Lesson 1 Summary

• The Statement of Management's Responsibility states that the company's management, and not the
independent auditors, is responsible for the information contained on the FS.

• The Independent Auditor's Report informs the reader of the opinion of the auditor on the fairness of
the financial statements based on their audit. Fairness refers to the correctness of the information
based on generally accepted accounting standards. In the Philippines, the adopted standard is the
Philippine Financial Reporting Standards.

• The Statement of Financial Position or Balance Sheet reports the resources available for the company
to use, obligations that the company is required to settle, and the equity that belongs to the owners of
the company.

• SFP is a snapshot of the financial condition of the company.

• SFP is the main financial statement because the bottom lines of the other three financial statements
find their way on this financial statement.

• The SFP is a report based on the accounting equation: Assets = Liabilities + Owner's Equity.

• Assets are resources that are within the control of the company and have potential economic benefits.

a. Cash refers to money readily available to be used in the company's operations. The cash accounts
report the balances of cash in the bank (savings and checking account) as well as bills, coins, and checks
on hand

b. Receivables are assets that pertain to the company's right to collect or the right to claim payment.

c. Inventory refers to the cost of unsold merchandise that the company purchased to resell to its
customers in the normal course of its business.

d. Prepaid Expense is an asset account that refers to the future expenses paid in advance before the
services of goods are used.

e. Property, Plant, and Equipment (PPE) are long-term assets that are used in the operations of the
company

f. Intangible assets are long-term assets that have no tangible properties.

• Liabilities are obligations that the company is required to pay.

a. Payables are obligations to make payments.

b. Accounts payable (AP) are obligation to the suppliers of purchased inventories.

c. Notes payable (NP) refers to obligation to pay documented in a promissory note.

d. Accrued expenses refer to the obligation to pay for goods and services already used in the operation
of the business such as salaries payable, utilities payable, rent payable, and interest payable.

e. Unearned income refers to advance payments made by customers while goods and services are not
yet delivered to the customers.
f. Long-term liabilities are obligations to pay to be settled at some specific date that is more than one
year away from the date of the SFP.

• Equity is equal to the net assets of the business. For sole proprietorship, the equity account is the
Owner's Capital. It is composed to the owner's investment and the accumulated net income of the
company, net of any distributions to the owners

• The SFP may be presented using two acceptable formats: the account form and the report form.

a. The account form follows the general ledger T-Account format-assets on the left and liabilities and
equity on the right.

b. The report form SFP is a simple listing assets are listed first, followed by liabilities, and finally the
equity account.

c. A classified SFP presents assets and liabilities classified as current and non-current Assets are classified
as current if it can be used or converted to cash within one year. Current liabilities are payables
scheduled to be paid within one year of the date of the Statement of Financial Position.

• Debit and credit refer to the sides of the T-account debit on the left and credit on the right.

• An account is increased by an entry on the side of its normal balance and decreased by an entry on the
opposite side of its normal balance.

• The normal balance of the assets account is debit.

• Liabilities and equity have normal balances of credit.

Lesson 2 Summary

Accounting of a Merchandising Business

• Service business earns income by rendering services to its clients

• Merchandising business generates income by buying and selling goods at a profit.

• Manufacturing business buys raw materials and processes then to become finished goods for sale.

• Service vs. Merchandising

Cost of Goods Sold

• Merchandise Inventory, Beginning P xxx

• Add: Net cost of Purchases xxx

• Cost of Goods Available for Sale xxx

• Less: Merchandise Inventory, End (xxx)

• Cost of Goods Sold P xxx

A. Inventory Systems

• Periodic

• Used for businesses selling goods with different low-priced items.

• Transactions are large in volume.

• A separate control account, “Purchases”, is used to accumulate costs.

• Perpetual

• Used for businesses selling goods with high-priced items

• Transactions are usually not large in volume

• The accounts Merchandise Inventory and Cost of Goods Sold are updated continuously.

B. Freight Payment Term

• Freight Prepaid - Freight charges are paid by the seller

• Freight Collect - Freight charges are paid by the buyer

C. Shipping Terms
• FOB Shipping Point - The title of the goods passes on the buyer once the goods leave the supplier’s
shipping dock.

• FOB Destination - The title of the goods passes on to the buyer once the goods reached the buyer’s

location.

D. Discounts

• Cash Discount

• This is given to encourage prompt payment for customers.

• Ex: 2/10, n/30

• Trade Discount

• This is given to encourage the customers to order more merchandise regardless of the time of
payment.

• Ex: 10% 10% (in application: P100 x .90 = P90 x .90 = P81)

Additional Account Titles for a Merchandising Business

A. Buyer’s Viewpoint

• Purchases – the account used to record the cost of goods or merchandise bought for purposes of
resale.

• Purchase Returns and Allowances – the account used to record returns acknowledged or allowances
granted by the supplier to the buyer from the purchase of goods.

• Purchase Discount – a reduction from the purchase price of the merchandise or goods bought granted
by the supplier to the buyer or customer for paying within the discount period.

• Freight-In – the cost of transporting the merchandise or goods from the seller’s place to the buyer’s
place of business. Also called as Transportation-In.

B. Seller’s Viewpoint

• Sales – the proceeds from the sales price of goods sold credited to the revenue account in the
accounting period when the sales were made.

• Sales Returns and Allowances – the account used to record returns acknowledged or allowances
granted by the supplier to the buyer from the sale of goods.

• Sales Discount – a reduction from the sales price of the merchandise or goods sold granted by the
seller to the buyer or customer for paying within the discount period.
• Freight-Out or Delivery Expense – the cost of transporting the merchandise or goods from the seller’s
place to the buyer’s place of business.

Documents normally used in a Merchandising Business

A. Buyer’s Viewpoint

• Purchase Order – a document sent by the buyer to the seller ordering certain goods where the date,
quantity, description of goods, and the total amount of the order is indicated. This authorizes the seller
to deliver the goods to the buyer under the agreed specifications, terms, and conditions.

• Receiving Report – a form prepared by the buyer’s receiving personnel stating the quantity and
condition of the goods delivered by the seller.

• Debit Memorandum – a written notice from the buyer informing the seller that the buyer will debit the
account or decrease the amount owed to the seller for returned goods or allowances requested due to
defect.

B. Seller’s Viewpoint

• Sales Invoice – contains the name and address of the buyer, the description of the goods sold, the
credit terms, unit price, quantities, total amount, and date of sale. This evidences the transfer of
ownership of the goods from the seller to the buyer.

• Official Receipt – a written acknowledgement of money received by the seller evidencing payment of
the buyer for goods purchased and received.

• Credit Memorandum – a written notice from the supplier signifying acknowledgement or acceptance
of the goods returned by the buyer. This notifies the buyer of a corresponding reduction in the amount
owed by the buyer because of goods returned or allowances granted due to defect or wrong
specifications.

The Accounting Cycle

• Analyzing Business Transactions from Source Documents

• Journalizing Business Transactions

• Posting Journal Entries to the Ledger

• Preparing Unadjusted Trial Balance

• Preparing Worksheet and Adjusting Entries

• Preparing Adjusted Trial Balance

• Preparing Financial Statements

• Journalizing and Posting Closing Entries

• Preparing Post-Closing Trial Balance

Lesson 3 Summary

Statement of Comprehensive Income

• The SCI is a statement that reports the results of operations of the business for one period.

The SCI is described as a “for the period” report.

• Income refers to a transaction that increases assets and/or decreases liabilities leading to an increase
in equity resulting from the operations of the business and not from the owner’s contribution.

• Expenses are transactions that decrease assets/ or increase liabilities leading to a decrease in equity
resulting from the operations of the business and not because of distribution to owners.

• There are two kinds of income-revenue and gains.

a. Revenues are income generated from the primary operations of the business.

b. Gains are income derived from other activities of the business.

• There are also two kinds of expenses-expenses and losses.

a. Expenses are related to the primary operations of the business.

b. Losses are from other activities of the business.

• Revenue is earned upon delivery of goods and services.

• There are three approaches in recognizing expense:

a. The matching principle requires that expenses should be recorded in the same period in which the
revenue, to which those expenses are related, is recognized.

b. The principle of rational allocation required the cost of long-term expenditure to be rationally
allocated throughout usage based on the expected pattern of usage.

c. Expenditures are changed immediately to expense if the period and the pattern of usage is not clear
such that there is no rational way to allocate.

• Two kinds of revenue

a. Service Income, used by service operations, is recorded based on the percentage of completion of
contractual services.

b. Sales revenue, used by trading operations, is recognized when goods are delivered.

b.1 Sales returns and allowances is a contra-sales account used to report the selling price of goods
returned by customers.

b.2 Sales discount is a contra-sales account used to report the amount of discount taken by customers.

b.3 Net sales is computed as gross sales less sales returns and allowances and sales discount.

• Cost of sales refers to the cost of inventories sold.

• There are two kinds of inventory accounting

a. Perpetual inventory accounting means that the inventory account is “perpetually” updated for goods

purchased and sold.

b. Periodic inventory accounting does not update the inventory account for purchases and sales.

• A separate account, purchases are used to report acquisitions of merchandise for sale.

• Purchases returns and allowances is a contra-purchase account that reports the costs of goods
returned to suppliers.

• Purchase discount is a contra-purchase account that reports the amount of discount taken by the
company.

• Freight-in refers to the shipping cost necessary to bring inventory purchased from the seller to the
premises of the company.

• Net purchases are gross purchases plus freight-in-less purchase returns and allowance and purchase
discount.

• Inventory is determined by the actual physical count of merchandise owned.

• Cost of sales is determined as follows: Beginning inventory+ Net purchases- Ending inventory= Cost of
goods sold.

• Operating expenses refer to all other expenses related to the operating of the business, other than the

cost of sales. Examples are salaries and utilities.

• Bad debts expenses are the estimated amount of loss resulting from uncollectible accounts
receivables.

• Losses and other expenses as well as gains and other income are reported separately after the

operating section of the SCI.

• There are two acceptable formats of the SCI:

a. Single-step SCI

- Groups all revenue together and groups all expense together. Net income is simply computed as total

revenues-total expenses.

- Expenses are listed based on the source of the expense such as salaries, supplies, utilities, fuel and

depreciations.

b. Multi-step SCI

- Revenue and expenses are classified and presented in the following sections: gross profit, operating
section and non-operating section.

- Subtotals are presented at the end of each section, namely, gross profit, operating income, and net
income.

- Expenses are listed based in usage or function of expense. Operating expenses are
categorized into cost of sales, general and administrative expenses, and selling expenses.

• The normal balance of revenue account is credit.

• The normal balance of expense accounts is debit.

LIST OF FORMULAS:

•Net Cost of Purchases = Purchases + Freight In

• Net purchases = gross purchases + freight-in – (purchase returns and allowance + purchase discount)

• Net Sales = Sales – Sales returns and Allowance - Sales Discount

• Cost of sales (COGS) = Beginning inventory + Net purchases = Cost of Goods Available for sale - Ending
inventory.

• Gross Profit = Sales - COGS

• Net Income = Gross Profit – General and Administrative Expenses – Selling Expenses
Lesson 4 Summary

Statement of Changes in Owner’s Equity

• The SoCE is prepared to help the readers understand the transactions that affected the balances of the

equity accounts.

• Sole Proprietorship is a simple form of business organization characterized by only one owner who is

also oftentimes the manager of the business.

• A partnership is owned by partners who polled together their resources to achieve a mutual goal to

operate a business and share the profits among themselves.

• A corporation is a business owned by many stockholders and ownership is expressed in terms of

shares of stock.

- Ownership is separated from management.

- The limited liability of stockholders meant that the creditors of the corporations only have claims to the
corporations’ assets and not the personal resources of the stockholders.

- Ownership in corporations is easily transferable by selling the shares of stocks.

• Only one equity account is presented on the SFP and the SoCE of sole proprietorships. This account
tracks the contributions from the owner, net income from the operations of the business, and the
owner’s drawings.

• The owner’s Drawing account is used to record the withdrawals of the owner. It is the nominal

account that is closed to the capital account at the end of the year.

Why is net income closed to the capital account?

Consider this:

a. the net income generated from the operations of the business is owned by the owner and

b. the capital account represents the part of the business that belongs to the owners.

• In partnership, the number of the capital account that will be presented on the SFP and the SoCE is
equal to the number of partners.

- Each capital account contains contributions of the specific owner, his share in the net income from the
operations of the business, and his drawings.

- The partnership net income (Allocation of net income) is allocated to individual partners based on their
profit and loss sharing agreement.

• The stockholder’s equity of a corporation is divided into two parts, paid-in capital, and retained
earnings.

- Paid-in capital is the amount of contribution given or will be given to the corporation in exchange for
the shares of stock. It is composed of capital stock and additional paid-in capital.
- The capital stock account reports the number of issued stocks at their par value or stated value.

- The excess of the issue price over par is reported as additional paid-in capital.

• The retained earnings account reports the undistributed earnings of the corporations-all the net
income less net losses and dividends from the date of incorporation up to the cut-off or balance sheet
date.

Sole Proprietorship
Partnership

Corporation
Lesson 5 Summary

Statement of Cash Flows

• Cash is an important asset. It is account affected by many transactions. The debit and credit sides of
the cash account generally represent cash receipts and cash disbursements, respectively.

• Statement of Cash Flows is the financial statement that explains the net change in cash for the year.

• The Statement of Cash Flows summarized the cash transactions that occurred during the year.

• “For the year ended”

• This helps owners see if their revenues are actually translated to cash collections or if they have enough
cash inflows in order to pay any maturing liabilities.

• The Statement shows cash transactions organized based on the three major activities of the business-

operating, investing, and financing.

• Cash transactions primarily derived from and used for the main revenue-producing activities of the

business are reported under operating activities.

• Positive cash flows from operations suggest that there is excess cash that can be used to purchase long
term assets, pay debts or distribute to owners.

a. Cash flows from operating activities revel the present ability of the company to generate cash from its
operations.

b. Cash flows from operating activities may be presented using the direct method or the indirect
method.

c. Direct method of presenting the cash flows from operating activities shows summarized cash

transactions. The following are examples of line items presented in the direct method of cash flows from
operations.

I. Cash received from customers (cash receipts from the sale of goods and rendering of services)

II. Cash received from fees, commissions, and other income

III. Cash payments to suppliers

IV. Cash payment to employees

V. Cash payments for other operating expenses

VI. Interest payments.

VI. Income tax payments

d. The indirect method of presenting the cash flows from operations reconciles the accrual net income
(from the Statement of Comprehensive Income) to net cash flows from operations. The following are
examples of reconciling adjustments for the indirect method of presentation:
I. Non-cash expenses such as depreciation and amortization are added back to net income.

II. Increases in current assets and a decrease in current liabilities are deducted from net income. On the
other hand, a decrease in current assets and an increase in current liabilities are added back to net
income. The change is computed as the difference in the ending and beginning balances of the accounts.

6. Cash transactions related to the acquisition and disposal of long-term assets are reported under
investing activities.

• cash flows from investing activities hints at the company’s ability to generate cash in the future.

a. The following are examples of cash flow transactions reported under investing activities:

I. Payments to acquire property, plant, and equipment; intangibles; and other long-term assets

II. Proceeds from sale of property, plant, and equipment; intangibles; and other long-term assets

III. Disbursements for loans made to other parties (long-term note receivable)

IV. Collections on long term note receivable

b. Negative cash flows from investing activities imply that the company used cash to acquire long-term
assets intended to generate cash and cash revenue in the future.

c. Positive cash flows from investing may indicate that the company is divesting or downsizing.

7. Cash received and paid to equity owners and long-term creditors are reported under financing
activities. The following are examples of cash flow transactions under financing activities:

a. Proceeds from issuing common shares (or capital contribution form owners)

b. Proceeds from issuing notes or getting a long term loan from a bank

c. Dividends payment

d. Withdrawal of owners

e. Payment for principal of long-term loan

8. Accountants need two Statements of Financial Position (current year and prior year balance sheet)
and the current year Statement of Comprehensive Income to prepare the Statement of Cash Flows.

9. The Statement of Cash Flows is a summary of transactions in the T-Account of cash. The summarized
transactions are then grouped into business activities-operating, investing, and financing activities.

• The T-account is a chronological record of all cash transactions.

• Net change in cash or net cash flow (increase/decrease) – The net amount of change in cash whether
it is an increase or decrease for the current period. The total change brought by operating, investing and
financing activities.

• Beginning Cash Balance – The balance of the cash account at the beginning of the accounting period.

• Ending Cash Balance – The balance of the cash account at the end of the accounting period computed
using the beginning balance plus the net change in cash for the current period.
• Cash Receipts

1. Cash sales to customers

2. Collection of customer accounts
3. Loan and borrowings
4. Owner’s contribution

• Cash Disbursement

1. Business expense
2. Purchase of inventories and other assets
3. Liabilities to creditors
4. Dividends to owners

• The Statement of Cash Flows is also used to assess:

1. Liquidity – the ability to pay current obligations.

2. Solvency – the ability of a company to survive over the long-term. (Insolvent – opposite of it)

3. Profitability – the ability to generate reasonable return on investments. (Bankcruptcy – opposite of it)

• Elements of statement of cash flows

• Operating Activities – income and expenses accounts

• Investing Activities – PPE, Intangible assets, and other long term asssets

• Financing Activities – Non-current liabilities and Equity (Common stocks/Preferred stocks)

• FORMULA OF ENDING CASH BALANCE

Beginning Cash Balance + Net change in cash = Ending Cash Balance

• METHODS

• Direct method

• Indirect method – have net income

- Both have investing and financing activities but differ in operating activities

• Inflows – pagpasok ng cash

• Outflows – paglabas ng cash

+ Receipts, collections, net income

O - Disbursement, payment, net loss

+ Gain on sale of PPE

I - Acquisition of PPE

+ Investment, loan from bank

F - Withdrawal, payment of loan
T - ACCOUNT
Direct method Indirect method