equity

d.

Statement of cash flows

e.

Notes and disclosures

7.

Preparing the closing entries – Recorded and posted for the purpose of closing all nominal or temporary accounts to the income summary account and the resulting net income or loss is afterwards closed to the capital or retained earnings account.

8.

Preparing the post closing trial balance – A listing of general ledger accounts and their balances after closing entries have been made. The post closing trial balance is the same with the year-end statement of financial position, the only difference is that valuation accounts like allowances for assets are found in the credit side instead of being deducted from the related asset account.

9.

Preparing reversing entries – The last and optional step in the accounting cycle. Reversing entries are made at the beginning of the new accounting period to reverse certain adjusting entries from the succeeding accounting period. The purpose of reversing entries is a matter of convenience for accruals and consistency for the adjustments in the following year for prepaid expenses and deferred income when the income statement method was used to record the cash flow. Once again, reversing entries will only apply to the following but remember that they are not necessary and only optional: 1. 2. 3. 4.

Accrued income Accrued expense Prepaid expense, only if the expense method was used in recording the payment Unearned income, only if the income method was used in recording the collection Accrued Income

Prepaid expense (Exp. Method)

12 mos. rental at 100 per month beginning Nov. 1, 2016.

18 mos. rental at 100 per month beginning Nov. 1, 2016

12/31/16 Adjustment:

11/1/2016

Rent Receivable

200

Rent Income

Rent Expense 200

Cash

1/1/2017 Reversing entry:

12/31/2016 Adjustment:

Rent Income

Prepaid Rent

200

Rent Receivable

200

1,800 1,800

1,600

Rent Expense

1,600

After the reversal, the rent receivable account will have a balance of ZERO and the rent income account will have a DEBIT balance of 200. Hence the collection of 1,200 will be recorded as follows:

The adjustment under the expense method will be for the unused portion or the prepayment of 1,600. If the asset method was used, the adjustment would have been for 200 or the portion for the expense.

10/31/2017

1/1/2017 Reversing entry:

Cash

1,200 Rent Income

Rent Expense 1,200

Prepaid Rent

1,600 1,600

After the reversing entry, the 1600 is once again expensed and the 12/31/2017 adjusting entry will be as follows:

Prepaid rent

400

Rent Expense

400

If the reversing entry was not prepared, the adjustment would have been a debit to Rent expense and credit to prepaid rent for 1,200 which is the adjustment used if the ASSET METHOD was used.

ACCOUNTING FOR MERCHANDISING Service Business

Source of revenue Income statement

Generates revenue from buying and selling of merchandise inventory

Generates revenue from rendering of services Revenue Expenses Net income

a

b

c

d

1.

Merchandising Business

xx (xx) xx

Net Sales Cost of Goods sold Gross profit Other revenues Other expenses Net income

Gross Sales

xx

Sales Discount

(xx)

Sales Returns

(xx)

Net Sales

xx

Merchandise Inventory, Beginning

xx

Net Purchases

xx

Cost of Goods available for sale

xx

Merchandise Inventory, Ending

(xx)

Cost of Goods sold (Cost of sales)

xx

Gross purchases

xx

Purchase Discount

(xx)

Purchase Returns

(xx)

Freight-in

xx

Net Purchases

xx

Administrative expenses

xx

Selling expenses (e.g. freight-out)

xx

Other expenses

xx

xx (xx) xx xx (xx) xx

(a) (b)

(d)

TERMS OF TRANSACTIONS

Credit period - Merchandise may be purchased and sold either on cash or on credit terms. When goods are sold on account, a credit period is allowed for payment. n/30 – Invoice is due within 30 days (credit period) n/eom – Invoice is due at the end of the month Cash discounts – Encourages prompt payment. Purchase discount for the buyer’s perspective, Sales discount for the seller’s perspective. It decreases the cash payment/collection. -Computed based on the Gross invoice price -Recorded on the book (Required a journal entry) 2/10 – Customer can avail 2% discount if paid for within 10 days (discount period) Trade discounts – Encourages buyers to purchase products because of the markdown from the list price. -Computed based on the list price

-Not recorded on the book (Do not require a journal entry) Ex. Merchandise inventory with a list price of 100,000 terms of 3/10, n/eom and trade discounts of 10%, 15%

LIST PRICE TRADE DISCOUNTS: 100,000x10% 90,000x15% GROSS INVOICE PRICE

100,000

-10,000 -13,500 76,500

(100,000x90%x85%) Note: Gross invoice price is the amount to be recorded in the Sales/Purchase not the list price. SALES – Revenue arising from the sale of merchandise inventory SALES DISCOUNT - Cash discount on the seller’s perspective, decreases cash collection. Contra-account to sales. SALES RETURNS -Return of Merchandise inventory on Seller’s perspective, Decreases accounts receivable (If initially sold on account/credit) or decreases cash (if initially sold for cash). Contra account to sales. COST OF GOODS SOLD –Major expense of a merchandising business. Cost of the inventory sold to customers. PURCHASES – Temporary account for merchandise purchased for resale. PURCHASE DISCOUNTS - Cash discount on the buyer’s perspective, decreases cash collection. Contra-account to ...