OVERVIEW OF ACCOUNTING PROCESS

Definitions of Accounting

Accounting is 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.

Accounting is the process of identifying, measuring and communicating economic information

to permit informed judgments and decisions by users of the information.

Accounting is the 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.

Accounting is an information system that measures, processes and communicates financial

information about an identifiable economic entity.

Fundamental Concepts of Accounting

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. 

Periodicity Concept – An entity-s life can be meaningfully subdivided into equal time periods for
reporting purposes. It will be aimless to wait for the actual last day of operations to perfectly measure
the entity’s net income.

Stable monetary Unit Concept – The Philippine peso is a reasonable unit of measure and that
its purchasing power is relatively stable. It allows accountants to add and subtract peso amounts as
though each peso has the same purchasing power as any other peso at any time.

Basic Principles of Accounting

Objectivity Principles – 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. Ideally, accounting records are based on information
that flows from activities documented by objective evidence.

Historical Cost – This principle states that acquired assets should be recorded at their actual cost
and not at what management thinks they are worth as at reporting date.

Revenue Recognition Principle – revenue is to be recognized in the accounting period when

goods are delivered (ownership has been transferred) or services are rendered or performed.

Expense Recognition Principles – expenses should be recognized in the accounting period in

which goods and services are used up0 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.

Consistency Principle – the firms should use the same accounting method from period to period
to achieve comparability over time within a single enterprise.
Elements of Financial Statements
 
The elements of financial statements refer to the quantitative information shown in the statement
of financial position and statement of comprehensive income. The elements directly related to the
measurement of financial position are assets, liability and equity. The elements directly related to the
measurement of performance are revenue and expenses.

• Assets are defined as “resources controlled by the enterprise as a result of past transactions or
events and from which future economic benefits are expected to flow to the enterprise”.

• Liabilities are “present obligations of the enterprise arising from past transactions or events the
settlement of which is expected to result in an outflow from the enterprise of resources
embodying economic benefits”.

• Equity is the “residual interest in the assets of the enterprise after deducting all its liabilities”.

• Revenue is the “gross inflow of economic benefits during the period arising in the course of
ordinary activities of an enterprise when those inflows result in increases in equity, other than
those relating to contributions from owners”.

• Expenses are the “gross outflow of economic benefits during the period in the course of ordinary
activities when those outflows result in decreases in equity, other than those relating to
distributions to owners”.

Financial Statements

Financial Statements are the means by which the information accumulated and processed in
financial accounting is periodically communicated to the users. In other words, the financial statements
are the end product or main output of the financial accounting process.

A complete set of basic financial statements includes the following components:

 
– Statement of Financial Position (Balance Sheet)
– Statement of Comprehensive Income (Income Statement)
– Statement of Changes in equity or statement of recognized gains and losses
– Statement of Cash Flows
– Accounting policies and explanatory notes.

Year-end financial statements must be prepared, although interim statements or statements of

less than one year may be prepared for internal purposes. Usually, interim statements are quarterly
financial statements or for a period of three months.
 
Financial Reports
 
Financial reports include not only the basic financial statements but also other
information such as financial highlights, summary or important financial figures, analysis of financial
statements and significant ratios. Financial reports also include nonfinancial information such as
description of major products, future projects, plant expansion, environmental reports and list of
corporate officers and directors. Thus, financial reports are much broader than financial statements
because they represent “narrative” and “interpretative” reports of financial position, performance and
cash flows.
Principles of statement presentation

The “principles of statement presentation” are the overall considerations in the preparation and
presentation of financial statements. These principles are:
 
1. Fair presentation – the financial statements should present fairly the financial position,
performance and cash flows of an enterprise.

2. Accounting policies – Management should select and apply accounting policies that are also
in accordance with Philippine Accounting Standards (PAS)

3. Going concern – Financial statements should be prepared on a going concern basis. This
means that the financial statements should be based on historical cost rather than market
value.

4. Accrual basis – an enterprise should prepare its financial statements in conformity with the
accr4ual basis of accounting.

5. Consistency of presentation – the presentation and classification of financial statement

items should be uniform from one accounting period to the next.

6. Materiality and aggregation – immaterial amounts of similar nature and function should be
grouped or condensed as one line item in the financial statements.

7. Offsetting – assets and liabilities, and income and expenses, when material, should not be
offsetted against each other.

8. Comparable information – comparative financial statements should be presented. In other

words, the financial statements of the current period should be presented with comparative
figures of the financial statements of the preceding year.

Statement of Financial Position (Balance Sheet)

It is a formal statement showing the financial position of an enterprise as of a particular date.

The statement of financial position presents the three elements of financial position, namely assets,
liabilities and equity.

Classification of Assets

Current Assets – include unrestricted cash and cash equivalents, assets which are held for
trading purposes or for the short-term and expected to be realized within one year from the balance
sheet date, and assets which are expected to be realized, sold or consumed in the normal course of the
enterprise’s operating cycle.

Cash and cash equivalents – includes cash on hand, petty cash fund, cash in bank and
any cash equivalent. However, the cash and cash equivalent should be unrestricted in use,
meaning available anytime for the payment of current obligations. Cash equivalents are short-
term highly liquid investment that are readily convertible into cash and so near their maturity
that they present insignificant risk of changes in value because of changes in interest rates.
 
Examples of Cash equivalents are:
 
> Three-month BSP treasury bill
> Three year BSP treasury bill purchased three months before date of maturity
> Three month time deposit
>Three month money market instrument.
 Trading Securities (Marketable Securities) whether equity or debt securities are
classified as current assets if they are expected to be realized within one year from the balance
sheet date regardless of the length of the operating cycle.

Realized, sold or consumed – these current asset category refers to trade receivables,
inventories and prepayments. These assets are classified as current assets because they are
expected to be realized, sold or consumed within the normal operating cycle (the average
period of time that it takes for an enterprise to acquire the merchandise inventory, sell the
inventory to customers and ultimately collect cash from sale) or one year, whichever is longer.

Non-current assets – all other assets not classified as current. It includes the following:
 
Property, plant and equipment – are tangible assets which are held by an enterprise for
use in production or supply of goods and services, for rental to others, or for administrative
purposes, and are expected to be used during more than one period.”
 
Long-term investments – an asset held by an enterprise for the accretion of wealth
through capital distribution, such as interest, royalties, dividends and rentals, for capital
appreciation or for other benefits to the investing enterprise such as those obtained through
trading relationships.

 Intangible assets – an identifiable nonmonetary asset without physical substance held

for use in the production or supply of goods or services, for rental to others, or for
administrative purposes.
 
Other non-current assets – assets that do not fit into the definition of the previously
mentioned noncurrent assets. 

Classification of Liabilities

  Current Liabilities – obligations which are expected to be settled in the normal course of the
enterprise’s operating cycle and ob ligations which are due to be settled within one year from the
balance sheet date.

Noncurrent liabilities – all liabilities not classified as current liabilities. Examples are as follows:
Noncurrent portion of long-term debt, Capital lease liability, noncurrent deferred tax liability, long term
obligations to company officers, long-term deferred revenue.
 
Equity
 
The terms used in reporting the equity of an enterprise depending on the form of the business
enterprise are:

Single Proprietorship - Owner’s Equity or capital

Partnership - Partner’s Equity
Corporation - Stockholders’ equity or shareholders’ equity
 
The elements of stockholders’ equity are:

Capital Stock – the portion of the paid-in capital representing the total par or stated
value of the shares of stock issued.

Subscribed Capital stock – the portion of the authorized capital stock that has been
subscribed but not yet fully paid and therefore still unissued.

Subscriptions receivable – represents the unpaid portion of the subscribed capital stock
and shall be reflected as a deduction from the related subscribed capital stock.
 Additional Paid-in Capital – the capital contributed by the stockholders in excess of the
par or stated value of the stock subscribed and issued.

Retained Earnings - represent the cumulative balance of periodic earnings, dividend

distributions, fundamental errors and other capital adjustments. It may be classified as
unappropriated retained earnings and appropriated retained earnings. Unappropriated retained
earnings represent that portion which is free and can be declared as dividends to the
stockholders. Appropriate retained earnings represent that portion which is restricted and
therefore not available for any dividend declaration

Revaluation increment – the excess of sound value over net book value. Sound value is
the value per appraisal computed by deducting observed depreciation from appraised value.
Net book value is computed by deducting accumulated depreciation on cost from historical cost.

Treasury Stock – is a corporation’s own stock that has been issued and then reacquired
but not canceled.

 THE ACCOUNTING PROCESS

Incurrence of a Supported with Business Documents such as:

Business Transactions Sales/Purchases ………….. Sales Invoices
Cash Receipts/Payments Official Receipts

Process of recording transactions to the Journal is called

JOURNALIZING.

JOURNAL is the book of original entry

Types of Journal:
General Journal – multi-purpose
JOURNAL
Sales Journal – used to record sales on credit
Cash Receipts Journal – to record cash receipts
Cash Payments Journal – to record cash payments
Purchase Journal – to record purchases on account

The process of transferring records from the Journal to

the Ledger is called POSTING

LEDGER is the book of the final entry.

It is composed of group of related accounts

ACCOUNT TITLE
LEFT SIDE RIGHT SIDE
LEDGER (DEBIT) (CREDIT)
ASSETS - Increases ASSET - Decreases
LIABILITIES Decreases LIABILITIES – increases
CAPITAL Decreases CAPITAL - increases
INCOME Decreases INCOME Increases
EXPENSES Increase EXPENSES Decreases
 TRIAL BALANCE is the test of the equality of debits and
TRIAL BALANCE credits

Adjusting Entries are entries used to update value of an

account
ADJUSTMENTS
Normally the following accounts are subject to
adjustments:
Accruals
Deferrals
Depreciation
Bad Debts

ADJUSTED TRIAL
BALANCE

Financial Statements are:

FINANCIAL Statement of Financial Position
STATEMENTS Statement of Comprehensive Income
Statement of Changes in Equity
Statement of Cash flows
Notes to Financial Statements

Closing Entries are used to ZERO out the balances of

CLOSING ENTRIES Nominal Accounts (Income and Expenses)

PROBLEMS

1. East Corporation’s trial balance reflected the following account balances at December 31, 2012:
 
Accounts Receivable 200,000
Marketable equity securities 100,000
Accumulated depreciation 300,000
Cash and cash equivalents 150,000
Inventory 500,000
Equipment and furniture 1,000,000
Patent 50,000
Prepaid expenses 20,000
Land 250,000
 
In East Corporation’s Dec. 31, 2012 statements of financial position, the current assets total is
(a) 970,000 (b) 950,000 (c) 870,000 (d) 850,000
 
 2. The December 31, 2012 statement of financial position of Hazel Co. showed the following
current assets:
Cash and Cash Equivalents 700,000
Accounts receivable` 1,200,000
Inventories 600,000
2,500,000
An examination of the accounts revealed that the accounts receivable include the following:

Trade accounts 930,000

Allowance for doubtful accounts ( 20,000)
Claim against shipper for goods lost in transit 30,000
Selling price of unsold goods sent by Hazel on consignment
at 130% of cost and not included in Hazel’s ending Inventory 260,000
1,200,000
What is the correct amount of current assets on December 31, 2013? (a) 2,412,000 (b)
2,240,000 (c) 2,440,000 (d) 2,500,000

3. The trial balance of Melan Co. included the following balances at December 31, 2012:

Accounts Payable 150,000

Bonds payable, due 2021 250,000
Discount on bonds payable 30,000
Dividends payable 80,000
Note payable to bank due 2014 200,000
 
What amount should be included in the current liability section of Melan’s December
31, 2012 statement of financial position? (a) 450,000 (b) 510,000 (c) 650,000 (d) 780,000