Financial Accounting

R. Z.
Palma Financial Accounting 1
Chapter 1
Business and Accounting
Learning Objectives:
After reading this chapter, the student should be able to:

1. explain why businesses are formed;
2. explain the two basic tests of business survival;
3. enumerate and explain the types of business enterprise;
4. enumerate and explain the different forms of business;
5. explain the advantages of the corporate form over sole proprietorship and partnership form;
6. explain the importance of accounting to individuals;
7. enumerate the users of accounting information;
8. define accounting;
9. enumerate the complete set of financial statements; and
10. differentiate between accounting and bookkeeping.
Objectives of a Business Enterprise
A business is defined as an economic unit with the sole purpose of earning profits for its owner or owners.
The objective of the management of a business is how to optimize the use all economic resources owned
by the business in order to earn profit for the owners and continue to grow. It is not possible for a
business to grow unless it meets the two basic tests of survival – profitability and solvency. The
owners of a business cannot possibly know the level of its profitability and the level of its solvency
without accounting.
Profitability
Organizations may be grouped into two – the profit-oriented organization and the non-profit organization.
As its name suggests, the primary objective of organizations that fall under profit-oriented enterprises is to
make profit, and these organizations are usually referred to as business enterprise. The main activities of
a business enterprise are focused on meeting its primary objective of making profit. Other activities are
also undertaken to meet the same main objective.
Upon the formation of a business enterprise, an individual or group of individuals, known as investors,
owners, equity holder’s, or providers of capital, commits its resources and/or abilities in the hope that
their investments will increase in value and that the goal of making profit will be attained. The common
objective of all businesses is the desire to make profit. The income that a business makes is also called
net income or net profit or return on investment.
In order for the business enterprise to operate successfully and survive continuously, the manager,
whether he is the owner or not, must handle the business affairs in such a way that it will earn a
satisfactory return on the owner’s investment. There are many investment alternatives with varying
degrees of risk that are available to an investor. If an investment does not yield a satisfactory amount of
profit as compared to the return that might be earned from other investment alternatives, the investor
would be well-advised to sell or terminate that business and invest his resources and/or abilities
elsewhere. A business enterprise that is continually making losses will eventually deplete its resources
and be forced out of existence.
On the other hand a non-profit organization, whether private or government, is established not for profit
but to render services and meet the needs of the members of the organization or community. These
R. Z. Palma Financial Accounting 2
needs may be directly or indirectly related to education, health and physical care, livelihood, cultural and
social uplift, and spiritual and moral development. Some examples of non-profit or non-business
organization are: educational foundations, philanthropic foundations, museums, public libraries , civic
clubs, churches and religious organizations, non-government organizations (NGO’s), and orphanages.
Businesses Should Be Solvent
Aside from making profit, another important objective of business enterprises is to make sure that they
have sufficient amount of cash that can be used to meet the expenses of their daily operation and to pay
their business obligations within a reasonable period of time. A business enterprise that has sufficient
cash to pay its debts as they mature is said to be solvent. Being and staying solvent must also be an
objective of a business enterprise.
In contrast, a business enterprise that cannot meet its obligations as they fall due is said to be insolvent.
An enterprise that becomes insolvent can be forced by its creditors to stop its operations and later on
discontinue its existence.
Types of Business Enterprises
A business enterprise exists when a person or group of persons makes an investment or contributes their
resources in order to sell products or render services to others, for the ultimate purpose of making profit.
There are three major types of business enterprises that may be established for the purpose of making
profit: service, merchandising, and manufacturing enterprises.
Service Enterprise
This type of business provides various forms of services (not tangible products), to its customers or
clients. Some examples of entities that render services are: professionals, repair shops, banks, brokers,
consultants, schools, hospitals, hotels, insurance companies, utility enterprises, and service contractors.
A service enterprise recognizes income in the form of service fees, rent income, interest income, royalty
income, retainer’s income, and commission income. The manner of accounting for a service enterprise
had been discussed in the previous subject, the Sole Proprietorship.
Merchandising Enterprise
This type of business entity is involve in the “buy and sell” activity. It is also called a trading enterprise
that buys ready-to-use products, such as appliances, vehicles, household items, toys, clothing apparels,
supplies, ready-to-eat food, cosmetics, toiletries, and other accessories and then sells these products to
end-customers at higher prices. A business enterprise that purchases ready-to-use materials from
wholesalers or manufacturers, and then, sells the same to the end user, without materially changing the
form of the product bought and sold, is classified as merchandising enterprise. The manner of
accounting for a merchandising enterprise had been discussed in the previous subject, the Sole
Proprietorship. .
Manufacturing Enterprise
Unlike a trader or a merchandiser, a manufacturer, also called a producer, manufacturer, assembler,

fabricator or processor, is in the normal business of converting raw materials into a new product that he
later on sell. A manufacturer has factory facilities where he produces finished goods out of raw materials
and supplies by applying labor and other manufacturing costs. For example, a manufacturer of adhesive,
popularly known as “Rugby, buys raw materials such as synthetic rubber, soda ash, resins, solvents and
containers and process these materials with the use of factory facilities such as rubber mill, mixers, and
dispensers to produce Rugby in bottles, liters, gallons and drums. Another example is a clothes
manufacturer who buys clothing materials and sewing supplies, and with the skills of the designers,
cutters, sewers and finishers and with the use of factory facilities such as cutters, sewing machines and
other equipment, the manufacturer comes out with the finished jeans or skirts that can be sold to traders,
merchandisers or end-customers.
Forms of Business Ownership
There are three common forms of business enterprise depending on who provides the resources and
abilities that are needed in the normal operations. A business enterprise may be organized as a sole
proprietorship, a partnership, or a corporation, depending on how its capital requirements are generated.
Sole Proprietorship
A business that is owned by one person is called a sole proprietorship or a single proprietorship. The
person who puts up the investment is the sole proprietor and is commonly referred to as the
entrepreneur, or simply the owner.
Partnership
A partnership is an association of two or more persons who bind themselves to contribute money,
property or industry to a common fund, with the intention of dividing the profits among themselves. The
owners of the partnership are called partners. The formation of a partnership requires some form of
written or oral agreement between the partners. Among others, the partnership agreement states how the
business will be managed, the capital contributions and responsibilities of each partner, how the periodic
profits or losses shall be divided among the partners, the compensation that each partner is entitled to
receive, and the form of settlement upon the withdrawal or death of any partner.
Corporation
A corporation is defined as an artificial being created by operation of law, having the right of succession
and the powers, attributes and properties expressly authorized by law or incident to its existence. It is a
business that has its ownership capitalization divided into hundreds or thousands of transferable shares
of stock. The corporation must have at least five owners or investors called stockholders or
shareholders. Certificates of capital stock issued by the corporation to each stockholder show the
number of shares held by each stockholder. At any time a stockholder may sell a part or all of his shares
of stock without disrupting the existence of the corporation. One very important advantage of a corporate
form of business enterprise over that of a partnership is the ease in transferring the stockholder’s
investment shares to another investor.
A group of at least five (5) persons who organized and found the corporation are called incorporators.
The incorporators must file an application for a corporate charter with the Securities and Exchange
Commission. When this application is approved, the corporation becomes an artificial person which exists
as a legal entity that is separate and distinct from its owners or stockholders.
Accounting Principles and Processes
The accounting principles and processes applicable to the three forms of business ownership are
basically the same.
What is accounting and its relation to individual activities and business?
Personal Accounting of an individual activities

Nearly every person is involved in some form of accounting, almost on a daily basis. For students, what is
important is the accounting of his weekly allowance from his parents. The student has to plan how his
weekly allowance should be spent so that at the end of the week, he still has some money left to be used
as savings or to be used to buy something that he wants. For the parents, what is important is the
accounting of their net take home pay; how much will be spent for food, how much will be spent for
electricity, water, communication, how much will be spent for the schooling of their children, for clothing or
even amortization or rental of their homes. We live in a time where accountability, whether in formal or
informal form, is a part of life.
Business Accounting of its activities

Whenever a person, whether natural or artificial, has a business activity, accounting is involved.
Accounting is involved in planning business activities and then recording and summarizing actual
business activities; and finally comparing the financial plan against the actual result of operation.
Even those very simple acts – such as paying for transportation fare, paying for electricity and water,
buying office supplies, making a telephone call, sending a text message, giving a pledge to the church,
mailing a letter, payment of taxes, or receiving cash for product sold or receiving the cash or account
receivable for services rendered to others – involve accounting for expenses and revenue.
Accounting as the Language of Business
Although accounting is frequently associated with organized businesses, the understanding of the basic
accounting principles and process is also needed in the day-to-day living of an individual. Every person
needs to systematically monitor or keep track of his personal finances – both his resources and
obligations. For example, accounting is needed when an employee applies for credit card or housing loan.
Even ordinary shopping activities, and the saving of unspent cash, require practical accounting skills.
Also, financial information is needed in filling the required income tax returns. Accounting data are needed
when a retiree computes for his post-employment benefits. The division of partnership profits among
partners needs certain financial information as well. Corporations, whether large or small, profit or non-
profit, are required to submit periodic financial statements to the Bureau of Internal Revenue and
Securities and Exchange Commission and other governmental agencies. Lastly, accounting is essential
for operations of both government and non-governmental organizations.
Accounting involves the systematic recognition, measurement, reporting, and interpretation of data that
are related to the financial activities of a natural or artificial person. Processing information in such a way
that would be useful in making economic decision is the primary purpose of accounting.
Accounting is often called the “language of business”.
The Committee on Accounting Terminology of the American Institute of Certified Public Accountants
(AICPA), defines accounting as follows:
“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.”
Over the years, the areas covered by accounting have expanded. Presently attention is focused on
accounting as a tool for decision-making. Thus a new definition of accounting is adopted. The
Philippine Accounting Standard Council in its old Statement of Financial Accounting Standard No. 1,
the definition of accounting is as follows:
“Accounting is a service activity. Its function is to provide quantitative information, primarily

financial in nature, about economic entities, that is to be useful in making economic decision.”
Data-Users of Accounting Information
Accounting is a communication tool that helps data-users to make certain informed financial decisions.
To be a useful tool, accounting must immediately respond to the changing needs of the data-users and
the economic environment.
The users of financial information are categorized as either external users or internal users.
External users are those outside the business organization whose financial interest would either be
present or future such as the lenders (banks /financial institutions), suppliers of goods and services, the
government, the customers, and the public.
Internal users are those who are within the business organization such as the owner/ owners, current
investors, officers and managers and employees.
Business Owners and Shareholders of the Business.

The owners primarily concern themselves with the profitability and solvency of the business.
Officers and Managers

Using accounting information, heads and executives fulfill their function of planning (budgeting), directing
(execution) and control (monitoring actual vs. budget) by evaluating the operational efficiency and taking
remedial actions whenever necessary.
Employees
Employees and their labor unions determine the ability of the business to meet their demands for higher
salary, better working condition, security of employment, and the others from financial statements. These
financial statements of the business facilitate the preparation of important labor negotiations.
Investors
Any investor looks into the business stability and profitability if he is to receive security and assurance of
fair return to his investment. Financial information is necessary in selecting where his resources should be
invested.
Lenders and Creditors.

These include suppliers, banks, financial institutions, and many others. They are mostly concerned with
business liquidity or the company’s ability to meet maturing obligations.
General Public and Consumers

General public are concerned with accounting information because businesses affect social problems,
standard of living, and national inflation. Also, consumers are concerned with the stability of the business,
particularly with respect to its ability to supply them with products and services they need..
Government.
Both national and local governments regulate/monitor most businesses. For purposes of compliance, they
may review the accounting records of businesses. Government regulatory bodies include the Bureau of
Internal Revenue, Securities and Exchange Commission, Commission on Audit, Bangko Sentral ng
Pilipinas, and the Department of Finance. Government labor, statistics and economic agencies use
accounting information from businesses to set up economic policies, economic programs, and forecast
economic activities of the country. Every year all businesses, big or small, must apply for business
permits from local government units where they are located.
Financial Statements (PAS 1)
The accounting information is presented in reports called financial statements. These reports, while
useful to management, are also prepared primarily to provide relevant information to external users.
Accordingly, the financial statement objective of reporting is to provide information:
1. that is useful for present and potential investors and creditors in making rational decisions. (general
financial information)
2. that is understandable to those persons involved in business and economic activities; (general financial
information)
3. about economic resources of an enterprise and claims to those resources; ( statement of financial
position or balance sheet)
4. about the financial performance of an enterprise for a specified period; (income statement) and
5. that help users assess the amounts, timing and uncertainty of future cash receipts from sales, interest
income, dividends income and cash disbursements for purchase of merchandise, payment of salaries,
payment of loan payables, payment of interest expenses and other expenses. (statement of cash flows)
The first two objectives apply to all financial accounting information. Note that the information presented in
the financial statements are not prepared for those persons who have not attained a reasonable
knowledge using financial statements. The third objective is related to the statement of financial position
or balance sheet; the fourth, is related to the income statement; and the fifth, is related to the statement of
cash flows. These objectives collectively suggest that these reports are intended to be used in making
decisions related to the present and future status of the business.
The Distinction Between Accounting and Bookkeeping
Accounting and bookkeeping are not the same. Bookkeeping is only a part of the wider field of
accounting. Bookkeeping involves those mechanical and repetitive recording and classifying procedures
related to the business activities of a natural or artificial person, until the voluminous financial information
is summarized and reported in the form of financial statements. Bookkeeping includes the record keeping
process of accounting. Bookkeeping is the clerical side of accounting. A person might become a
reasonably proficient bookkeeper after completing a course in the fundamentals of accounting. However,
several years of study, experience and maturity are needed to become an accountant.
Among others, accounting includes: the analysis and interpretation of financial statements, the
income tax work, the design and installation of an accounting system, audits, and the preparation of the
forecast, budgets, and feasibility studies.
They say, accounting as a highly technical field that can be understood only by professional
accountants. It is not true.
There are some people who are not accounting graduates yet they have become comfortable in
dealing with the accounting information, accounting methods, and accounting reports. Majority of
presidents and treasurers of large corporations are not accounting graduates but they are adept in
using accounting information in making management decisions.
Accounting as the Basis for Business Decisions
The primary responsibility of management covers the following areas:
 Planning and organizing the operating activities of the business enterprise,

 Controlling and assessing the performance of the business enterprise, and executing
corrective actions to financial problems.
 Investing and borrowing activities
Accounting information will greatly help managers, lenders, investors, and owners in answering questions
such as:
Owner:
1. What is the possibility of earning a profit next year?
2. Do we need to borrow to finance the operation of our business?
3. What is the break-even sales?
4. What should be the most reasonable unit selling price for my finished product?
5. Should I branched out my operations to another city or stay within this city ?
6. Should I continue producing my product or just buy it from another manufacturer ?
7. How would I know if my goods are being stolen?
8. Is this year’s performance better or worse than last year?
9. Are my competitors making more profit than I do?
10. Should I advertise my new product? by how much?
11. For the current year, how much salary increase should I give to my employees?”
12. How many products should I sell to earn P1,000,000 a month?
.
Lender
1. Is the business of the borrower liquid? stable?
2. Can this borrower pay back his loan plus interest to me?
Employee
1. Considering the profitability situation of my employer, is a salary increase possible this year?.
There are hundreds of questions or situations that will require answers or decisions. For a manager to be
effective, he needs decision-making skills related to planning, organizing, investing, financing, and
controlling of the business. However, his skills are useless, unless there is available financial information
that he can use in making management decision.
Officers and managers

In large-scale business enterprises, the top-level managers cannot directly get the details of the
operations of lower levels due to lack of direct contact.
Consequently, these managers would depend on the useful financial information provided by the
accounting system. This financial information must have value, not only in assessing what already
happened but also in predicting what may happen in the near future. These accounting data help in
evaluating the over-all profitability and solvency of a business enterprise.
Corporate Financial Accounting
Corporate financial accounting is the branch of accounting that is primarily concerned with the
measurement and communication of information that summarizes and reports the financial condition and
operating results of a profit oriented corporation. These financial data are supplied to both the direct
and indirect data-users, principally in the form of financial statements. An important requirement of
financial accounting is that information should be recognized measured, and reported in conformity with
generally accepted accounting principles. These accounting principles apply to all types and all sizes of
business organizations. The application of theses accounting principles is helpful to decision makers as
they evaluate a wide range of financial issues related to the business enterprise.
Financial information is intended to be useful not only to management but also to various third party data-
users. Financial accounting provides, as objective as possible, the financial information needs of both the
internal and external data-users who may have conflicting interest in the business affairs. The examples
of conflicting interests are:
 Financial information that is favorable from management’s point of view may be unfavorable from the
government’s point of view.
 Financial information that is beneficial to the stockholders may not be beneficial to the labor union.
Financial accounting supplies the information needs of the various interest groups without favoring any
particular group.
Other financial data that are not provided in the financial statement are made available to the data-users
through some other form of financial reporting, such as annual reports, prospectus, letters and financial
reviews by management, sales catalogues and brochures, etc.
Financial information is very useful as top management performs its planning, coordination, investing,
financial and, controlling activities. It needs financial information in carrying out its daily responsibilities
related to the operations of the business. Since it does not have that much time to examine details of the
operating information, frequently, it relies on the summaries of data that are made available through the
accounting internal reporting system. Specific problems that are identifiable at different organizational
levels are solved with the help of financial information that is provided by this system.
Chapter 1
I. Review Questions
Answer the following questions:
INSTRUCTION: This is a take home assignment. In a yellow pad, answer the following questions:
1. What are the two basic test of survival of a business?
2. What is the primary objective of business?
3. When is a business solvent and when it is insolvent?
4. What are the three types of business enterprise?
5. What are the three forms of business ownership?
6. What are the advantages of a corporation over a sole proprietorship or partnership?
7. What are the two definitions of accounting?
8. Accounting is sometimes referred to as the “language of business”. Why?
9. What is the major difference between bookkeeping and accounting?
10. Can a business continue to operate without the proper accounting information system?
11. Who are the users of financial statement and other financial information?
II. EXERCISES
Exercise 1.1 True or False
Instruction: Indicate on the blank, before each number, the word True, if the statement is correct and the
word False, if the statement is wrong.
______ 1. Organizations may be grouped into two: the profit oriented and the non-profit
organizations.
______ 2. A business enterprise that has sufficient cash to pay its debts as they mature is said to
be a good debtor.
______3. A service enterprise recognizes income in the form of service fees, rent income,
interest income, royalty income, retainer’s income, and commission income.
______4. A business enterprise buys materials, such as appliances, vehicles, household item,
toys, clothing apparel, and applying labor and other manufacturing cost to produce
another finished product is called manufacturing enterprise.
______5. A partnership is an artificial being created by operation of law, having the right of
succession and the powers, attributes and properties expressly authorized by law or
incident to its existence.
______6. A group of persons who originally formed a new corporation are called incorporators.
______7. Processing financial information in such a way that it would be useful to the user is the
primary purpose of accounting. This processing of information is called accounting information
system.
______8. Lenders and creditors are mostly concerned with business liquidity or the company’s
ability to meet maturing obligations.
______9. The accounting information is presented in reports called annual reports.
______10. Bookkeeping involves the mechanical and repetitive recording and classifying
procedures related to the business activities of a natural or artificial person and
summarized and reported in the form of financial statements.
Exercise 1.2
Multiple choices. Choose the best answer by encircling the letter of the correct answer.
1) Which of the following is not true?

a) Accounting is not an exact science.
b) Accounting is the language of business.
c) Accounting is a communication tool that is useful to both internal and external
decision-makers.
d) Accounting is useful only to profit- oriented organizations
2) Which of the following statements is not correct?

a) Accounting is an art.
b) Accounting is a service-oriented discipline
c) Proper accounting of the transactions of a business will benefit both the people
inside and outside the enterprise.
d) Being a bookkeeper requires the same kind of training and preparation as that of
being an accountant.
3) Which of the following is not part of the functions of the accounting system?
a) Analyzing and recording the business transactions of the enterprise
b) Classifying and summarizing the effect of the transaction on the accounting elements
c) reporting the results of operations during a reporting period
d) Preparing financial statements that are favorable to specific data-users.
4) The common types of business are engaged in:

a) Rendering services to clients or customers. c) Trading or merchandising.
b) Manufacturing or fabrication d) All of the above
5) To a proprietor:
a) One must be engaged in a business of trading or merchandising.
b) One must put up a certain investment for the purpose of making profit.
c) One must have partners or co-investors.
d) One must have a fixed place of business.
6) Which of the following is mechanical aspect of accounting?

a) Analyzing the transactions preparatory to the recording process
b) Preparation of a financial budget
c) Reviewing the effectiveness of the internal control procedures
d) Designing the accounting system
7) Which of the following statements is not true?

a) A non-accounting graduate may work as a bookkeeper or accountant of a business
enterprise.
b) A non-CPA may be the chief accountant of the business enterprise.
c) A non-CPA may be engaged in public accounting.
d) To be good accountant, one must have mastery of the mathematics.
Exercise 1.3
True or False. Indicate on the blank whether each statement is true or false.
_____a) Accounting and bookkeeping are synonymous.

_____b) Business enterprises are primarily organized for the purpose of making profit.
_____c) A business enterprise that cannot meet its obligations as they mature is said to be
solvent.
_____d) Service enterprises are classified as non-profit organization since they are
organized primarily for the purpose of rendering services to others.
_____e) According to the business entity principle, the owner of the business is the
absolute owner of all the business’ assets.
_____f) Business entity principle assumes that the business has a personality that is
separate and distinct from that of its owner or owners.
_____g) A corporation must have a least three investors or incorporators.
_____h) Generally, stockholder of a corporation cannot transfer his shares to another
investor without the prior approval of the other stockholders.
_____i) Only the accountant and the manager may have access to the books of the
accounts and other financial records of the business enterprise.
_____j) Only a CPA may be employed as a chief accountant of a business enterprise.
Chapter 2
Laws on the Formation of a Corporation
After studying Chapter 2, the students should be able to:
1. Explain and discuss why the Corporation is the most ideal form of business organization for a
growing and profitable business;
2. Understand the nature of a corporation and how it is formed;
3. Know the attributes of a corporation;
4. Know and explain the different classes of corporations;
5. Know and explain the different classes of shares of stock of a corporation;
6. Know the minimum paid up capital;
7. Determine the advantages and disadvantages of a corporation over the other form
of business organization; and
8. Explain the following: legal capital, outstanding shares of stock, subscribed capital, paid up capital, and
stock certificate.
Real World Example
Microsoft Corporation
Microsoft started as a partnership on April 4, 1975 by William H. Gates III and Paul Allen. Microsoft was
first to dominate the computer software market with its MS-DOS system and subsequently the Windows
platform. In four years, from 1978 to 1981, Microsoft exploded and the staff increased from 25 to 128.
Revenue shot-up from $4 million to $16 million. Because of the nature of partnership, it can solicit only
limited funds in spite of being very profitable. Because of this situation, there was no way but to
incorporate. As a corporation, it is easier to issue shares of stocks to fund its’ expansion. In the middle of
1981, Microsoft was incorporated. Gates was appointed as the President and Chairman of the Board
while Paul Allen was appointed as the Executive Vice President. By 1983, Microsoft is going global with
offices in Great Britain and Japan. By this time, it was estimated that 30%of the world’s computers were
using its software. In 1986, Microsoft went public and held an initial public offering (IPO). At the
beginning of the IPO, the shares started at $21 per share, and towards the middle of 1987, the market
price of Microsoft’s stocks shot-up to $90.75 per share. Gates held 45 percent of the company’s 24.7
million shares. Gates became an instant billionaire at the age of 31.
In 1990, Microsoft launched several versions of Microsoft’s Window platform and captured over 90% of
the market share of the world’s computer software. It is almost a monopoly. In 1999, with Microsoft’s
stock price at all time high and the stock splitting 8-folds since its IPO, Gates became the number one
billionaire. How Bill Gates did it with Microsoft Corporation is one of the best marketing, production, and
financial management lessons that everyone should study.
Bill Gates, married, with two children, was worth US$50 billion, in year 2000. He is the richest man in the
world at that time. His net worth mainly came from the market value of his shares of stocks in Microsoft.
But after the anti-trust trial of Microsoft, the market price of Microsoft’s stocks stumbled and Bill Gates
net worth went down to $38 billion. (History of Microsoft-Wikipedia; Fast Facts About Microsoft; Bill
Gates Biography; Internet- Google Search)
Paul Allen, the original partner of Bill Gates, single, resigned at Microsoft in 1983 after being diagnosed
with Hodgkin’s disease. He was able to sell a great amount of his Microsoft stocks to finance his other
investments in media and communications. He also owns the NBA basketball team, the Portland
Trailblazers and the NFL Seattle Seahawks. (Paul Allen Biography; Internet – Google Search.)
Forbes magazine’s list of 2014 billionaires showed that Bill Gates bounced back to being the number 1
billionaire with a net worth of $78.4 billion while the second place went to Carlos Slim, the Mexico
telecom tycoon, with a net worth of P$71.6 billion and the third is Warren Buffett with a net worth of
$64.4 billion. Paul Allen is also among the world’s billionaires with a net worth of $16.1 billion. (Forbes
Magazine, 2014)
In 2020, Jeff Bezos is number one at US$130 billion while Bill Gates is number two at US$ 110 billion.
Why Corporation is the Better Business Organization?
As can be seen in the above Real World Example, all large and growing firms should choose the
corporate form for one reason: ease in raising capital. Because of the limited liability, the ease of
transferring ownership through the sale of common shares and the flexibility in dividing the shares, the
corporation is the ideal business entity in terms of attracting new capital. In contrast, the unlimited
liabilities of the sole proprietorship and general partnership are deterrents to raising equity capital. Also
the impracticality of having a large number of partners and the restricted marketability of an interest in a
partnership prevent this form of organization from competing effectively with the corporation.
Without question, the ease of raising capital is the major reason for the popularity of the corporate form.
While studying the process of raising capital, we first must look at the flow of capital through the financial
markets among the corporation, individuals, and the government.
Initially, the corporation raises funds in the financial markets by selling securities or shares of stocks.
Later on, the corporation receives cash in exchange of securities sold: 1. its own shares of stocks and 2.
debt securities such as bonds. Then, the corporation invests these cash inflows in profit generating assets
or projects. And finally, the net cash flow (profit) from those projects is then given back to the equity
investors and debt security investors and the balance is either reinvested by the corporation for new
product line or business expansion.
Laws on the Formation of A Corporation in the Philippines
All laws and statutes pertaining to Corporations are found in the “CORPORATION CODE OF THE
PHILIPPINES” (Batas Pambansa Blg. 68, which became effective on May 1, 1980)
“SECTION 2. Corporation defined. - A corporation is an artificial being created by operation of

law, having the right of succession and the powers, attributes and properties expressly
authorized by law or incident to its existence.”
Attributes of a Corporation
a. Artificial being
b. Created by operation of law
c. Has the right of succession
d. Has the powers, attributes and properties expressly authorized by law or
incident to its existence.
The Corporation as an Artificial Being.
A corporation is an artificial being because it is created by the operation of law. Since the corporation is
created by law, it is also called as a juridical person. As a juridical person, it possessed of a personality
distinct and separated from its owners called stockholders or members. It can acquire and posses
property of all kinds, as well as incur obligations and bring civil or criminal action, in conformity with the
laws and regulations of its organization.
A Corporation is Created by Operation of Law.
A corporation is created and organized under a general law and is considered a legal body with rights and
powers. It is not created by agreement of persons just like partnership.
A Corporation has a Right of Succession (continuity of existence)
The corporation shall continue to exist for the period stated in the Articles of Incorporation, and the death
of any stockholder shall not dissolve the corporation. The corporate life of a corporation continues until
the term expires or unless sooner dissolved for other causes or its term extended in accordance with law.
By succession is not meant that the corporation is immortal. It simply means that the corporation has a
continuity of existence independent of its members or shareholders. This continued existence of a
corporation is, however, limited to the period stated in its Articles of Incorporation or in the act creating it.
The death or withdrawal of the members or shareholders of a corporation will not affect its corporate
existence.
“Section 11 of the Corporation Code of the Philippines states that " A corporation shall exist for a
period not exceeding 50 years from the date of incorporation unless sooner dissolved or unless such
period is extended. The corporate term, as originally stated in the Articles of Incorporation, may be
extended for periods not exceeding 50 years in any single instance by an amendment of the Article of
Incorporation, in accordance with the Code. Provided, that no extension can be made earlier than 5
years prior to the original or subsequent expiry date(s) unless there are justifiable reasons for an
earlier extension as may be determined by the Securities and Exchange Commission."
A Corporation has Powers, Attributes, and Properties.
The powers of the corporation maybe express powers or incidental powers. As a creation of law, the
corporation can perform only such powers as it may be expressly or impliedly authorized to do in
accordance with its Articles and By laws, the Corporation Code, and such other laws pertinent to a
corporation. Incidental powers are those which, although not expressly stipulated by law are inherently
necessary in the exercise of its corporate powers in the pursuit of its corporate existence.
A corporation by means of its creation can exercise the following powers:
a. those expressly granted by law, (all the rights of a natural person in pursuing the growth of a
business)
b. power inherent to corporate existence, (sue and be sued) and
c. implied powers. (other rights under the law needed for its continued existence)
Nationality or Citizenship of a Corporation
From the moment a corporation acquires its own legal existence, there develops its own nationality.
If the corporation is organized in accordance with Philippine laws, then it is a Domestic Corporation.
If the corporation is organized in accordance with the laws of countries other than the Philippines, then it
is a Foreign Corporation.
Stock and Non-Stock Corporation
“SECTION 3. Classes of Corporation. Corporations formed or organized under this Code may be
stock or non-stock corporations. Corporations which have capital stock divided into shares and
are authorized to distribute to stockholders of such shares, dividends or allotment of the surplus
profits on the basis of shares held are stock corporations. All other corporations are non-stock
corporation.”
Corporators and Incorporators
“SECTION 5. Corporators and Incorporators, Stockholders and Members.

Corporators are those who compose a corporation, whether as stockholder or members.
Incorporators are those stockholders or members mentioned in the Articles of Incorporation as
originally forming and composing the corporation and who are signatories thereof.”
Corporators are the persons who owned the corporation which include the incorporators, the
stockholders, and/or members.
Stockholders or shareholders are corporators in a stock corporation. These are the persons who own
shares of stocks in the stock corporation.
Members are corporators in a non-stock corporation. These are the persons who own membership
certificates in a non-stock corporation.
Incorporators are the original founders and organizers of the corporation, stock or non-stock. The law
provides that incorporators must be at least five (5) but not more than fifteen (15).
Incorporators are considered as corporators but not all corporators are incorporators.
Preferred and Common Shares
“SECTION 6. Classification of Shares. - The shares of stock of stock corporations may be divided
into classes or series of shares, or both, any of which classes or series of shares may have
such rights, privileges or restrictions as may be stated in the articles of incorporation: Provided,
that no share may be deprived of voting rights except those classified and issued as ”preferred”
or “redeemable” shares, unless otherwise provided in this Code: Provided further, that there
shall always be a class or series of shares which have complete voting rights. Any or all of the
shares or series of shares may have a par value or have no par value as may be provided for in
the Articles of Incorporation: Provided, however, that banks, trust companies, insurance
companies, public utilities, and building and loan associations shall not be permitted to issue no
par value shares of stock.
Preferred shares or redeemable of stock issued by any corporation may be given preference in
the distribution of the assets of the corporation in case of liquidation and in the distribution of
dividends, or such other preferences as maybe stated in the articles of incorporation which are
not violative of the provisions of this Code: Provided, that preferred shares of stock may be
issued only with a stated par value. The Board of Directors, where authorized in the articles of
incorporation, to fix the terms and conditions of preferred shares of stock or any series thereof:
Provided, that such terms and conditions shall be effective upon the filing of a certificate thereof
with the Securities and Exchange Commission.
Shares of capital stock issued without par value shall be deemed fully paid and non-assessable
and the holder of such shares shall not be liable to the corporation or to its creditors in respect
thereto: Provided, that shares without par value may not be issued for a consideration less than
the value of five (P5.00) pesos per share: Provided further, that the entire consideration received
by the corporation for its no par value shares shall be treated as capital and shall not be available
for distribution as dividend.”
In the absence of any distinction in such rights and privileges accorded to preferred and
redeemable shares, all other shares shall be called common or ordinary shares. Common or
ordinary shareholders shall always have a complete voting rights. Common or ordinary
shareholders are the true owners of the corporation. Normally, preferred and redeemable shares
have no voting rights.”
Accounting Account Titles
The Philippines is following the International Accounting Standard Council pronouncements about
account tiles, so in accounting books, you might see these changes;
Common shares is also called ordinary shares.

Preferred shares is also called preference shares.
Restrictions on Shares Issued
As the rule states, certain shares of stocks are subject to some restrictions as follows:
1. No shares may be deprived of voting rights except the preferred and redeemable shares;
2. There shall always be a class or series of shares which have complete voting rights;
3. Any or all of the classes of shares may have a par value or no par value as may be
provided in the articles of incorporation;
4. Banks, trust companies, insurance companies, public utilities companies, and building
and loan associations can not issue no par value shares; and
5. No par value shares may be issued at less than P5.00 per share as provided by law.
Required Minimum Authorized Capital Stock and Minimum Paid-up Capital
The new corporation code does not require any minimum authorized capital stock as long as the paid up
capital is not less than P5,000.
Characteristics of a Corporation
The legal definition of a corporation gives the attributes of a corporation. There are, however, important
characteristics of a corporation which distinguished it from other business organizations. Some of those
characteristics are:
1. Greater capital
The owners of the corporation are called corporators, members or stockholders.

The Corporation Code states that corporators are those who compose a corporation, whether
stockholders or members. Corporators who are mentioned in the articles of incorporation and
who are signatories thereof are called incorporators. Corporators in a stock corporation are
called shareholders or stockholders. Corporators in a non-stock corporation are called
members. Since there can be one hundred or more owners in a corporation, it can accumulates
bigger amount of capital.
2. Limited liability
Like a limited partner in a partnership, a stockholder has limited liability. This means that he is
liable to corporate creditors only up to this subscriptions, in case of liquidation.
3. Better management
The management of a corporation is delegated to a board of directors duly elected by the

shareholders. Inasmuch as there are more people to choose from in a corporation, the
stockholders can get those with expertise to manage the business. In the other forms of
business, the owners themselves manage the company.
4. Unlimited life
Unlike a partnership whose life is limited or which is dissolved upon death, withdrawal of
incapacity of any partner, a corporation of its right of succession has a more stable life. It shall
exist for a period stated in the articles of incorporation or longer as when its term is extended in
accordance with law. It is dissolved only upon the expiration of the corporate term or unless
sooner dissolved for other reasons. Thus, in a corporation, the element of continuity exists.
5. Transferability of interest
A characteristic of a corporation not found in the two other forms of business is the free and ready
transferability of ownership. Shareholders may transfer their shares of stock and all other rights
that accompany them even without the consent of the other shareholders.
6. Separate entity
A corporation is a person. It is expressly considered as a juridical person to which the law grants
a juridical personality separate and distinct from that of each shareholder, e.g. it can sue and be
sued, the obligation of the corporation is not the obligation of the shareholders and vice versa.
Advantages and Disadvantages of a Corporation Compared to Other Forms of Business

Organizations
Advantages of a Corporation
1. Capacity to act as a juridical person with legal personality.

2. Continuity of life.
3. The liability of the stockholders is limited to their fully paid investment in the corporation.
4. There is better management as the best service may be extracted from the bigger
membership of a corporation.
5. There is a more unified form of control which is reposed in the Board of Directors.
6. Shares of stocks may be transferred even without the consent of other stockholders.
7. There is a greater source of capital.
Disadvantages of a Corporation
1. A corporation is subject to greater government control.

2. Frequent and varied reports are required of a corporation.
3. A corporation may not engage in any business other than the business specified in the
Articles of Incorporation.
4. Minority stockholders may be at the mercy of the majority stockholders.
5. A corporation cannot transact business in another state unless it obtains a license
for that purpose.
6. It is subject to double taxation. The income of a corporation is subject to income tax and
the distribution of corporate income in the form of dividends to its shareholders is also
subject to income tax of its’ shareholders.
7. Outstanding stocks cannot be more than the authorized capital stock.
8. Credit of corporation is limited on account of limited liability of stockholders.

9. There is a greater possibility of abuse of power.
Differences Between a Partnership and a Corporation

Partnership Corporation
1. As to creation By voluntary agreement and By operation of law

mutual consent of the partners
2. As to life or No time limit but easily dissolved. May exist for 50 years subject to
duration Dependent on the agreement of extension of another 50 years
the partners.
3. As to liability General partners, including Stockholders are liable only to the

industrial partners, are liable for extent of their subscriptions.
the partnership's contractual
liabilities up to the extent of their
personal assets.
Limited partners are liable only to

the extent of their contributions.
4. As to transfer- No partner may transfer his share A stockholder may sell his shares
ability of interest in the partnership to a third person in a corporation to a third person
without the consent of all other even without the consent of the
partners. other stockholders. Must be duly
recorded in the stock and transfer
book of the corporation.
5. As to ability to As a mutual agent, a partner can Stockholders cannot bind the

bind the bind the partnership in a contract corporation in a contract. Only the
organization. Even without the consent of other Board of Directors and other
partners provided he is with authorized officers of the
authority. corporation
6. As to power of A partnership has no power of A corporation has the power of

succession succession. Dissolution takes succession. Death, insolvency or
place upon death, insolvency or insanity of director, officer, or
insanity of any one partner. stockholders do not dissolve the
corporation.
Kinds of Corporations
1. According to the purpose of its creation
A corporation is either public or private. When the intention of the organizers is to serve the people as
government-owned unit, the enterprise is known as a public corporation. Examples of this type are the
Government Service Insurance System (GSIS), the National Development Company (NDC), the Social
Security System (SSS), the Farm System Development Company (FSDC), and the National Power
Corporation (NPC). Under the old corporation law (Act 1459 Sec. 3), a public corporation is one organized
for the government or a portion of a state like a province, city or town. The officers of a public corporation
are appointed by the State or elected by the people. A private corporation is an agency or instrumentality
of private persons. It is created for private purposes, benefit, aim and profit. The officers of private
corporations are elected by stockholders and subject to the removal, also, by the stockholders.
Public corporations are those formed or organized for the government ( Securities and Exchange Commission
(SEC), Development Bank of the Philippines (DBP), or a portion of the state, such as town, city, province
and barangay.
Private corporations are those which are created, wholly or in part, for purposes of private benefit, profit, and
emolument. Examples: PLDT, Meralco, San Miguel Corporation, Bank of Philippine Islands, cooperatives,
religious and charitable institutions and others.
2. According to shares authorized to issue
Stock corporations are those which have capital stocks divided into shares and are authorized to distribute to
the holders of shares dividends or allotments of the surplus profits on the basis of the shares held.
Non-stock corporation are those where there is no such stock, but the membership therein is otherwise
represented.
A non- stock corporation is generally non-profit in nature like religious and charitable institutions. Since no
stocks are issued, the owners are called members. This corporation may be organized for other purposes
under Sec. 88 of the Corporation Code. A Non-Stock Corporation can derive profit as long as no part of its
income will be distributed to its members. A stock corporation, which is the emphasis of this book, is
organized for the purpose of engaging in business. As such, it is profit oriented.
3. According to number of stockholders or members
A corporation aggregate is composed of more than one member or stockholder, like the San Miguel
Corporation, PLDT, RCBC, Meralco and others.
A corporation sole is composed of a single member and his successors in office. Thus, for the administration of
the temporalities of any religious denomination, society or church, and the management of the state and
properties thereof, it shall be lawful for the bishop, chief priest, or presiding elder or any such religious
denomination, society or church to become a corporation sole, unless inconsistent with the rules, regulations
or discipline of his religious denomination, society, or church or forbidden by competent authority thereof.
4. Ecclesiastical and lay
An ecclesiastical corporation is one created to secure the public worship of God.
A lay corporation is one established for temporal purposes and is comprised of laymen.
5. De jure and de facto
A de jure corporation is one created in strict or substantial conformity to the requirements of the law governing
corporation. Therefore, its right to exist cannot be successfully attacked in a direct proceeding for that
purpose by the State.
A de facto corporation is one so defectively created that its creation does not conform strictly or substantially
with laws governing corporation.
6. Eleemosynary and civil
An eleemosynary corporation is created for purposes of charities, such as orphanage, hospitals, schools, and
the like. ( Bouvier's Law Dictionary)
A civil corporation is created to facilitate the transaction of business for profit. ( Bouvier's Law Dictionary)
7. As to nationality
A domestic corporation is a corporation created or existing under the laws of the Philippines.
A foreign corporation is a corporation created or existing under the laws of other States or countries other than
the Philippines.
8. Open and close
An open corporation is one in which the general public may become a stockholder or members thereof.
A close corporation is one in which the stockholders or members are limited to a few persons such as the
members of a family only.
9. As to relationship to other corporations
A parent or holding corporation is one which has the power to directly or indirectly own more than 50% shares
of voting stock of another corporation and can elect the majority of the Board of Directors of such other
corporation which is called subsidiary corporation.
A subsidiary corporation is one which is so related to another corporation that a majority of its directors can be
elected directly or indirectly by other such corporation called parent corporation. The parent corporation
owns more than 50% shares of the subsidiary corporation.
An affiliated corporation is one which has a significant influence in another corporation owning at least 20% but
not more than 50% of its outstanding common stock, or by a long term lease of its properties or other control
device.
10. Other kinds of corporations
A wasting assets corporation is one the sole purpose of which is to invest its capital in a specific property and
afterwards to consume that property or extract it's value at a profit, such as mining a property and oil or gas
well.
A government owned or controlled corporation is one organized by the government or of which the
government is the majority stockholder, such as the Philippines Railways, National Power Corporation, Land
Bank of the Philippines, and National Development Corporation . The fact that the government happens to
be a stockholder of a corporation does not make it a public corporation.
A corporation by estoppel is one which is not really a corporation but which has represented itself to the public
as a real corporation and which cannot now be permitted to deny such representation.
A quasi-public corporation is a private corporation which has accepted from the state the grant of a franchise
or contract involving the performance of public duties such as Meralco, PLDT, LRT, MRT. The mere fact that
the undertaking of the corporation is one which the state itself might enter as part of its public works does
not make it a public corporation.
A quasi corporation is an association of government or political institution or officers which is not a corporation
in the full sense but which is invested by law with some of the attributes of a corporation, such as the
capacity to sue or be sued as a corporate body, to have corporate existence unaffected by death or disability
of members, or to make particular contracts or hold particular property or rights as a corporation, such as
the Board of Accountancy and the Board of Nursing.
Owners of a Corporation
1. The incorporators are stockholders or members mentioned in the Articles of Incorporation as originally
forming and composing the corporation and who are signatories thereof.
2. Corporators are the owners of a corporation whether as stockholders or members.
3. Stockholders or shareholders are corporators of a corporation which has capital stocks.
4. Members are corporators of a corporation which has no capital stock.

5. A subscriber is one who has agreed to buy shares of stock from the corporation under a
subscription agreement on the original issue of such stock. The stocks are not yet fully paid.
Other important persons related to the corporation
6. A promoter is one who alone or with others undertakes the wish of the incorporators to form a
corporation and to obtain for it the rights, instrumentalities, and capital by which it is to carry out the
purposes, set forth in its charter, and to establish it as fully able to do its business.
7. An underwriter is one who, under the agreement with the corporation, is responsible to
sell original corporate shares to the public, and in the event the public will not take them, the underwriter
will be the one to buy them.
Corporations in which Philippine Citizenship is Required
By provision of law , Filipino citizenship of a certain percentage of the capital stock or capital is
required in the following cases:
1. Public utilities should be at least 60% owned by Filipinos.

2. Corporation for development or exploitation of natural resources should be at least 60% owned
by Filipinos.
3. Corporation engaged in mass media should be wholly or 100% owned by Filipinos.
4. Educational institutions other than those established by religious orders, mission, boards
and charitable institutions, should be at least 60% owned by Filipinos.
5. Corporations engaged in coast wise shipping should be at least 60% owned by Filipinos.
6. Civil Aeronautics Corporation should be at least 60% owned by Filipinos.
7. Corporations engaged in retail trade should be wholly or 100% owned by Filipinos.
8. Corporations engaged in Cottage industry should be at least 75% owned by Filipinos.
9. Financing Companies should be at least 60% owned by Filipinos.
10. Pawnshops should be at least 70% owned by Filipinos.
11. Corporations engaged in the rice and corn industry should be wholly owned by Filipinos.
12. Security, watchman or detective agencies should be wholly owned by Filipinos.
13. Atomic energy corporation should be at least 60% owned by Filipinos.
14. Banking corporations should be at least 70% owned by Filipinos.
15. Rural Banks should be wholly or 100% owned by Filipinos.
16. For savings and loan associations, at least 70% of the voting stock should be owned by Filipinos.
The stockholders have four rights, namely:
1) the right to vote in an annual stockholders meeting;

2) the right to share in corporate profit;
3) the right to share in the distribution of asset upon corporate liquidation; and
4) the pre-emptive right or the right to purchase additional shares of stock in the event that the
corporation increases the amount of stock outstanding. This is to maintain the respective
percentage ownership of the stockholders in the company, unless denied in the Article of
Incorporation (Sec. 30).
Stock Certificate
An investor who purchases shares of stock and who pays his subscription in full is issued a document
known as a stock certificate. It is usually the practice to issue one certificate for every block of stock
purchased. The certificate contains the name of the investor, the number and type of shares
purchased, as well as the par value per share.
Corporation Law provides that "the capital stock of a stock corporation shall be divided into shares for
which certificates signed by the president or vice-president, countersigned by the secretary, and
sealed with the seal of the corporation shall be issued in accordance with the by-laws.
Classes of Shares of Stock
1. Common and Preferred Stock
Common stock as mentioned in the Philippine Corporation Code entitles the owner the power to
vote to elect a director in the Board and to a pro rata dividends, without any priority or preference
over any other stockholder. In accounting, the account title used to follow the International
Accounting Standard (IAS) is ordinary shares.
Preferred stock as mentioned in the Philippine Corporation Code is that class of stock which is
entitled to certain preferences over common stock such as over dividends and assets of the
corporation in case of liquidation. It maybe deprived of voting rights that should be stated in the
Articles of Incorporation. In accounting, the account title used to follow IAS is preference share.
The Philippine Corporation Code provides that "the shares of stock in corporations may be
divided into classes of series shares, or both, any of which classes of shares may have such
rights, privileges, or restrictions as may be stated in the articles of incorporation. To attract
investors, some corporations issue two types of shares, namely common and preferred.
Common shares entitle the owner to a pro-rata division of profits without any preference or
advantage over any class of stockholders. Preferred shares, on the other hand, entitle the owner
priority in the distribution of dividends as well as of assets of the corporation in case of
liquidation.
When we say preference over dividends, it means that although preferred shares are not
guaranteed to receive annual dividends, they are given priority over common shares, when
dividends are declared by the board of directors. Stocks which has preference as to dividends
may either be cumulative or non-cumulative and/or participating or non participating. There are
some classes of preferred shares on which payment of dividend is guaranteed and these are
called guaranteed shares.
In some cases, dividends are not declared for a certain period. This is known as a passed
dividend or dividend in arrears. If the preferred share is cumulative, it is entitled to passed
dividends or dividends in arrears. So, before dividends can be paid to common stockholders, the
corporation must first pay preferred shareholders for dividends pertaining to the previous year(s)
(dividend in arrears) that have not yet been paid as well as the current year's dividends . If the
preferred share , on the other hand, is non-cumulative, the corporation need not provide for
dividends that have passed. Thus, the stockholder is entitled only to the current year's dividends.
When a preferred share is participating, it may either be fully participating or participating to a

certain maximum rate or amount. If dividends are currently declared, the amount due to preferred
stockholders is first paid; then the dividends due to common stockholders, the remainder, if any,
will proportionately be shared peso for peso by preferred and common stockholders ( if
preference shares are fully participating).
Non-participating preferred share, as the name implies, does not ( after it has received its
preferred dividends) share in the remainder of the dividend with common shares. Computation of
dividends per share is discussed in a later chapter.
When a stock is preferred as to assets, it has upon liquidation, prior claim over common shares in
the distribution of corporate assets. Shares with preference as to assets may be issued only at
par.
2. Voting and Non-voting Stocks
A voting stock is a class of stock which entitles the holder to vote in the meeting of the
corporation. This is the common stocks or ordinary shares.
A non-voting stock is a class of stock which is not entitled to vote in the meeting of the
corporation. This is normally called the preferred stock or preference share. It is expressly stated
in the articles of incorporation that it has no voting right.
3. Par and No-par Value Stock
Par value stock is a class of stock with a par value appearing on the face of the certificate of
stock
Non-par value stock is a class of stock without any nominal or par value on the face of the stock
certificate.
Preferred stock is required by law to have par value. However, should the corporation issue
preferred no-par value stocks, such stocks should always have stated values as required by
law.
A par value stock has a nominal value stated in the stock certificate. It serves as the minimum
amount a stockholder must pay to obtain one share of stock on its original issue.
Where the value of the property or consideration received in exchange for shares given is less
than par value on its original sale, the stock is said to be watered. Sale of watered stock is illegal
in the Philippines.
Sale of Stock at a Discount
Under the Corporation Law, on its original sale, selling stock below par or at a discount is illegal.
The purchaser is held liable to the creditors of the corporation for the amount of the discount in
case of insolvency or dissolution of the corporation. Furthermore, "any director or officer of a
corporation consenting to the issuance of stock for a consideration less than its par shall be
solidarily liable with the stockholder concerned . "
4. Other classes
A formative stock is the starting minimum number of stocks to be subscribed as required by the
charter and not necessarily by the law.
An overissued or spurious stock is stock issued in excess of the authorized capital stock and
is therefore void.
A treasury stock is stock lawfully issued by the corporation and subsequently reacquired by it.
A watered stock is stock which has been issued by the corporation as fully paid up when in fact
it is not because it has been issued as bonus or otherwise, without any consideration at all, or for
less than par or for property, labor or services at an overvaluation.
A bonus stock is stock issued to persons who subscribe for bond of a corporation under the
condition that they shall receive an equal amount of ordinary shares therewith, and the money
paid on the subscription is payment for the bond alone.
A promotion stock is stock issued to those who, in the case of a mining company, may originally
own the mining ground or valuable rights connected therewith, in consideration of their deeding
the same to the mining company when the company is incorporated.
A founder's stock is stock issued to the founders or organizers of a corporation.
Shares in escrow are shares subject to an agreement under which the shares are deposited by
the grantor or his agent with a third person, to be delivered by the depository to the grantee
(buyer) or subscriber upon the happening of certain conditions. The issuance of share is subject
to suspensive condition. Title to the stock does not pass to the grantee until the conditions are
performed and delivered by the depository to the grantee. It does not retroact to the date of the
deposit of the stock.
Advantages and disadvantages of par value shares
The advantages of par value share are:
a) the convenience or ease of sale;

b) greater protection to the creditors, since the shares cannot be sold below par; and
c) shareholders and investors are secured of sale either at par or above par as well as
fair computation of dividends.
The disadvantages are:

a) the subscribers are liable for unpaid subscriptions or in case of default, refund of
what has been previously paid may not be made; and
b) misrepresentation of its stock value.
No Par Value Shares
A no par- value share has no normal value stated in the stock certificate. The corporation law
provides however, that no par stock may not be issued for an amount less that P5.00.
Callable or Redeemable Preferred Stock
Another type of stock is the callable or redeemable preferred stock. This share can be redeemed
by the corporation at a specified rate, which is usually higher than par value or original issue
price. This is at the option of the corporation.
Convertible Preferred Stock
Convertible preferred stock is another type of stock which can be changed or converted to
another class of stock (usually common stock), at a certain price within a specified period of time
at the option of the holder.
Who May Form a Corporation
1. Natural persons may form a corporation as provided by the law which states that, "any number of
persons not less than five (5) but not more than fifteen (15), all of legal age and majority of whom
are residents of the Philippines may form a private corporation. Each of them must own or be a
subscriber to at least one (1) share of the capital stock of the corporation."
2. Individuals may form a corporation.
3. Partnerships may form a corporation.
4. Corporations may form a majority owned corporation.

A domestic corporation, though an artificial person created by law, is still a person. A corporation
may be majority owned by another corporation. Thus, a holding corporation may form a 100%
owned subsidiary corporation. The Securities and Exchange Commission (SEC), allows big
corporations to be an incorporator of a wholly owned subsidiary corporation.
Holding Corporations or parent corporations such as the San Miguel Corporation, Ayala
Corporation, and SM Holding Corporation have incorporated many wholly owned and majority
owned or subsidiary corporation for their own interest.
Formation of a Domestic Corporation.
To form a corporation, the incorporators must file an application with the Securities and Exchange
Commission (SEC). (The SEC allows a corporation to be an incorporator of another corporation.)
Together with the application, they must submit their Articles of Incorporation duly notarized. A
temporary treasurer must execute an affidavit as to the amount of capital that has been subscribed
and paid. Once approved, and after the issuance of incorporation papers by the SEC, the
incorporators meet and elect the Board of Directors or Board of Trustees and pass the by-laws that
are to govern the affairs of the corporation. The Board of Directors or Board of Trustees later on
appoint a set of officers. These incorporators are also called stockholders for corporations that issue
shares of stocks to its owners and also called members for non-stock non-profit corporations. A
corporation may have more than 15 stockholders; thus, the corporation may sell shares of stocks to
as many persons as possible. At this point, the corporation’s activities may commence.
Articles of Incorporation
The articles of incorporation "enumerate the powers and restrictions conferred upon the corporation by the
government," and also constitute a contract among the incorporators. Section 14 of the Philippine Corporation
Code provides that "All corporations organized under this Code shall file with the Securities and Exchange
Commission articles of incorporation in any of the official languages duly signed and acknowledged by all of the
incorporators, containing substantially the following matters, except as otherwise prescribed by this Code or by
the special law:
1. The name of the corporation;

2. The specific purpose or purposes for which the corporation is being incorporated;
(Where a corporation has more than one stated purpose, the articles of incorporation shall state
which is the primary purpose and which is/are the secondary purpose or purposes: provided, that a
non-stock corporation may not include a purpose which would change or contradict its nature as
such.)
3. The place where the principal office of the corporation is to be located, which must be
within the Philippines;
4. The term for which the corporation is to exist;
5. The names, nationalities, and residences of the incorporators; (not less than 5)
6. The number of directors or trustees, which shall not be less than five (5) nor more than fifteen
(15);
7. The names, nationalities, and residences of the persons who shall act as directors or trustees
until the first regular directors or trustees are duly elected and qualified in accordance with this
Code;
8. If it be a stock corporation, the amount of its authorized capital stock in lawful money of the
Philippines, the number of shares into which it is divided, and in case the shares are par value
shares, the par value of each, the names, nationalities, and residences of the original
subscribers, and the amount subscribed and paid by each on his subscriptions, and if some or all
of the shares are without par value, such fact must be stated;
9. If it be a non-stock corporation, the amount of its capital, the names, nationalities, and residences
of the contributors and the amount contributed by each; and
10. Such other matters as are not inconsistent with law and which the incorporators may deem
necessary and convenient.
The Securities and Exchange Commission shall not accept the articles of incorporation of any stock
corporation unless accompanied by a sworn statement of the Treasurer elected by the subscribers showing that
at least twenty-five (25%) percent of the authorized capital stock of the corporation has been subscribed, and at
least twenty-five (25%) percent of the total subscription has been fully paid to him in actual cash and/or property
the fair valuation of which is equal to at least twenty-five (25%) percent of the said subscription, such paid-up
capital being not less than five thousand (P5,000) pesos.
Corporation law also states that "unless otherwise prescribed by special law, the articles of incorporation of all
domestic corporations shall comply substantially with the following form:
Example of an Article of Incorporation
_________________________________________________________________________________________
ARTICLES OF INCORPORATION
OF
_____________________________
Name of Corporation
KNOW ALL MEN BY THESE PRESENTS.
The undersigned incorporators, all of legal age and majority of whom are residents of the
Philippines, have this day voluntarily agreed to form a (stock) (non-stock) corporation under the laws of the
Republic of the Philippines.
And we hereby certify;
First: That the name of the corporation shall be"________________. Inc. or Corporation”;
Second: That the purpose or purposes for which such corporation is incorporated are: (if
there is more than one purpose, indicate primary and secondary purposes);
Third: That the principal office of the corporation is located in the City/Municipality of
_____________ Province of _______________Philippines;
Fourth: That the term for which the said corporation is to exist is _____ years from and
after the date of issuance of the certificate of incorporation;
Fifth: That the names, nationalities, and residences of the incorporators of the
Corporation are as follows:
Name Nationality Residence
----------------------- ------------- -------------------

----------------------- ------------- -------------------
----------------------- ------------- -------------------
----------------------- ------------- -------------------
----------------------- ------------- -------------------
Sixth. That the number of directors or trustees of the corporation shall be _______, and
the names, nationalities, and residences of the first directors or trustees of the corporation are as follows:
Name Nationality Residence
---------------------- ------------- ---------------------

---------------------- ------------- ---------------------
---------------------- ------------- ---------------------
---------------------- ------------- ---------------------
---------------------- ------------- ---------------------
Seventh. That the authorized capital stock of the corporation is ___________________

(P_______ pesos in lawful money of the Philippines, divided into ________ shares with the par value of
__________________ (P_______) pesos each, in lawful money of the Philippines.
(In case the shares are with par value and without par value)
That the capital stock of the corporation is _______ shares without par value. (In case some shares have par
value and some are without par value); That the capital stock of the said corporation consists of _________
shares of which _____________ share are of the par value of (P__________) pesos each, and of which
____________ shares are without par value.
Eighth. That at least twenty-five (25%) percent of the authorized capital stock above stated has been
subscribed as follows:
Name of Nationality No. of Shares Amount of

Subscriber Subscribed Subscription
----------------- ------------- ---------------------- --------------------

----------------- ------------- ---------------------- --------------------
----------------- ------------- ---------------------- --------------------
----------------- ------------- ---------------------- --------------------
----------------- ------------- ---------------------- --------------------
Ninth. That the above named subscribers have paid at least twenty-five (25%) percent of=
the total subscription as follows:
(Modify Nos. 8 and 9 if shares are with no par value. In case the corporation is non-stock, nos. 7, 8 and 9
of the above articles may be modified accordingly, and it is sufficient if the articles state the amount of capital or
money contributed or donated by specified persons, stating the name, nationalities and residences of the
contributors or donors and the respective amount given by each).
Tenth. That _______________has been elected by the subscribers as Treasurer of the

Corporation to act as such until his successor is duly elected and qualified in accordance with the by-laws, and
that as such Treasurer, he has been authorized to receive for/and in the names and for the benefits of the
corporation, all subscriptions (or fees) or contributions or donations paid or given by the subscribers or members.
Eleventh. (Corporations which will engage in any business or activity reserved for Filipino citizens shall
provide the following):
"No transfer of stock or interest which will reduce the ownership of Filipino
citizens to less than the required percentage of the capital stock as provided
by existing laws shall be allowed or permitted to be recorded in the proper
books of the corporation and the restriction shall be indicated in all the stock
certificates issued by the corporation."
Republic of the Philippines)

_____________________) S.S
In witness whereof, we have hereunto signed these Article of Incorporation, this

____day of _____________,20____, in the City/Municipality of ___________, Province of
___________________, Republic of the Philippines.
(Names and Signatures of the Incorporators)
Signed in the presence of:
__________________
__________________
__________________
__________________
__________________
(Notarial Acknowledgment)
TREASURER'S AFFIDAVIT
REPUBLIC OF THE PHILIPPINES)

CITY /MUNICIPALITY OF ------) S.S.
PROVINCE OF --------------------)
I,_______________________,being duly sworn, depose and say:
That I have been elected by the subscribers of the corporation as Treasurer thereof, to act as such until my
successor has been duly elected and qualified in accordance with the by-laws of the corporation, and that as
such Treasurer, I hereby certify under oath that at least twenty-five (25%) percent of the authorized capital
stock of the corporation has been subscribed and at least twenty-five (25%) percent of the total subscription
has been paid and received by me, in cash or property, in the amount of not less than five thousand
(P 5,000) pesos, in accordance with the Corporation Code.
----------------------------
(Signature of Treasurer)
Subscribed and sworn to before me, a Notary Public, for ___________________and in the City/Municipality
of _________________,Province of ______________,this ____ day of ____________20___ by
__________________with Residence Certificate No. ________ issued at ________________on
___________________20___.
NOTARY PUBLIC
My commission expires on
________________ 20____
_________________________________________________________________________________________
By Laws
The by-laws of the corporation supplement the articles of incorporation. The by-laws usually
govern the internal administration of the organization. Included in the by-laws are matters
such as
1. The date, place and manner by which annual stockholders meetings are to be
called;
2. The manner of conducting meetings;
3. The manner of voting and the use of proxies;
4. The manner of electing the board of directors;
5. The term of office of the directors;
6. The duties of the directors;
7. The procedures for amending the articles of incorporation; and
8. The procedures for amending the by-laws.
Authorized Capital Stock / Authorized Share Capital
The corporation law does not require a minimum authorized capital stock for a stock corporation,
except as specifically provided for by a special law. However, 25% of the total authorized capital
stock should be subscribed and 25% of the total subscriptions should be paid-up. And as stated
earlier, this total paid-up capital must not be less than P5,000.
The maximum number of shares that a corporation may issue as stated in its articles of incorporation
multiplied by par value is called the authorized capital stock. The firm may sell shares amounting to
less than the authorized capital stock but not more than such amount. The corporation may,
however, amend the articles of incorporation to increase/decrease authorized capital stock. But
because of the tedious process of amending the articles of incorporation, it is a usual practice to set
in the articles of incorporation a reasonable number of shares to be issued.
Illustrative Problem 1
On January 5, 2016, A, B. C, D and E formed a corporation named Alphabet Co. Inc. and filed with
the Securities and Exchange Commission its Article of Incorporation for approval. It has an authorized
capital of 10,000 ordinary shares with a par value of P 100 per share or a total of P1,000,000.
Question 1. How much is the authorized capital stock?
Answer.
The authorized capital stock is equivalent to the maximum number of shares as stated in the
articles of incorporation times the par value.
10,000 shares x P100 par = P1,000,000
Question 2. How much is the minimum amount to be subscribed by the incorporators as prescribed by
the SEC?
Answer.
The incorporators must subscribe to at least 25% of the authorized capital stock of P 1,000,000
amounting to P 250,000. But this amount need not be divided equally among the incorporators.
Question 3. How much of the subscribed amount must be paid up in cash or other property?
Answer.
At least 25% of the subscribed capital of P 250,000 must be paid up. The total paid up capital
should be a minimum of P62,500. This does not mean that each of the incorporators be required
to comply with the 25% paid up requirement. There is enough legal compliance as long as the
total paid up capital is equivalent to 25% of the total subscribed capital.
Illustrative Problem 2 – Shares of Stock in Series
Let us assume that the par value shares of a proposed corporation are divided into different
series:
Series A 50,000 shares with par value of P1.00/share P 50,000
Series B 50,000 shares with par value of P2.00/share 100,000
Series C 50,000 shares with par value of P3.00/share 150,000
Series D 50,000 shares with par value of P4.00/share 200,000
Series E 50,000 shares with par value of P5.00/share 250,000
Question 1. How much is the authorized capital stock?
Answer.
The authorized capital stock is equivalent to the maximum number of shares of each series as
stated in the articles of incorporation times the par value.
Series A 50,000 shares with par value of P1.00/share P 50,000

Series B 50,000 shares with par value of P2.00/share 100,000
Series C 50,000 shares with par value of P3.00/share 150,000
Series D 50,000 shares with par value of P4.00/share 200,000
Series E 50,000 shares with par value of P5.00/share 250,000
Total Authorized capital stock P750,000
Question 2. How much should the minimum subscriptions by the incorporators be?
Answer.
The incorporators must subscribe to at least 25% of P 750,000 or P 187,500. But this amount
need not be divided equally among the incorporators.
Question 3. How much of the subscribed amount must be paid in cash or other property?
Answer.
At least 25% of P 187,500 must be paid up. The total paid up capital should be P46,875. This
does not mean that each of the incorporators will be required to comply with the 25% paid up
requirement. There is enough legal compliance as long as the total paid up capital is equivalent
to 25% of the total subscribed capital.
Subscriptions and Subscribed Capital Stock
A subscription is an agreement to purchase shares of unissued stock. It may exist before

incorporation as a pre-corporation subscription or after incorporation. The common element is that
one who is known as a subscriber wishes to invest or become a stockholder of a corporation. The
subscriptions may be paid in full immediately or at a later date or in installments. It may be paid in
cash, property, or service.
When shares with par value are sold, the proceeds should be credited to share capital accounts to
the extent of the par value of the shares with any excess being reflected as share premium or
additional paid in capital ... if shares are issued for a consideration other than cash, the proceeds
should be measured by the fair value of the consideration received. When shares are issued for
services received, then the measure should be the value of such services.
At the time the subscription contract is entered into, Subscriptions Receivable is debited and the
account credited is Subscribed Share Capital . Upon collection from the subscriber, Cash is debited
and Subscriptions Receivable is credited. When a subscription is paid in full, the subscriber is issued
a certificate. The Corporation code states that "no certificate of stock shall be issued to a subscriber
until the full amount of his subscription has been paid, " such shares are then known as issued
capital stock or issued share capital.
Subscriptions which are not yet paid in full are known as subscribed capital stock. In accounting,
the account title is subscribed share capital.
Unpaid subscriptions, may, under the Corporation Code, vote in stockholders meetings
and shall be entitled to dividends, unless such shares are declared delinquent. Unpaid
subscriptions are considered as outstanding shares although not yet issued.
Issued and Outstanding Shares (Law vs. GAAP)
In accounting, a share of stock is issued when its stock certificate is already in the hand of the
stockholder. Issued shares of stock are always outstanding shares in accounting and in law.
However, in law, once a share has been subscribed for, it is already outstanding although its stock
certificate had not been issued. Therefore, for purposes of distribution of dividends, even if the
shares have not been fully paid, as long as it was subscribed and with an official subscription
agreement, it will get its share of the dividend.
In accounting, recording of journal entries is based on the date of subscription, date of payment, and
date of issuance of stock certificate. A share of stock becomes issued and outstanding only upon
issuance of a certificate which is an evidence as to full payment of the subscription price.
The law will prevail over accounting practices. Therefore, when computing for outstanding shares,
add the total shares issued and the total shares subscribed minus the number of treasury shares.
When a corporation purchases back its own issued shares of stock such share are called
treasury shares. In case of a treasury share, it is said to be issued but not outstanding. It is a
deduction in the number of outstanding shares and does not receive dividend. A treasury share is
also called treasury stock.
Legal Capital
For par value shares, legal capital is that amount equal to the aggregate of all issued and
subscribed par value shares times its par value.
For no-par value shares, legal capital is the aggregate of cash or fair value of non-cash assets
received as compensation for all issued no-par value shares.
Illustrative Problem 1 (One Type of Share Capital )
On January 5, 2016, A, B. C, D and E formed a corporation named Alphabet Co. Inc. and filed with
the Securities and Exchange Commission its Articles of Incorporation for approval. It has an
authorized capital of 10,000 ordinary shares with a par value of P 100 per share or a total of
P1,000,000.
On February 5, 2016, the Securities and Exchange Commission approved the Articles of
Incorporation showing the following information:
Authorized Share Capital, 10,000 shares, par P100 P1,000,000

Share Capital (issued 2,500 shares) @ par P100 250,000
Subscribed Share Capital (3,000 shares) @ par P100 300,000
Subscription Receivable 50,000
Premium on share capital (5,500 x P10) 55,000
Question 1. How much is the authorized share capital? Answer: P1,000,000 (given)
(10,000 shares x P100 par)
Question 2. How much is the issued share capital ? Answer: P250,000 (given)
(2,500 shares x P100 par)
Question 3. How many shares of stock have been issued? Answer: 2,500 shares (given)
If not given, it can be computed: P250,000 / P100 par = 2,500 shares
Question 4. How many shares of stock are still unissued? Answer: 7,500 shares.
Authorized share capital minus issued equals unissued.
Computation: 10,000 authorized shares – 2,500 issued shares = 7,500 shares

Question 5. How many shares are subscribed? Answer: 3,000 shares (given)
If not given, it can be computed: Subscribed share capital / par value = no. of shares subscribed
P300,000 / P100 par = 3,000 shares
Question 6. How many shares are outstanding? Answer: 5,500 shares
Outstanding shares includes all issued shares plus subscribed shares less treasury
shares. Therefore, all issued shares (2,500 shares) are outstanding and subscribed shares (3,000
shares) by law are also outstanding, there is no treasury share, so there are 5,500 shares
outstanding. (2,500 shares + 3,000 shares = 5,500 shares)
Question 7. How many shares are issued and outstanding? Answer: 5,500 shares
The answer is the same as no. 5 because subscribed shares are also considered as outstanding:
Issued shares + subscribed shares = outstanding shares

2,500 shares + 3,000 shares = 5,500 shares.
Question 8. How many shares are unissued and yet outstanding? Answer: 3,000 shares
Answer: The subscribed shares, 3,000 shares is unissued and yet outstanding. According
to the law even if the shares are not yet issued, as long as there is a valid subscription
agreement, the shares are outstanding. Only outstanding shares shall receive dividends
declared. Subscribed shares shall receive dividends together with those issued shares but
treasury shares do not receive dividends as they are not considered as outstanding shares.
Question 9. How much is the total paid up capital or contributed capital? Answer: P555,000
Contributed capital equals: issued share capital + subscribed share capital – subscription receivable +
share premium (The total amount received from shareholders of the corporation.)
Answer:
Share Capital (issued) P 250,000
+ Subscribed share capital P 300,000
Subscription receivable ( 50,000)
Partial payment 250,000
+ Share premium 55,000
Total Contributed Capital or paid up capital P 555,000
Take note: Paid up capital is also called contributed capital.
Question 10. How much is the premium per share on share capital issued and subscribed?
Answer: P10 per share
Answer.
Total share premium P55,000
Divided by total shares issued and subscribed 5,500
Equals: Share premium or additional paid in capital per share P 10
Question 11. How much is the total share premium on issued share capital ? Answer: P25,000
Answer. 2,500 issued shares x P10 = P25,000

Question 12. How much is the total share premium on subscribed share capital ? Answer: P30,000
Answer. 3,000 subscribed shares x P10 = P30,000
Question 13. How much is the contributed capital from subscribed share capital? Answer: P280,000
Answer
Subscribed share capital (3,000 shares @ P100) P 300,000
+ Premium of subscribed share capital:
P55,000 / 5,500 shares = P10 Premium per share
P10 x 3,000 shares subscribed = 30,000
Total collectible from subscriber P330,000
- Subscription receivable, end (50,000)
= Paid up capital collected from subscribed capital stock P 280,000
Question 14. How much is the average price per share of share capital and subscribed
share capital? Answer: P110 per share
Answer.
Share capital P 250,000
Subscribed share capital 300,000
Share Premium or Additional paid in capital 55,000
Total P 605,000
Divide by:
Total shares issued and subscribed 5,500 shares
Average price per share P 110/ share
15. Assuming that from January 1 to June 30, 2016, the corporation earned a net profit from
operation of P100,000. Also on June 30, 2016, the corporation reacquired 500 of its own
shares of stock for P60,000. No other equity transactions transpired during the six months
period.
a. How much is the total shareholders’ equity as of June 30, 2016? Answer: P595,000
Answer.
Issued Share Capital P250,000 (2,500 shares x P100)
Subscribed Share Capital P300,000 (3,000 shares x P100)
Subscription receivable ( 50,000) 250,000
Premium on share capital 55,000
Retained earnings (profit) 100,000
Treasury stock ( 60,000) (500 shares)
Total stockholders’ equity 595,000
b. How many shares are outstanding as of June 30, 2016? Answer: P5,000 shares
Answer.
Issued shares 2,500
Subscribed shares 3,000
Treasury shares ( 500)
Outstanding shares 5,000
c. How much is the legal capital as of June 30, 2016? Answer: P550,000
Answer:
Issued shares 2,500 x P100 par = P250,000
Subscribed shares 3,000 x P100 par = 300,000
Legal capital 550,000
Note: Legal capital is always at par value.
Additional Illustrative Problems
Problem 1. Minimum Paid Up Capital as Required by Law
XYZ Corporation was organized on January 2, 2016 with an authorized capital consisting of 100,000
ordinary shares @ P80 par value. The incorporators subscribed for 25,000 shares of the total authorized
ordinary shares at P105 and paid cash amounting to P656,250 upon subscription.
Multiple Choice:
Question1. How much must be paid up upon subscription to comply with the minimum requirement of
the Securities and Exchange Commission?
a. P656,250 b. P625,000 c. P652,000 d. P 500,000 e. P600,000 f. None of these
Answer: ( D ) 100,000 authorized ordinary shares X P80 X 25% X 25% = P500,000

As long as the paid up capital is not less than P500,000, they have complied with the
minimum requirement of the Securities and Exchange Commission.
Problem 2. Two Types of Shares of Stock
Mae Tagui Hyawat Corporation, maker of skin medical products, was organized on January 5, 2016 with
two types of shares of stocks, preferred and common. The authorized capital stock of preferred consist of
20,000 preferred shares with a par value of P 100 per share and the authorized capital stock of common
consist of 100,000 no par value common shares with stated value of P50.
On December 31, 2016, after one year of operation, made a profit of P100,000. The ledger of the
corporation included the following balances:
Capital Stock – Preferred shares (6,000 shares @ P100 par) 600,000
Capital Stock – Common shares (40,000 no-par shares @ P50 stated value) 2,000,000
Subscribed share capital – Common (10,000 no-par shares @ P50 stated value) 500,000
Subscription receivable - Common 250,000
Share Premium – Preferred 90,000
Share Premium – Common 300,000
Retained earnings 100,000
Additional information.
a. Two thousand shares of preferred were issued for brand new equipment with fair market
value of P220,000. The remaining preferred shares were issued for cash. There is no
subscription receivable for preference shares. All preference shares were issued in January,
2016
b. All common shares were issued for cash. There is subscription receivable for common shares.
Multiple Choice. Select the correct answer and indicate the letter on the blank.
Question 1. How much is the total authorized capital stock for preferred and common shares? ______
a. P2,000,000 b.P4,000,000 c. P5,000,000 d. P7,000,000 e. P10,000,000 f. None of these
Answer: ( D )
Preferred 20,000 shares x P100 = P2,000,000
Common 100,000 shares x P50 = 5,000,000
Total authorized capital stock P 7,000,000
Question 2. How much is the average premium per share of preferred shares? _____
a. P15.00 b. P13.00 c. P12.00 d. P10.00 e. P50.00 f. None of these
Answer: ( A ) P15.00
1st compute the Preferred shares: P600,000 / P100 par = 6,000 shares
The average premium per share - P90,000 / 6,000 shares = P15 per share
Note: It is important to know the average premium per share because the information is
necessary in the preparation of journal entries for the retirement of treasury shares and
redeemable preference shares. (See retirement of treasury shares.)
Question 3. How much is the average premium per share of common shares?
a. P7.50 b. P7.00 c. P6.50 d. P6.00 e.P5.50 f. None of these
ANSWER: (D) P6.00
1st compute the total issued and subscribed outstanding shares:

Issued, P2,000,000 / P50 par = 40,000 shares
Subscribed, P500,000 / P50 = 10,000 shares
Outstanding shares 50,000 shares
Average premium per share – P300,000 / 50,000 shares = P6 per share
Question 4. The number of preferred shares issued for cash is

a. 3,500 shares b. 4,000 shares c. 4,500 shares d. 5,000 shares e. 6,000 f. None of
these
Answer: ( B) 4,000 shares
Compute: The total quantity of preferred shares : P600,000 / P100 par = 6,000 shares
The total number of shares sold for equipment 2,000 shares
The rest is issued for cash 4,000 shares
Question 5. Average price per share of preferred shares issued for cash is
a. P110 b. P112 c. P150 d. P120 e. P117.50 f. None of these
Answer: ( E ) P117.50
The 6,000 preferred shares was sold for (P600,000 + P90,000) P690,000
The 2,000 preferred shares was sold for equipment 220,000

Therefore, the 4,000 preferred shares was sold for cash 470,000
Average price per share of preferred shares issued for cash – P470,000 / 4,000 shares = P117.50
Question 6. Number of shares of common shares issued for cash is (shares)

a. 60,000 b. 50,000 c. 30,000 d. 40,000 e. 20,000 f. None of these
Answer: ( B ) 50,000 shares
All common shares are issued for cash payment.
Issued common shares (P2,000,000 / P50 par) 40,000

Subscribed common shares (P500,000 / P50 par) 10,000
Total common shares issued for cash 50,000
Question 7. What is the average price per share of common shares?

a. P50 b. P52 c. P54 d. P56 e. P55. f. None of these
Answer: ( D ) P56
Capital stock – common P2,000,000

Subscribed share capital – common 500,000
Share premium – common 300,000
Total selling price of all common shares P2,800,000
Divided by total common shares (40,000 + 10,000) 50,000
Average price per share P 56.00
Problem 3 Two Types of Shares of Stock
The trial balance of Maixi Company, Inc. , a foreign corporation from England, as of December 31,2016
showed the following balances:
10% Preference stock, P15 par, authorized, 700,000 shares

Issued P3,150,000
Subscribed 2,250,000
Subscription receivable-preference 750,000
Ordinary stock, P25 stated value, authorized, 750,000 shares

Issued P11,250,000
Subscription receivable-ordinary 1,350,000
Additional paid in capital

Premium share – preference P 2,160,000
Premium share – ordinary 3,780,000
Take note: In England, common shares are called ordinary shares while preferred shares are called
preference shares.
Multiple Choice:
Question1. How much is the total authorized capital stock of preference shares?
a. P5,400,000 b. P11,250,000 c. P10,500,000 d. P10,750,000 e. P4,650,000 f. None of these
Answer: ( C ) P10,500,000 (700,000 shares x P15)
Question 2. How much is the total authorized capital stock of ordinary shares?
a. P17,500,000 b. P18,000,000 c. P18,500,000 d. P19,000,000 e. P18,750,000 f. None of
these
Answer: ( E ) P18,750,000
750,000 shares x P25 stated value = P18,750,000
Question 3. How many shares of ordinary stock is outstanding?

Answer: ( A ) P540,000 shares
Outstanding shares = Issued shares + subscribed shares – treasury shares
Issued = P11,250,000 / P25 par = 450,000 shares

+ Subscribed = 2,250,000 / P25 par = 90,000 shares
Total outstanding ordinary shares 540,000 shares
Question 4. How much is the total contributed capital coming from preference shares?
Answer: ( B ) P6,810,000
Contributed capital = share capital + subscribed share capital – subscription receivable + share
premium.
P3,150,000 + 2,250,000 – 750,000 + 2,160,000 = P6,810,000
Take note: Contributed capital is also called paid up capital.
Question 5. How much is the contributed capital coming from ordinary shares?
a. P12,150,000 b. P18,630,000 c. P16,030,000 d. P15,900,000 e.P15,930,000 f. None of
these
Answer : ( E ) P15,930,000
Contributed capital = share capital + subscribed share capital – subscription receivable + share
premium.
11,250,000 + 2,250,000 – 1,350,000 + 3,780,000 = 15,930,000
Question 6. The number of preference shares issued

Answers: ( E ) P210,000 shares

P3,150,000 / P15 par = 210,000 shares
Question 7. The number of ordinary shares issued

a. 540,000 b. 450,100 c. 440,000 d. 450,000 e. 455,000 f. None of
these
Answer: ( D ) 450,000 shares
P11,250,000 / P25 stated value = 450,000 shares
Question 8. The number of preference shares outstanding is (shares)

Answer: ( A ) 360,000 shares
Outstanding share = issued + subscribed - treasury shares

= 210,000 + 150,000 = 360,000 shares
Question 9. The average selling price of preference shares issued and subscribed is
a. P15 b. P17 c. P18.92 d. P20 e. P21 f. None of these
Answer: ( E ) P21 issued + subscribed + premium divided by number of shares

(P3,150,000 + 2,250,000 + 2,160,000 ) / 360,000 shares = P21.00
Question10. The average selling price of ordinary shares issued and subscribed is
a. P25 b. P30 c. P32 d. P35 e. P29.50 f. None of these
Answer: ( C ) P32 issued + subscribed + premium divided by number of shares
(11,250,000 + 2,250,000 + 3,780,000) / 540,000 shares = P32.00
The Officers of a Corporation
The officers of a corporation as provided for in the corporation law are:
1. Directors or Trustees in the Board of the corporation;

2. President;
3. Corporate Secretary;
4. Corporate Treasurer; and
5. others as stated in the by laws.
The corporate board of directors are elected by the stockholders of the corporation. The corporate
board of trustees are elected by members. Corporate officers such as the president, treasurer,
secretary, and others are appointed by the Board of Directors or Board of Trustees.
Important Qualifications of Corporate Officers
1. The President must be a director.

2. The treasurer may or may not be a director.
3. The secretary of the Board of Directors may or may not be a director but must be a
resident and citizen of the Philippines.

4. Any two or more positions may be held concurrently by the same person, except that no
one shall act as president and secretary or as president and treasurer at the same time.
Chapter 2 Exercises
I. Definitions
Define or explain the following:
1. Corporation. 11. Minute Book

2. Incorporator 12. Stock and Transfer Book
3. Corporator 13. Books of Accounts
4. Stockholder 14. Subscription Book
5. Board of Directors 15. Stockholder's Ledger
6. Board of Trustees 16. Par Value Shares
7. Subscriber 17. No Par Value Shares
8. Initial Public Offering 18. Voting Shares
9. Articles of Incorporation 19. Treasury Stock
10. By Laws 20. Convertible Stock
II. Enumeration
1. What are the four attributes of a corporation?

2. What are the advantages and disadvantages of a corporation?
3. What are the classification of corporation ?
a. According to issuance of capital stock
b. According to nationality
c. According to whether for charitable purpose or not
d. According to legal right to corporate existence
e. According to degree of public participation with regard to ownership
f. According to whether for public or private purpose
g. According to relation to other corporations.
4. What are the steps in the creation of a corporation?
5. What are the rights of a stockholder?
6. What are the two classes of shares in general?
7. What are articles of incorporation? State seven important provisions included in the articles
of incorporation.
8. In a private corporation, give at least seven rules of action that maybe provided for in it's BY
LAWS?
9. What are the qualifications necessary in order that one may be elected to the Board of
Directors?
10. How much is the minimum amount of initial capital stock to be subscribed and paid for?
Name:__________________________ Score: _____________

Room: __________________________ Date : _____________
True or False
Encircle letter T if the statement is correct, and the letter F if the statement is untrue.
T F 1.
A corporation may be an incorporator.
T F 2.
A partnership may be an incorporator.
T F 3.
A corporation may be a general partner in a partnership.
T F 4.
A corporation controlled by another corporation is called subsidiary corporation.
T F 5.
A corporation is created by operation of law. It can not come into existence by mere
agreement of the parties.
T F 6. Ordinary shares has a P100 par value always.
T F 7. Contributed capital or paid in capital has two major components-legal capital
and additional paid in capital.
T F 8. At the time of incorporation, at least 25% of the authorized capital stock must
be subscribed and at least 50% of the total subscribed capital stock should be paid.
T F 9. A public corporation is one formed for the government or a portion of the state.
T F 10. A partnership or a corporation may be an incorporator of another corporation.
T F 11. All private corporations issue shares of stock .
T F 12. The most powerful position in a corporation is the President.
T F 13. A corporation can be a limited partner in a partnership.
T F 14. No par value shares can be issued.
T F 15. A corporation can be a corporator but not an incorporator.
T F 16. All incorporators (if they continue to be stockholders) are corporators of a corporation.
T F 17. Each of the incorporators of a stock corporation must own or be a subscriber to at least
one (1) share.
T F 18. Incorporators can be artificial beings or juridical persons.
T F 19. The arbitrary value assigned to a share of stock is called par value or stated
value.
T F 20. The shares may have no par value but may have a stated value.
T F 21. A corporation has continuity of existence which permits the business to operate
for 50 years only.
T F 22. The president of a corporation must be a director of the corporation.
T F 23. A certificate of stock is a written acknowledgment by the corporation of an interest in the
corporation.
T F 24. Any individual stockholder of a corporation may personally be held for all obligations of
the corporation.
T F 25. The stockholders in a corporation elect the board of directors, who in turn appoint the
Chairman of the Board.
Name: __________________________ Score: _____________

Room: __________________________ Date : _____________
T F 1. The board of directors is responsible for the formulation and implementation of

corporate policies.
T F 2. All business transactions of the corporation are recorded in the books of accounts.
T F 3. Shares without par value may not be issued for a consideration less than P5.00 per
share.
T F 4. No-par value shares may not be issued without being fully paid.
T F 5. Preference shares of stock should only be issued as par value shares.
T F 6. Preference shares of stock may be issued with par or no-par value.
T F 7. The amount of the stockholders' investments is called authorized capital stock.
T F 8. All stockholders of a corporation elect the board of directors, who in turn appoint
the top executive of the corporation.
T F 9. The stockholders or members mentioned in the Articles of Incorporation are
called incorporators.
T F 10. Ordinary shares or common shares may be issued at a price lower than its par value.
T F 11. Death of a stockholder will not dissolve the corporation.
T F 12. Persons who compose the corporation, whether as stockholders or members, are
called corporators.
T F 13. The entire consideration received by the corporation for its no-par value shares
is called paid in capital.
T F 14. Eleemosynary corporations are those organized for public charity.
T F 15. When capital stock is sold for a price higher than par value, the excess amount
over par value is called share premium or additional paid in capital.
T F 16. A de jure corporation is a corporation existing in fact and in law.
T F 17. Shares of stock whether fully or partially paid, as long as there is a binding subscription
agreement shall be included in the outstanding capital stock.
T F 18. No-par value shares have a maximum stated value of P5,000 per share.
T F 19. A corporation is created by agreement of the stockholders.
T F 20. Ordinary shares has no par or stated value.
T F 21. At least twenty-five percent of authorized capital stock must be subscribed and
no more than twenty five percent of subscribed capital stock should be paid.
T F 22. A corporation can not be held liable for personal indebtedness of a stockholder,
even the stockholder can not be held liable for the indebtedness of the corporation.
T F 23. The owners of shares in a stock corporation are called members.
T F 24. The owners of share in a non-stock corporations are called non-stockholders.
T F 25. The liability of the stockholders for the payment of corporate debts is limited to his
investment in the corporation.
Name: __________________________ Score: _____________

Room: __________________________ Date : _____________
I. Matching Type
Complete each statement below in Column II by selecting one of the terms being referred to from
Column I. Write the letter on the blank.
Column I Column II
a. Authorized capital stock ___1. It is an artificial being created by operation of law, having
b. Subscription book the rights of succession and the powers, attributes and
c. Preferred stock properties expressly authorized by law or incident to its
existence.
d. Corporation Sole ___2. A class of capital stock which has a claim prior to ordinary
stockholders in terms of dividends and liquidation of assets.
e. Members
f. Watered stock ___3. It is composed of more than one member or stockholder.
g. Ecclesiastical corporation ___4. Issued by corporation which permits the stockholder at his
h. Corporators option and within a specified period, to exchange shares
currently held for ordinary share at a specified rate.
i. Outstanding capital stock
j. Corporation aggregate ___5. Is one created to secure the public worship of God.
k. Spurious Stock ___6. Stock issued by a corporation which may be retired at the
option of the corporation after a specified date at an amount
l. No par value shares above par value
m. Callable Preference shares ___7. Created for the purpose of charities, such as orphanage.
n. De jure corporation ___8. Stock which have been issued by the corporation as fully
paid up when in fact it is not because it has been issued as
o. Promotion stock bonus or without any consideration at all.
p. Convertible Preference share
q. Stockholders’ equity ___9. It is required by law to have par value.
r. Outstanding shares ___10. Stock issued to the organizers or founders of a corporation.
s. Founder’s stock ___11. Stocks issued in excess of authorized capital stock.
t. Corporation ___12. For par value shares it is that amount equal to the aggregate
of all issued and subscribed par value shares times its par value.
u. Share premium
v. Stock and transfer book ___13 Are the corporators of non-stock corporation.
w Treasury stock ___ 14. Is the maximum number of shares that a corporation may
issue as stated in the articles of incorporation multiplied by
x. Unissued shares par value
y Legal capital ___15. Is the book where the names of stockholders, their stock
z. Voting Stock acquisitions and disposals are recorded.
aa. Eleemosynary corporation ___16. Is the residual amount after the claims of the creditors are
bb. Contributed capital subtracted from total assets of the corporation.
cc. Retained earnings ___17. Is the total shares of stock at the hands of stockholders plus
total shares subscribed, whether fully or partially paid, as long
dd. By laws as there is a binding subscription agreement.
ee. Stockholders’ Ledger

ff. Bonus stock ___18. Is the account title used for the amount paid in excess of par
gg. Formative stock or stated value.
hh. Shares in escrow ___19. Is the amount of cash and property received by the
corporation from stockholders for the shares of stocks
ii. Promoter sold.
jj. Subscriber ___20. Is the number of shares of stock that remain unsold after
deducting the issued capital stock from the authorized capital
stock.
Name: __________________________ Score: _____________

Room: __________________________ Date : _____________
Multiple Choice One Type of Share of Stock
On June 1, 2009, five incorporators formed a corporation named Parisan Mo Co. Inc. and filed
with the Securities and Exchange Commission its Articles of Incorporation for approval. Its
has an authorized capital of 10,000 ordinary shares with a par value of P 200 per share.
On July 2, 2009, the Securities and Exchange Commission approved the Articles of Incorporation
showing the following information:
Authorized Share Capital, 10,000 shares, par P200 P2,000,000

Share Capital 500,000
Subscribed Share Capital 600,000
Subscription Receivable 100,000
Share premium or Additional paid in capital 110,000
Tasks:
Multiple Choice
Instruction: Indicate on the blank the letter of the correct answer.
___Q1. How much is the authorized share capital ?

___Q2. How much is the issued share capital ?

a. P1,000,000 b. P750,000 c. P500,000 d. P250,000 e. P2,000,000 f. None of these
___Q3. How many shares of stock have been issued? (shares)

___Q4. How many shares of stock are still unissued? (shares)

a. 10,000 b. P9,500 c. 7,500 d. 6,750 e. 8,000 f. None of these
___Q5. How many shares are subscribed?

___Q6. How many shares are outstanding?

a. 5,000 b. 5,500 c. P4,500 d. 5,000 e. 3,000 f. None of these
___Q7. How many shares are unissued and yet outstanding?

___Q8. How much is the total contributed capital or paid in capital?

___Q9. How much is the average premium per share of share capital issued and subscribed
combined?
a. P50 b. P55 c. P25 d. P30 e. P20 f. None of these
___Q11. How much is the total share premium of issued share capital ?
a. P50,000 b. P55,000 c. P25,000 d. P47,500 e. P30,000 f. None of these
___Q12. How much is the total share premium of subscribed share capital?
___Q13. How much is the contributed capital from subscribed share capital?
___Q14. How much is the average price per share of capital stock and subscribed share
capital ?
a. P200 b. P210 c. P220 d. P230 e. P250 f. None of these
Name:__________________________ Score: _____________

Room: _________________________ Date : _____________
Multiple Choice
Problem 1. Masipag Corporation was organized on January 2, 2016 with an authorized capital of
P1,000,000 consisting of 100,000 common shares @ P10 par value. The incorporators subscribed for
25% of the total authorized capital common shares at P12.
Q1. How much must be paid up upon subscription to comply with the minimum requirement of
the Securities and Exchange Commission?
a. P300,000 b. P250,000 c. P62,500 d. P75,000 e. None of these
Problem 2. Pampam Corporation, maker of beauty products, was organized on January 5, 2016 with
preferred authorized capital stock of P1,000,000 consisting of 10,000 preferred shares with a par value of
P 100 per share and common authorized capital stock of P10,000,000 consisting of 1,000,000 no par
value common shares with stated value of P10.
On December 31, 2016, after one year of operation, the ledger included the following balances:
Capital Stock - Preferred 250,000

Capital Stock - Common 3,000,000
Share Premium – Preferred 65,000
Share Premium – Common 150,000
Additional information.
a. One thousand shares of preferred were issued for brand new equipment with fair market
value of P120,000. The remaining preferred shares were issued for cash. All preferred
shares were issued in January, 2016
b. All common shares were issued for cash.
Q2. How much is the total authorized capital stock for preferred and common shares as of
12/31/16?
a. P1,000,000 b.P10,000,000 c. P11,000,000 d. P3,250,000 e. None of these
Q3. How much is the average premium per share of preferred shares as of 12/31/16?
a. P20 b. P24 c. P26 d. P30 e. None of these
Q4. How much is the average premium per share of common shares as of 12/31/16?
a. P10 b. P15 c. P5 d. P7.50 e. None of these
Q5. The number of preferred shares issued for cash is

a. 2,500 shares b. 2,000 shares c. 1,500 shares d. 1,000 shares e. None of these
Q6. Average price per share of preferred shares issued for cash is
Q7. Number of shares of common shares issued for cash is

a. 60,000 shares b. 50,000 shares c. 30,000 shares d. 40,000 shares e. None of these
Q8. The average price per share of ordinary shares issued for cash is
a. P100 b. P110 c. P105 d. P112.50 e. None of these
Q9. The total contributed capital is

a. P3,250,000 b. P3,150,000 c.P3,465,000 d. P3,585,000 e. None of these
Q10. The share premium of preferred shares arising from issuance in exchange for equipment is
Problem 3 The trial balance of Mahusay Company, Inc. as of December 31, 2016 showed the following
balances:
10% Preference share, P100 par, authorized, 80,000 shares

Issued P2,880,000
Subscription receivable-preference 720,000
Ordinary share, P20 stated value, authorized, 300,000 shares

Issued P2,720,000
Subscribed 560,000
Subscription receivable-ordinary 364,000
Additional paid in capital

Premium share – preference P 432,000
Premium share – ordinary 656,000
Q11. How much is the total authorized share capital of preference shares?
a. P5,040,000 b. P4,320,000 c. P8,000,000 d. P4,032,000 e. None of these
Q12. How much is the total authorized share capital of ordinary shares?
Q13. How many shares of ordinary stock is outstanding?

a. 136,000 b. 145,800 c. 164,000 d. 178,600 e. None of these
Q14. How much is the total contributed capital coming from preference shares?
Q15. How much is the contributed capital coming from ordinary shares?
Q16. The number of shares of stock preference shares issued is

Q17. The number of shares of stock of ordinary shares issued is

Q18. Number of shares of stock of preference shares subscribed is

Q19 Number of shares of stock of ordinary shares subscribed is

Q20. The average selling price of preference shares issued and subscribed combined is
Q21. The average selling price of ordinary shares issued and subscribed combined is
Chapter 3
Nature and Objectives of Financial Statements
Learning Objectives
1. Enumerate the basic components of a financial statement;

2. Illustrate who are the users of financial statements;
3. Explain the importance of financial statements understanding to management;
4. Explain who is responsible for the preparation of financial statements of an entity and why;
5. Enumerate and explain the various generally accepted accounting principles (GAAP) based
from the pronouncements of the Financial Reporting Standard Council; and
6. List down the various generally accepted account titles used in the income statement and
statement of financial position.
Financial Statements
The financial information being provided to users are called financial statements. These financial
statements are general purpose financial statement. General purpose financial statements are prepared
at least annually and are directed toward the common needs of a wide range of users who are not in the
position to demand reports tailored to meet their particular information need. General purpose financial
statements are prepared by all commercial, industrial, and business reporting entities, whether in the
public or private sectors. A reporting entity is an entity for which there are users who rely on the financial
statements as their major source of financial information about the entity.
Components of Financial Statements
According to PAS 1, Presentation of Financial Statement (revised 2007), paragraph 10, a complete set
of financial statements comprises:
1. a statement of financial position (balance sheet) as at the end of the period;

2. a statement of income for the period (income statement);
3. a statement of changes in equity for the period:
4. a statement of cash flows for the period ;
5. notes, comprising a summary of significant accounting policies, and other explanatory
information; and
6. a statement of financial position as at the beginning of the earliest comparative period when an
entity applies an accounting policy retrospectively or makes a retrospective restatement or items

in its financial statements or when it reclassifies items in its financial statements.
The Importance of Financial Statements Understanding to Management
Every businessman must know the full potential of his company and be thoroughly aware of the means
by which this potential can be realized before he can guide his organization to ultimate success. And no
manager can consider himself entirely informed about the position of his company, his competitors, or
his industry unless he understands financial statements and the information they contain. He cannot rely
upon general impressions of financial structure or vague notions of the competitive climate to provide
him with an adequate background for making the exact decisions which successful operations demand.
Precise financial knowledge is absolutely essential in making the right decisions, and this knowledge is
within the grasp of every manager who understands how to use the income statement, balance sheet,
cash flows statements and financial statements analysis.
The chief executive officer (CEO) or any corporate officers considered as among those belonging to the
top management echelon, need not be an accountant, an auditor, or a CPA. He can master fundamental
financial management skill and make major policy decision with assurance if:
1. He knows the meaning of each asset and liability account on his balance sheet and
and the meaning of each major item appearing on the income statement;
2. He is thoroughly familiar with the financial ratio analysis of his financial statements so that
he can accurately assess his company’s position and draw meaningful conclusions when
comparing the results of his company with those of its competitor and industry
The Objective of Financial Statements
The objective of financial statements is to provide information about the financial position, financial
performance, and cash flows of an entity that is useful to a wide range of users in making economic
decisions.
Financial statements prepared for this purpose meet the common needs of most users. However,
financial statements do not provide all the information that users may need to make economic decisions
since they largely portray the financial effects of past events and do not necessarily provide non-financial
information.
Financial statements also show the result of the stewardship of management, or the accountability of
management for the resources entrusted to it. Those users such as share holders, who wish to assess
the stewardship or accountability of management do so in order that they may make economic
decisions; these decisions may include, for example, whether to buy some more or hold or sell their
investment or whether to reappoint or replace the management.
To meet this objective, financial statements provide information about an entity’s:
a. assets;
b. liabilities;
c. equity;
d. income and expenses, including gains and losses;
e. changes in equity; and
f. cash flows.
How should financial statements be presented?
According to Philippine Accounting Standard No. 1 (PAS 1):

“Financial statements shall present fairly the financial position, financial performance and cash
flows of an entity. Fair presentation requires the faithful representation of the effects of transactions,
other events and conditions in accordance with definitions and recognition criteria for assets,
liabilities, income and expense set out in the Framework.
The application of the International Financial Reporting Standard (IFIRS), with additional disclosure
when necessary, is presumed to result in financial statements that achieve a fair presentation.”
Who is responsible for the preparation of an entities financial statements?
The management of an entity is primary responsible in the preparation and presentation of its financial
statements. The Board of Directors reviews and authorizes the financial statements for issuance to the
stockholders of the entity and to the public.
As required by the Securities and Exchange Commission and the Bureau of Internal Revenue, all
audited financial statements should include the Statement of Management Responsibility, which state
that the management of the company is primarily responsible for the preparation of the financial
statements being audited. (Show the students an example, see appendix.)
Generally Accepted Accounting Principles (GAAP)
Accounting evolve through time with the needs of society and because of this, accountants develop rules,
procedures, and conventions that become the generally accepted accounting principles. These GAAP is
the accounting standard being followed in the preparation of financial statements.
In the Philippines, the development of GAAP was initially formalized through the creation in 1981 of the
Accounting Standard Council (ACS). The accounting standards promulgated by ASC constitute the GAAP
in the Philippines.
From the start of the accounting profession up to 1995, the Philippines is developing its accounting
standard following the standard setting body in the USA, the Financial Accounting Standard Board
(FASB). But beginning 1996, the Philippines have started to develop new accounting standard or GAAP
based from another international organization based in London, the International Accounting Standard
Board (IASB). The pronouncements of IASB are called “International Financial Reporting Standard”
(IFRS). Today, there are professional accounting bodies from 115 countries, including the Philippines,
whose financial reporting and measurement standards are aligned with the International Accounting
Standard Board (IASB).
Republic Act 9298 otherwise known as the Accountancy Act of 2004 was passed and approved with the
objective of standardization and regulation of accounting education and practices in the Philippines.
Today, the Generally Accepted Accounting Principles (GAAP) includes those principles regarding the
recognition criteria for assets, liabilities, income and expense set out in the PAS ‘s Framework for the
Preparation and Presentation of Financial Statement.
The following are the various GAAPs as presented in the Framework for the preparation of
financial statements:
Underlying Assumptions of financial statements
1. Accrual Basis Principle (PAS 1, Framework, revised 2007, paragraph 22)

In order to meet their objectives, financial statements are prepared on accrual basis of accounting.
Accrual accounting refers to the recording of revenues of a company as these are earned and
expenses as these are incurred, even when no money has changed hands yet. Under this basis,
the effects of transactions and other events are recognized, when they occur (and not as cash or its
equivalents is received or paid) and they are recorded in the accounting records and reported in
the financial statements of the periods to which they relate.
2. Going Concern Principle (PAS 1, Framework , revised 2007, paragraph 23)

The financial statements are normally prepared on the assumption that an entity is a going concern
and will continue in operation for the foreseeable future in the absence of evidence to the contrary.
Hence, it is assumed that the entity has neither the intention nor the need to liquidate or curtail
materially the scale of its operations; if such intention or need exist, the financial statement may
have to be prepared on a different basis and, if so, the basis used is disclosed.
Qualitative Characteristics of financial statements
1. Separate Entity Principle

From the point of view of accounting, the enterprise is assumed to be a separate and distinct entity
from its owner. The assets and liabilities of the owner should not be mingled with the assets and
liabilities of the enterprise.
2. Monetary Unit Principle

To allow for aggregation and comparability, assets (economic resources) and liabilities (obligations)
should be measured in monetary terms. This principle also imposes the constraint that only
information which can be expressed in objectively in monetary terms should be presented in the
financial statements. All financial statements issued in the Philippines for shareholders and
investors should be in terms of Philippine peso; those issued in the United States of America,
should be in US dollars; and those issued in Japan, should be in Japanese Yen. Thus, a multi-
national corporation whose shares of stocks are traded in various stock markets in the world are
required to prepare financial statement in terms of local currency of the host country.
3. Cost Principle
The financial statements shall be prepared on the basis of historical cost, except when a Standard
or Interpretation permits, and do not take into account changing market prices and current cost of
non-current assets. Assets are recorded at the amount of cash or cash equivalents paid or the fair
value of the consideration given to acquire them at the time of their acquisition.
4. Materiality Principle (PAS 1, Framework, revised 2007, paragraph 29)

The relevance of information is affected by its nature and materiality. In the preparation of financial
statements, each material class of similar items shall be presented separately. Items of a dissimilar
nature or function shall be presented separately unless they are immaterial. An item in the financial
statements is material if its omission or misstatement could individually or collectively influence the
economic decisions of the users. Materiality depends on the size and nature of the omission or
misstatement judged in the surrounding circumstances. The size or nature of the item, or a
combination of both, could be the determining factor.
5. Reliability Principle (PAS 1, Framework, revised 2007, paragraph 31 to 36)

Information has the quality of reliability when it is free from material error and bias ( neutrality) and
can be depended upon by users to represent faithfully (faithful representation) that which it either
purport to represent or could reasonably be expected to represent. Information may be relevant but
so unreliable in nature or representation that its recognition may be potentially misleading to the
user. Included in reliability is completeness. To be reliable, the information in the financial
statement must be complete within the bounds of materiality and cost. All transactions in the
financial statement should be supported by business documents such as sales invoice, official
receipts, promissory notes and others. An omission can cause information to be false or
misleading and thus unreliable.
Neutrality Principle
This is one of the elements of reliability. To be reliable, the information contained in the financial
statements must be neutral, that is free from bias.
Faithful Representation Principle

This is one of the elements of reliability. To be reliable, the information must represent faithfully
the transactions and other events it either purports to represent or could reasonably be expected
to represent. Most financial information is subject to some risk of being less than a faithful
representation of that which it purports to portray.
Completeness Principle
This is an element of reliability. To be reliable, the information in the financial statements must be
complete within the bounds of materiality and cost. An omission can cause information to be false
and misleading and thus unreliable and deficient in terms of its relevance.
6. Comparability Principle (PAS 1, Framework, revised 2007, paragraph 39)

Users must be able to compare the financial statements of an entity through time in order to identify
trends in its financial position and performance. Users must be able to compare the financial
statements of different entities in order to evaluate their relative financial position, performance,
cash flows, and changes in equity. This is consistency in applying accounting policies year after
year for actual comparison of two or more years. Thus, included in the essence of comparability is
the quality of consistency of the application of accounting policies through time for true
comparability to occur. It means the presentation and classification of items in the financial
statements should be retained from one period to another. Except when a Standard or an
Interpretation permits or requires otherwise, comparative information shall be disclosed in respect
of the previous period for all amounts reported in the financial statements. Comparative information
shall be included for narrative and descriptive information when it is relevant to an understanding of
the current period’s financial statements.”
Also, financial statements should be prepared for this year and last year for easy comparison,
analysis and preparation of cash flows statement.
7. Matching Principle
Expenses are recognized in the period in which the related revenue was earned. The cost of
inventory sold, therefore, is charged from income in the period when the sale (revenue) was made.
Cost that are difficult to match with revenues earned during the period, or whose benefit in future
periods is uncertain or indeterminable, are immediately recognized as expense such as research
and development expenses. This is also called Matching cost against revenue principle.
8. Relevance Principle (PAS 1, Framework , revised 2007, paragraph 26)

To be useful, the information must be relevant to the decision-making needs of users. Information is
relevant when it influences the economic decisions of users by helping them evaluate past , present
or future events or confirming, or correcting, their past evaluations. The predictive and confirmatory
roles of information are interrelated.
9. Prudence (Conservatism) Principle

The preparers of financial statements have to contend with the uncertainties that inevitably
surround many events and circumstances, such as the collectivity of doubtful account receivables,
the probable useful life of plant and equipment and the number of warranty claims that may occur.
In this regard, the exercise of prudence or conservatism in the preparation of financial statements is
required. Prudence or conservatism is the inclusion of a degree of caution in the exercise of the
judgments needed in making the estimates required under conditions of uncertainty, such that
assets or income are not overstated and liabilities or expenses are not understated.
10. Understandability Principle (PAS 1, Framework, revised 2007, par. 25)

An essential quality of the information provided in financial statements is that it is readily
understandable by users. For this purpose, users are assumed to have a reasonable knowledge of
business and economic activities and accounting and a willingness to study the information with
reasonable diligence. The account titles used in the financial statements can easily be understood
even by a non-accountant who are willing to learn.
11. No Offsetting Principle

Assets and liabilities, and income and expenses, shall not be offset unless required or permitted by
a Standard or an Interpretation. A receivable and a payable to the same company should not be
offset and an income from a company and an expense to the same company should not be offset.
Measuring assets net of valuation allowance – for example, obsolescence allowance on
inventories, allowance for doubtful account for receivables – is not offsetting.
Constraints on Relevant and Reliable Information are:
1. Timeliness
Financial statements should be reported to users within a shortest period of time. If there is undue
delay in the reporting of information, it may lose its relevance to users. It may be necessary to
report the financial statements even before some immaterial transaction or other event are known,
2. Benefit and Cost Principle

The balance between benefit and cost is a pervasive constraint rather than a qualitative
characteristic. The benefits derived from information should exceed the cost of providing it.
Compliance with GAAP
An entity whose financial statements comply with generally accepted accounting principles shall make
an explicit and unreserved statement of such compliance in the notes to the financial statements.
Financial statements shall not be described as complying with GAAP unless they comply with the
Philippine Accounting Standard or all the requirements of each applicable Philippine Financial
Reporting Standard (PFRS).
Chapter 3
Review Exercises
1. Define accounting.
2. What are the components of financial statements?
3. Who are the users of financial statements?
4. What is the objective of financial statements?
5. How should financial statements be presented?
6. Who is responsible for the preparation of financial statements?
7. What is a generally accepted accounting principle (GAAP)?
8. Explain the following:
Going concern principle
Accrual basis principle
Comparability principle
Understandability principle
Relevance principle
Reliability principle
Prudence principle
Historical cost principle
No offsetting principle
9. Define the following:
Balance sheet
Income statement
Cash flow statement
Statement of Changes in Equity
Notes to Financial Statements
10. Explain and differentiate an income, a revenue, and a gain?
11. Explain an expense and classify it’s various classification.
12. What is a cash equivalent?
13. What are trading securities?
14. What is the purpose of notes to financial statements?
15. What is a cash flow statement?
Name: __________________________ Score: _________

Room: __________________________ Date: __________
True or False
Instruction: Indicate on the blank the word True, if the statement is correct and the word False, if the
statement is wrong.
______1. A reporting entity is an entity for which there are users who rely on the financial statement as
their major source of financial information about the entity.
______2. The chief executive officer (CEO) or any corporate officers considered as among those
belonging to the top management echelon, should be a former accountant, or an auditor, or a
finance officer to be effective because he know the meaning of each asset and liability on his
balance sheet.
______3. The chief accountant is the primary responsible in the preparation and presentation of the
financial statement of an entity.
______4. Accounting evolve through time with the needs of society and because of this, accountants
develop rules, procedures, and conventions that become the generally accepted accounting
principles.
______5. Cash accounting refers to the recording of revenues of a company as these are earned and
expenses as these are incurred, even when no money has changed hands yet.
______6. An item in the financial statements is material if its omission or misstatement could not
individually or collectively influence the economic decisions of the users.
______7. When an information is free from material error and bias, the principle is called neutrality.
______8. A one year reporting period that ends on a date other that December 31 is called a calendar
year.
______9. That accounting principle where the financial statements should be prepared on the basis of
historical cost is called accrual principle.
_____10. The certified public accountant (CPA) of an entity is primary responsible in the preparation
and presentation of its financial statements.
Name: __________________________ Score: _________

Room: __________________________ Date: __________
FILLING THE BLANK
Instruction: On the blank, indicate the missing word or phrase.
1. The financial information being provided by business entity to users are called
____________________.
2. __________________ are interested in information which enables them to assess the ability of the
entity to provide remuneration, retirement benefits and employment opportunities.
3. Precise ______________________ is absolutely essential in making the right decisions, and this
knowledge is within the grasp of every manager who understands how to use the income statement,
balance sheet, cash flows statements and financial statements analysis.
4 – 6. The objective of financial statements is to provide information about the

4) _____________________, 5)_______________________, and 6)________________ of an entity
that is useful to a wide range of users in making economic decisions.
7. The __________________ of an entity is primary responsible in the preparation and presentation of

its financial statements.
8. _______________________ refers to the recording of revenues of a company as these are earned

and expenses as these are incurred, even when no money has changed hands yet
9. An item in the financial statements is _______________ if its omission or misstatement could

individually or collectively influence the economic decisions of the users.
10. To be reliable, the information contained in the financial statements must be neutral, that is
_________________________.
11. ____________________________ is the inclusion of a degree of caution in the exercise of the

judgments needed in making the estimates required under conditions of uncertainty, such that assets
or income are not overstated and liabilities or expenses are not understated.
Problem 3-1
Multiple Choice: Indicate the letter of the correct answer on the ANSWER SHEET below:
ANSWER SHEET
1. _______ 6. _______
2. _______ 7. _______
3. _______ 8. _______
4. _______ 9. _______
5. _______ 10. ______
1. Suppliers and other trade creditors are interested in information

a. That enables them to determine whether amounts owing to them will be paid when due.
b. About the continuance of an entity, especially when they have a long-term involvement with or
are dependent on the entity.
c. In order to regulate the activities of the enterprise, determine taxation policies and as the basis
for national income and similar statistics.
d. About the stability and profitability of the entity.
e. None of the above
2. These users require financial information in order to regulate the activities of an enterprise, determine
taxation policies and as a basis for national income and similar statistics.
a. Lenders
b. Public
c. Investors
d. Government and their agencies
e. None of these
3. Investors and providers of capital

a. Have an interest in information about the continuance of an entity especially when they have a
long-term involvement with or are dependent on the entity.
b. That enables them to determine whether amounts owing to them will be paid when due.
c. In order to regulate the activities of the enterprise, determine taxation policies and as the basis
for national income and similar statistics.
d. About the stability and profitability of the entity.
e. Are concerned with the risk inherent in and return provided by their investments and need
information to help them determine whether they should buy or sell.
4. Which statement is incorrect concerning financial statements

a. Financial statements are prepared and presented at least annually and are directed toward the
common information needs of a wide range of users.
b. The objective of financial statements is to provide information about financial position,
performance, and cash flows of an enterprise that is useful to a wide range of users in making
economic decisions.
c. Financial statements also show the results of the stewardship of management and the
accountability of management for the resources entrusted to it.
d. The external auditor of an enterprise has the primary responsibility for the preparation of the
financial statements of such enterprise.
e. None of these
5. Information about the performance of an entity is required in order to assess potential changes in the
economic resources that is likely to control in the future. This information is primarily provided in the
a. Cash flow statement
b. Statement of retained earnings
c. Statement of financial position or balance sheet
d. Income statement
e. Statement of changes in equity
f. None of these
6. An essential quality of the information provided in the financial statements is that it is readily
understandable by users. For this purpose, users are:
I. Assumed to have a reasonable knowledge of business and economic activities and

accounting and a willingness to study the information with reasonable diligence.
II. Informed of the accounting policies employed, any changes in those policies and the effects of
such changes.
a. I only
b. II only
c. both I and II
d. Neither I nor II
7. Information has the quality of relevance
I. When it influences the economic decision of users by helping them evaluate past,
present and future events or confirming or correcting their past evaluations.
II. When it is free from material error and bias and can be depended upon by users to represent
faithfully that which it purports to represent or could reasonably be expected to represent.
a. I only
b. II only
c. both I and II
d. Neither I nor II
8. The information contained in the financial statements is neutral when the information
a. Is free from bias and error
b. Is complete within the bounds of materiality and cost
c. Reflects the economic substance of the transactions rather than their mere legal form
d. Represents faithfully the transactions and other events that it purports to represent.
e. None of these
9. Which is incorrect concerning comparability of financial statements?

a. Users must be able to compare the financial statements of an enterprise through time in order to
identify trends in its financial position and performance.
b. Users must be able to compare the financial statements of different enterprise in order to
evaluate their relative financial position, performance and cash flows.
c. It is appropriate for an enterprise to leave its accounting policies unchanged when more relevant
and reliable alternatives exist.
d. It is important that financial statements show information for the preceding period because users
wish to compare financial position, performance and cash flows of an enterprise over time.
e. None of these
10. The following statements relate to the constraints on relevant and reliable information. Which
statement is incorrect?
a. The benefits derived from the information should exceed the cost of providing it.
b. In achieving the balance between relevance and reliability, the overriding consideration is how
best to satisfy the economic decision making needs of users.
c. If there is undue delay in the reporting of information, it may lose its relevance and reliability.
d. To provide information on a timely basis, it may often be necessary to report before all aspects of
a transaction or other event are known, thus impairing reliability.
Name: _______________________ Score: _____________

Room: _______________________ Date : _____________
Problem 3-2 Multiple choice (ACP)
Encircle the letter of the correct answer.
1. Which accounting process is the assigning of peso amounts to the accountable economic
transactions and events?
a. Identifying
b. Communicating
c. Summarizing
d. Measuring
2. Casualty loss from an earthquake is
a. Not recognized
b. External transaction
c. Deferred loss
d. Internal transaction
3. The basic purpose of accounting is
a. To provide the information that the managers of an economic entity need to

control its operations.
b. To provide information that the creditors of an economic entity can use in
deciding whether to make additional loans to the entity.
c. To measure the periodic income of the economic entity.
d. To provide quantitative financial information about a business enterprise that
is useful in making rational economic decision.
4. They encompass the conventions, rules, and procedures necessary to define what is accepted
accounting practice.
a. Generally accepted accounting principles x

b. Accounting assumptions
c. Qualitative characteristics
d. Recognition principles
5. It is the new accounting standard setting body created by PRC upon the recommendation of the
Board of Accountancy in compliance with R.A. No. 9298.
a. Financial Reporting Standards Council x

b. Financial Reporting Standards Board

c. Auditing and Assurance Standards Council
d. Philippine Accounting Standards Board
Name: _______________________ Score: _____________

Room: _______________________ Date : _____________
Indicate the letter of the correct answer on the ANSWER SHEET below:
ANSWER SHEET
1. _______ 6. _______
2. _______ 7. _______
3. _______ 8. _______
4. _______ 9. _______
5. _______ 10. ______
1. These are also known as postulates.
a. Accounting concepts
b. Accounting standard
c. Accounting principles x
d. Accounting assumptions
2. Determination of periodic income and financial position depends on the measurement of

economic resources and obligation and changes in them as the changes occur rather
simply on recording receipts and payments of money.
a. Entity
b. Going concern
c. Time period
d. Accrual
3. Which of the following statements is incorrect?
a. The accrual method, which builds directly on the revenue and matching principles, ignores the
timing of cash receipts or payments in determining when to recognize revenue or expenses.
b. Expenses are matched with revenues, not the reverse.
c. In accordance with the unit of money assumption, accounting normally revise the amounts to
reflect the changing purchasing power of money due to inflation or deflation.
d. In accordance with the going concern assumption, the life of business is presumed to be
indefinite.
4. If a business is not being sold or closed, the amounts reported in the accounts for assets used in the
business operations are based on the cost of the assets. This practice is justified by
a. Continuity assumption
b. Monetary unit
c. Full disclosure principle
d. Accounting entity
5. A proprietor is the sole owner and manager of Clean Laundry Service. The proprietor purchased a
car for Personal use. The proprietor uses a van in the business.
Which of the following is violated if the proprietor recorded the cost of the car as an asset of the
business?
a. Accounting entity
b. Going concern assumption
c. Full disclosure
d. Time period
6. What is the traditional accounting period?
a. Three months
b. Six months
c. Two years
d. Twelve months
7. Which underlying concepts serves as the basis for Preparing financial statements at regular
intervals?
a. Time period
b. Going concern
c. Accounting entity
d. Stable monetary unit
8. The accounting function is to account for nominal pesos only and not for changes in purchasing
power.
a. Accrual
b. Constant peso
c. Separate entity
d. Unit of measure
9. The relatively stable economic political and social environment supports.
a. Conservatism
b. Materiality
c. Timeliness
d. Going concern
10. Liquidity is defined as the
a. Ability of the entity to pay currently maturing obligations.

b. Ability of the entity to meet obligation over a longer term
c. Invested capital of the entity
d. Borrowed capital of the entity
11) The business entity principle:

a) Assumes that the business and owner of the business are one person.
b) Assumes that the business and the owner are separate and distinct persons.
c) Assumes that the business enterprise is principally organized for the purpose of making profit.
d) Applies only to partnerships and corporations, but not to single proprietorships.
12) Public accounting, as a sub-discipline of accounting, includes:

a) Management accounting. c) Internal auditing
b) Managerial advisory services. d) Cost accounting
13) Private accounting as a sub-discipline of accounting includes:

a) Managerial accounting c) Managerial advisory services
b) External auditing d) Tax consultancy
Name: _______________________ Score: _____________

Room: _______________________ Date : _____________
Indicate the letter of the item being defined or described on the ANSWER SHEET below.
ANSWER SHEET
1. _______ 6. _______
2. _______ 7. _______
3. _______ 8. _______
4. _______ 9. _______
5. _______ 10. ______
A. Understandability F. Neutrality
B. Relevance G Conservation
C. Reliability H. Completeness
D. Comparability I Faithful representation
E. Substance over form J. Materiality
___1. It is the degree of confidence users place upon the truthfulness of the representations in
the financial statements.
___2. Information that has no bearing on an economic decision to be made is useless.
___3. It is the ability to bring together for the purpose of noting points of likeness and difference.
___4. It requires that users have some knowledge of the complex economic activities of
enterprises, the accounting process and the technical terminology in the statements.
___5. Prepares of statements should not try to increase the Usefulness of the information to a
few users to the detriment of others who may have opposing interests.
___6. In case of conflict between economic substance and legal Form of a transaction, the
economic substance shall prevail.
___7. Small expenditures for tools are expensed immediately.
___8. Historically, managers and accountants have generally preferred that possible errors in
measurements be in the direction of understatement of net income and net assets.
___9. The information should be p[resented in a manner that facilitates understanding and
avoids erroneous implication.
___10. The information must represent faithfully the transactions and events it either purports to
represent or could reasonably be expected to represent.
Indicate the letter of the item being defined or described on the ANSWER SHEET below.
ANSWER SHEET
1. _______ 6. _______
2. _______ 7. _______
3. _______ 8. _______
4. _______ 9. _______
5. _______ 10. ______
A. Accrual F. Prudence
B. Going concern G. Reliability
C. Separate entity H. Asset recognition principle
D. Monetary unit I. Income recognition principle
E. Comparability J. Expense recognition principle
Definition or description
___1. The same accounting methods should be used by an entity from period to period or from
industry to industry.
___2. The use of money as a measurement basis to record and report economic activity.
___3. An inappropriate assumption for an entity undergoing bankruptcy.
___4. Business activity is separated from the owner’s personal activity
___5. Data can be corroborated by reference to source documents, physical count, and
measurement by several qualified measures.
___6. Future economic benefits must be probable and the cost of the asset can be measured
reliably.
___7. The inflow of economic benefits has occurred and can be measured reliably.
___8. Discouragement of over optimism in recording assets and income.
___9. The basis for determining when expenses should be recorded.
___10. The matching principle and the revenue principle are the necessary consequence of the
concept.
Chapter 4
Income Statement and Statement of Financial Position
Learning Objectives
1. Explain the various generally accepted account for income statement;

2. Explain the various generally accepted accounts for statement of financial position;
3. Correctly classify of all generally accepted account for income statement and statement of
financial position;
4. Differentiate the function of expense method from the nature of expense method of presenting
the income statement;
5. Correctly prepare the cost of sales for a merchandising and manufacturing concern;
6. Prepare properly the income statement for a merchandising and manufacturing concern using
the revised SFAS Bulletin No. 1 which is based on International Accounting Standard that
recommends that income statement be presented at the minimum using line items with
supporting notes for the details.
7. Prepare properly the statement of financial position or balance sheet using the revised SFAS
Bulletin No. 1, which is based on International Accounting Standard that recommends that
statement of financial position be presented at the minimum using line items with supporting
notes for the details.
Philippine Accounting Standard (PAS) 1
PAS 1 is effective for annual financial statement periods beginning on or after January 1, 2005.
Income Statement
Income statement is that financial statement that shows the financial performance of the entity during
a given period of time, usually a year. The financial performance is also called the result of operation
during a given period of time. Income statement measures the profitability of the entity considering its
resources. Sometimes it is also called Profit and Loss statement.
Income
The conceptual framework defines income as an increase in economic benefit during the accounting
period in the form of inflows or enhancements of assets or decreases of liabilities that result in increases
of equity, other than those relating to contributions from equity participants. According to PAS 1,
paragraph 74 to 77, the term income includes revenues and gains. Revenue arises in the course of
the ordinary activities of an entity that include sales of products, professional fees, service income,
interest income, dividend income, royalty income and rent income. Gains represent other items that
meet the definition of income and may, or may not, arise in the course of ordinary activities of the
enterprise. Gains represent increases in economic benefits and as such are no different in nature from
revenue. Gains are incidental income from peripheral transaction of the entity. Gains include, for
example, those arising on the disposal of non-current assets, those unrealized gains arising on the
revaluation of marketable securities and those resulting from increases in the carrying amount of long
term assets. It is normally reported as other income .
Expense
Expense is the opposite of income. The conceptual framework defines expense as a decrease in
economic benefit during the accounting period in the form of outflow or depletion of assets or incident of
liabilities that result in the decrease of equity, other than those relating to distributions to equity
participants. According to PAS 1, paragraph 78 to 80, the definition of expenses encompasses losses
as well as those expenses that arise in the course of the ordinary activities of the entity. Expenses that
arise in the course of ordinary activities of the entity include, for example, cost of sales, wages and
depreciation. They usually take the form of an outflow or depletion of assets such as cash and cash
equivalents, inventory, property, plant and equipment. Losses represent other items that meet the
definition of expenses and may, or may not, arise in the course of the ordinary activities of the entity.
Losses include, for example, those resulting from disasters such as fire, flood, as well as those arising
on disposal of non-current assets. It also includes unrealized losses arising from the effects of increases
in the rate of exchange for a foreign currency in respect of the borrowings of an entity in that currency.
When losses are recognized in the income statement, they are usually displayed separately because
knowledge of them is useful for the purpose of making economic decisions. Losses are often reported
net of related income, for example, fire losses are reported net of proceeds from insurance company.
Losses are usually reported as other expenses.
Classification of expenses includes the following:
1. Cost of goods sold or cost of sales

Cost of goods sold is the value of goods sold to customers. The accounts required to compute the
cost of goods sold are purchases, purchase discounts, purchase returns and allowances, freight in,
the cost of merchandise inventory at the beginning of the period and the cost of merchandise at the
end of the period for merchandising entity. For manufacturing entity, the formula to compute the
cost of goods sold: cost of goods manufactured plus finished goods at the beginning of the period
minus finished goods at the end of the period equals cost of goods sold.
2. Selling or distribution expenses

Selling expenses are expenses related to selling and marketing activities of products and services,
such as advertising and promotion and delivery of products to customers. Selling expenses, for
example, include expenses of a store such as store supplies expense, sales lady’s salary, store
rent expense, store utility expense, and depreciation expense of store furniture, equipment, delivery
vehicles and all depreciable assets in the store.
3. Administrative or general expenses

Administrative expenses are expenses of managing the business. These are office expenses
such as office salaries and wages, office employees fringe benefits, office supplies, office rent
expense, taxes and licenses (excluding income tax), bad debts expense, professional fees
expense, transportation expense, depreciation expense of office building, office furniture and
equipment, and amortization of intangibles.
4. Other expenses
Other expenses are expenses or losses from peripheral or incidental transaction of the entity such
as loss on sale of investments, property, plant and equipment, loss due to flood, loss due to fire,
loss on foreign exchange, loss on revaluation of trading securities, loss from expropriation and
others of the same nature.
5. Financing cost or Financing expenses

Financing costs are the expenses incurred for borrowing to finance the operation of the business
such as interest expense from a bank loan, interest expense from bonds payable and others.
6. Income tax expense

The income tax expense is equal to the accounting income subject to tax times the tax rate. The
accounting income is the net income before deducting the income tax expense as declared in the
income statement using the generally accepted accounting principles as enumerated in the
Philippine Accounting Standard (PAS) 1. The Income tax payable as stated in the liability section
is equal to the taxable income times the tax rate. Sometimes the income tax expense is not equal
to the income tax payable.
Capital Maintenance Adjustments
PAS 1, paragraph 81 states that, the revaluation or restatement of assets and liabilities gives rise to
increases or decreases in equity. While these increases or decreases meet the definition of income and
expenses, they are not included in the income statement under certain concept of capital
maintenance. Instead these items are included in equity as capital maintenance adjustment or
revaluation reserves. For example, the revaluation increment of land and the unrealized income (losses)
from revaluation of long term investments.
Methods of Income Statement Presentation
PAS 1 states that an entity shall present on the face of the income statement an analysis of expenses
using classification based on either the function of expenses or the nature of expenses whichever
provides information that is reliable and more relevant.
Function of Expense Method or Cost of Sales Method
The function of expense method is the most commonly used form of income statement, because it is
more reliable and more relevant. It is also called the cost of sales method. It classifies expenses as to
function such as cost of goods sold, selling expenses, administrative expenses, financing cost, and other
income and other expenses. To the Filipinos, this is the common form that they are used to and
therefore easily understood, thus will give more relevant information to them.
Pro-forma Income Statement
The revised SFAS Bulletin No. 1 is based on International Accounting Standard that recommends the
use of income statement presented at the minimum using line items with supporting notes for the details
is shown below.
An example Income Statement for a Corporation using the Function of Expense Method or Cost of
Sales Method with notes is shown below:
X Corporation
Income Statement
For the Year Ended December 31, 2020

Note
Income:
Sales or Service income 1 1,000,000
Cost of Sale 2 ( 600,000)
Gross Profit 400,000
Other Income 3 90,000
Total Income P 490,000
Less: Operating Expenses:

Selling or Distribution Expenses 4 ( 170,000)
Administrative Expenses 5 ( 167,000)
Other Expenses 6 ( 15,000)
Total operating expenses (352,000)
Net Operating Income or Earnings before Interest and Taxes (EBIT) 138,000
Less: Financing Costs/ Interest expense 7 ( 16,000)
Net Profit before Income Tax and non-recurring items 122,000
Income Tax Expense ( 36,600)
Net Profit (Loss) for the Period P 85,400
Note 1 Net Sales

Sales 1,100,000
Sales discount ( 20,000)
Sales returns and allowances ( 80,000)
Net Sales 1,000,000
Note 2 Cost of Sales for a Merchandising Entity
Purchases 650,000
Purchase returns and allowances ( 40,000)
Purchase discounts ( 15,000)
Net purchases 595,000
Freight In 15,000
Net cost of purchases 610,000
Merchandise inventory, Jan. 1 60,000
Total cost of goods available for sale 670,000
Merchandise inventory, December 31 ( 70,000)
Cost of sales or cost of goods sold P 600,000
Note 2 Cost of Sales for a Manufacturing Company
First, compute the Cost of Goods Manufactured
Cost of materials:
Material purchases 396,000
Freight In 2,000
Net cost of material purchases 380,000
Material inventory, Jan. 1 30,000
Total cost material available for use 410,000
Material inventory, December 31 ( 10,000)

Material cost used in production 400,000
Direct labor 150,000
Factory Overhead or Manufacturing Overhead 70,000
Total Factory Cost or Manufacturing Cost 620,000

Add: Work in Process, beginning 10,000
Total Cost Put in Process 630,000
Less: Work in Process, end ( 20,000)
Cost of Goods Manufactured 610,000
Then Compute the Cost of Sales / Cost of Goods Sold

Finished goods inventory, beginning 60,000
Add: Cost of Goods Manufactured (see above) 610,000
Total Cost of Goods Available for Sale 670,000
Less: Finished goods inventory, end ( 70,000)
Cost of Sales P 600,000
Note 3: Other Income

Interest income 10,000
Rent income 60,000
Commission income 3,000
Dividend income 15,000
Gain on sale of equipment 2,000
Total other income 90,000
Note 4: Selling and Distribution Expense

Salesmen commission expense 20,000
Sales salaries and wages 50,000
Advertising and promotion expense 30,000
Freight out 10,000
Rent expense – store 30,000
Depreciation expense – store furniture & equipment 5,000
Utilities expense - store 12,000
Fuel and oil for delivery equipment 8,000
Repair and maintenance delivery equipment 2,000
Insurance expense – store 3,000
Total selling and distribution expense 170,000
Note 5: Administrative Expense

Office salaries and wages 70,000
Office supplies expense 2,000
Bad debts expense 1,000
Rent expense – office 30,000
Insurance expense – office 3,000
Depreciation expense – office furniture & equipment 15,000
Taxes and licenses 10,000
Transportation expense – office 2,000
Office light, water and communication expense 3,000
Employees fringe benefits 5,000
SSS employer’s contribution 7,000
Pag-ibig employer’s contribution 2,000
Phil-health employer’s contribution 2,000
13th month pay 12,000

Miscellaneous expenses 3,000
Total administrative expense 167,000
Note 6: Other expenses

Loss due to fire 6,000
Loss due to flood 1,000
Loss due to theft and robbery 5,000
Loss on sale of equipment 3,000
Total other expenses 15,000
Note 7: Financing cost or Financing Expenses

Interest expense on bank loan 8,000
Interest expense on promissory note 2,000
Interest expense on mortgage payable 6,000
Total financing cost 16,000
Nature of Expense Method
Take Note: We will not discuss this type of presentation because it is not used in the Philippines.
The pro-forma Income Statement of a Corporation using the Nature of Expense Method is shown
below: (Not used in the Philippines.)
X Corporation
Income Statement
For the Year Ended December 31, 2020
Note
Revenue 1 xxx
Other Income 2 xx
Changes in inventories of finished goods and work in process 3 ( xx)
Work performed by the entity and capitalized 4 x
Raw materials and consumables used 5 ( xx)
Employee benefits expense 6 ( xx)
Depreciation and amortization expense 7 ( xx)
Impairment of property, plant and equipment 8 ( xx)
Other expenses 9 ( xx)
Finance costs 10 ( xx)
Net profit before Income Tax xx
Income Tax Expense ( xx)
Net Profit (Loss) for the Period xx
Statement of Financial Position (Balance Sheet)
The Statement of Financial Position, commonly known as the balance sheet, is that financial statement
that shows the financial position and condition of an entity as of a particular date. It shows the three
elements of balance sheet: assets, liabilities, and equity and with proper analysis, it will show the
company’s ability to pay current and long-term obligations as well as the management’s efficiency in
using the company’s resources.
The three elements of financial position: assets, liabilities and equity are explained below:
1. Assets.
Assets are economic resources owned by the entity as a result of past transactions and events from
which future economic benefits are expected to flow to the entity.
Assets are classified into current and non-current.
Current assets are assets that satisfies the following criteria:

1.1 it is expected to be realized in cash (receivables) within, or is intended for sale (inventories) or
consumption (supplies) within the entities normal operating cycle or one year whichever is longer;
(receivables ,prepaid expenses, supplies, inventories, investments)
1.2 it is held primarily for the purpose of being traded; (inventories)
1.3 it is expected to be realized (receivables) within twelve months after the balance sheet date or
within its normal operating cycle and finally
1.4 it is cash or a cash equivalent (as defined in the Cash Flow Statements) unless it is restricted
from being exchanged or used to settle a liability for at least twelve months after the balance sheet
date and therefore should be classified as non-current asset.
Normal operating cycle of an entity is the time between the acquisition of inventories for
processing and their realization in cash or cash equivalents. When the entity’s normal operating
cycle is not clearly identifiable, its duration is assumed to be twelve months.
Current assets are also called liquid assets, and presented in the statement of financial position
(balance sheet) in the order of liquidity or nearness to cash.
Under a merchandising and manufacturing entity, current assets include:
a. Cash and cash equivalents (IAS 7, paragraph 6 and 7)
Cash comprises cash on hand and cash in bank, petty cash fund, change fund, etc..
Cash equivalents are short term, highly liquid investments that are readily convertible to known
amounts of cash and which are subject to an insignificant risk of changes in value. These are
mostly debt securities bought within 3 months before maturity.
b. Financial assets or short term investments such as: trading securities or marketable securities; and
money market placements current portion only); and other marketable financial assets that will
mature within one year.
c. Receivables:
Trade receivables such as: accounts receivable; notes receivables; and the contra-asset
account, allowance for bad debts or allowance for doubtful account.
Non-trade receivables such as: advances to employees, interest receivable; rent receivable;
accrued rent income; accrued interest income, commission receivable; and installment
receivable, current portion, where the company is the lender.
d. Inventories such as: merchandise inventory; material inventory; work in process inventory;
finished goods inventory; and factory supplies inventory, at the end of the year.
e. Prepaid expenses, are expenses paid in advance such as unexpired insurance expense, prepaid
interest expense, prepaid rent expense, unused office supplies , store supplies on hand. Note:
office supplies and store supplies are considered as prepaid expense and not as inventory
because of materiality principle.
Non-current asset which is also called long lived assets or fixed assets include: tangible, intangible
and financial assets of a long term nature. All assets that are not included in the classification of
current assets are non-current assets.
Sub-classification of non-current assets are:
a. Property, plant and equipment such as: land; building; furniture and fixtures; office equipment;
delivery equipment; factory machinery and equipment; tools, molds and dies; and their
corresponding contra – asset account, accumulated depreciation. This is also called fixed assets
b. Long term investments such as: investment in stock; investment in bonds; investment in
subsidiary; investment in associates, accounted for by the equity method; cash surrender value;
idle land used as investment to be sold 5 years from balance sheet date; plant expansion fund;
sinking fund; loan receivable (installment) non-current portion, where the company is the lender;
c. Intangible assets, such as franchise, patent, goodwill, copyright, brands, intellectual properties,
production process, chemical formula, etc..
d. Other non-current assets such as long-term refundable deposit (Meralco electric meter deposit,
containers deposit for oxygen and acetylene tanks and soft drinks)
2. Liabilities (Debts)
Liabilities are present obligations of an entity arising from past transactions or events, the settlement of
which is expected to result in an outflow of economic resources from the entity. An amount owed to
another person to be paid in the future.
Liabilities are classified into current and non-current liabilities.
2.1 Current liabilities
Current liabilities are obligations that are expected to be settled within one year or the entity’s normal
operating cycle whichever is longer. The entity does not have an unconditional right to defer the
settlement of the liabilities for at least twelve months after the balance sheet date
Current liabilities are presented in the balance sheet in the order of maturity or nearness to date of
payment. The sub-classification of current liabilities are:
a. Payables:
Trade payables are current obligations that arise directly to the acquisition of inventories and non-
current assets used in the operation and uses such accounts as: accounts payable; notes payable
– trade, advance deposit from customers, installment payable, current portion.
Non-trade payables are current obligations that are not included in the definition of trade payables
and uses such accounts : dividend payable; bank over drafts; SSS payable, withholding tax
payable, income tax payable, etc..
b. Accrued expenses are expenses already spent or incurred but not yet paid such as: accrued
salary expense, accrued interest expense, rent payable, utilities payable. Accrued expense means
payable.
c. Unearned income are income or revenue received in advance such as unearned interest income,
unearned rent income, unearned commission income, etc..
d. Short term borrowings such as notes payable and bank loan payable due within one year;
e. Current portion of long term debt, such as the current portion of a long term installment
payable; and
f. Current tax liability such as income tax payable, VAT payable and percentage tax payable.
2.2 Non-Current Liabilities
All liabilities that will mature beyond one year from balance sheet date are non-current liabilities. In
short, all liabilities that are not considered as current are non-current liabilities.
Non-current liabilities includes:

a) Mortgage loan payable - long term loan.
b) Bonds payable – long term borrowings
c). Non-current portion of long-term debt such as that portion of a long term installment payable or
note payable due after one year from balance sheet date;
d) Deferred tax liability; (taxes that are payable beyond one year)
e). Finance lease liability; and
f). Long term deferred revenue (unearned income that will be earned beyond one year).
3. Shareholders’ Equity
The shareholders’ equity is the residual interest in the assets of the corporation after deducting all its
liabilities.
The shareholders' equity section of the balance sheet has four sub-classifications, presented as follows:
1. Share Capital which includes:

a. Share Capital (Common or Ordinary and Preferred or Preference)
b. Subscribed Share Capital (Common or Ordinary and Preferred or Preference)
c. Subscription Receivable (Common and preferred). This account is a deduction
from subscribed share capital, if it is considered as non-current asset. However, if
collectible within one year, it should be presented as current asset and it should be included
in the receivable non-trade portion.
2. Reserves which includes:

a. Share Premium on Share Capital
b. Share premium :
Treasury stock
Donated assets
Stock dividend
c. Appropriated Retained Earnings (restricted retained earnings)
d. Revaluation Increment on Property
e. Unrealized gain (loss) on non-current investments.
f. Unrealized gain (loss) on foreign exchange differences on translating
investment of foreign operation
g. Unrealized gains (losses) on foreign exchange differences on translating long
term foreign loan payable.
3. Retained Earnings, (unappropriated or free retained earnings)

4. Treasury shares, the re-acquired owned shares of stock previously issued. (Deduction)
Share Capital
Under paragraph 76, of PAS 1, share capital should disclose in the notes for each class of capital
stock the following:
1. The number of shares authorized;

2. The number of shares issued and fully paid;
3. Par value per share, or that the share has no par value;
4. The rights, preferences, and restrictions attaching to that class including
restrictions on the distribution of dividends and the repayment of capital;
5. Subscribed capital stock;
6. Shares of the enterprise held by the enterprise itself or by subsidiaries or
or by associates of the enterprise.
7. Shares reserved for issuance under options and sales contracts, including
the terms and conditions. Included here are stock dividends to be issued
and stock option plans for employees.
Reserves
Reserves should disclose the description of the nature and purpose of each reserve. The following
account titles are included in the reserve portion:
1. Those called share premium or additional paid in capital such as:

a. Share premium – Ordinary (excess over par)
b. Share premium - Preference (excess over par)
c. Share premium - Stock Dividend
d. Share premium - Treasury Stock
e. Share premium - Donated Stock
f. Share premium - Donation
2. Appropriation reserves - those appropriated from retained earnings for a specific purpose. This
reserve is also called restricted retained earnings or appropriated retained earnings.
Examples are:
a. Appropriated for Plant Expansion
b Appropriated for Retirement of Preference shares
c. Appropriated for Contingencies
d. Appropriated for Treasury Stock acquisition
e. Appropriated for Bond Redemption
3. Revaluation increment in property is the increase in the value of property,

plant, and equipment. It is the excess of sound value over net book value.
4. Unrealized gain (loss) of non-current investment, for temporary increase or decline in value.
Retained Earnings
Retained Earnings account is the accumulated profits minus losses, and dividend distribution from the
inception of the corporation. It is also called the Surplus Profit. Only the retained earnings at the end of
the period will be shown on the face of the balance sheet and should include only the free or
unappropriated retained earnings. The appropriated retained earnings is included in the reserves
portion.
The retained earnings presentation includes the following:
1. Retained earnings, beginning;

2. Correction of fundamental errors that affects prior years net income; if there is any;
3. Changes in accounting policies that affects prior years net income; if there Is any;
4. Restated balance, retained earnings, beginning if there are corrections and changes;
5. Net income or loss for the period;
6. Dividends’ declared ;
7. Appropriations of retained earnings or closing of previously appropriated retained earnings ; and
8. Retained earnings at the end of the year.
Treasury Share
Treasury Share or treasury stock is the account title used to denote the acquisition of the corporation’s
own shares of stocks that have previously been issued. This is normally debited at cost. When the
corporation reacquires issued shares from the stockholders, these reacquired shares are called treasury
shares or treasury stocks. When the corporation does not formally retire or cancel these reacquired
shares or treasury share, the share is said to be issued but not outstanding. Therefore, treasury shares
does not earn dividend. This is a deduction from the Shareholders’ Equity.
Pro-forma Statement of Financial Position
The revised SFAS Bulletin No. 1 is based on International Accounting Standard that recommends the
use of statement of financial position or balance sheet presented at the minimum using line items with
supporting notes for the details is shown below.
The pro-forma Consolidated Statement of Financial Position for a Group Corporation shown below:
XYZ Group Corporation

Consolidated Statement of Financial Position
As at December 31, 2020
ASSETS
Note
Current Assets:
Cash and cash equivalents 11 xx
Financial assets (short term investment) 12 xx
Trade and non-trade receivables 13 xx
Inventories 14 xx
Prepaid Expenses 15 xx
Total Current Assets xxx
Non-current Assets
Property, plant and equipment 16
(net of accumulated depreciation) xx
Long term investments 17 xx
Intangible assets 18 xx
Other assets 19 xx
Total Non-current Assets xxx
Total Assets xxx
LIABILITIES AND SHAREHOLDERS’ EQUITY

Note
Current Liabilities
Trade and non-trade payables 20 xx
Short term borrowings 21 xx
Current portion of long term borrowings 22 xx
Current tax payable xx
Accrued expenses 22 xx
Unearned income 24 xx
Total Current Liabilities xxx
Non-current Liabilities
Long term borrowings, non-current portion 25 xx
Deferred tax liabilities 26 xx
Long term provisions 27 xx
Total Non-current Liabilities xxx
Total Liabilities xxx
Shareholders’ Equity, attributable to equity holders of the parent

Share Capital 28 xx
Reserves 29 xx
Retained Earnings 30 xx
Treasury Shares (at cost) 28 ( x)
Total Equity of the parent xxx
Minority interest xx
Total Shareholders’ Equity xxx
Total Liabilities and Shareholders Equity xxx
Illustrative Problem – Merchandising Company
The adjusted trial balance of Matalino Cadao Corporation, shown below is not in proper order. Prepare
the Income Statement and Statement of Financial Position of Matalino Cadao Corporation using the
Function of Expense Method or Cost of Sales Method and answer the multiple choice questions by
indicating the letter of the correct answer on the blank.
The adjusted trial balance of Matalino Cadao Corporation, a trading company as of December 31, 2020,
presented below, is not in proper order.
Debit Credit
Unearned Interest Income 32,000
Office Utility Expense 12,000
Accounts Payable 180,000
Tax Payable ( payable in 4 months) 4,000
Income tax expense 21,000
Purchase discount 10,000
Depreciation Expenses – HO Bldg. 20,000
Share Capital - Common 300,000
Share Capital – Preferred 100,000

Premium on share capital - Common 12,000
Notes Receivable (trade) 80,000
Trading securities 20,000
Insurance Expense 8,000
Accrued Interest Expense 56,000
Purchase returns 60,000
Allowance for Bad Debts 12,000
Interest expense 12,000
Purchases 340,000
Prepaid Interest Expense 8,000
Advertising expense 12,000
Office Salary Expense 92,000
Land 200,000
Interest Income 18,000
Building 400,000
Furniture and equipment 60,000
Acc. Depreciation – Bldg. 34,000
Acc. Depreciation – Furniture and Equipt. 6,000
Unused Office Supplies 4,000
Rent Receivable 12,000
Sales discount 20,000
Sales returns and allowances 40,000
Merchandise inventory, Jan 1 20,000
Freight in 2,000
Freight out 8,000
Office Supplies Expense 14,000
Loss on sale of trading securities 2,000
Tools 12,000
Cash 40,000
Rent Income 30,000
Gain on sale of used furniture 2,000
Accounts Receivable 240,000
Transportation Expense - office 8,000
Salesmen commission expense 59,000
Bank loan payable (payable P50,000
every December 1 of each year) 200,000
Sales 600,000
_________ _________
Total 1,766,000 1,766,000
Additional information:
1. Merchandise inventory, December 31, 2020 – P30,000.
2. Authorized capital stock of ordinary share, 10,000 shares at P100 par value.
3. Authorized capital stock of preference share, 5,000 shares at P100 par value.
4. No dividend was declared during the year.
MULTIPLE CHOICE
Indicate on the blank before each number, the letter of the correct answer.
___1. - The net sales is

a. P600,000 b. P580,000 c. P560.000 d. P550,000 e. P540,000 f. None of these
___2. - The cost of goods sold is

___3. - The other income is

___4. - The selling expense is

___5. - The administrative expense is

___6. - The total other expenses is

a. P0 b. P1,000 c. P2,000 d. P20,000 e. P4,000 f. None of these
___7. - The finance cost is

___8.- The net income before income tax is

___9.- The net income after tax is

___10 – The total current assets is

___11 - The total non-current assets is

___12 - The total assets is

a. P1,054,000 b. P1,062,000 c. P1,035.000 d. P1,052,000 e. P1,053,000 f. None of these
___13 - The total current liabilities is

___14 - The total non-current liabilities is

___15 - The total liabilities is

___16. - The total share capital is

___17. - The retained earning as of December 31, 2020 is

___18 - The total stockholders equity is

After answering, check your answer to determine your level of intelligence. See solution below.
Solution
Matalino Cadao Corporation

Income Statement
For the Year Ended, December 31, 2020
Answers
Income:
Revenue from net sales 1 540,000
Cost of goods sold 2 ( 262,000)
Gross profit from sales 278,000
Other income 3 50,000
Total revenue 328,000
Operating Expenses:
Selling expenses 4 ( 79,000)
Administrative expenses 5 ( 154,000)
Other expenses 6 ( 2,000)
Total operating expenses (235,000)
Net Operating Income or EBIT 93,000 (Earnings Before Interest and

Taxes)
Finance costs 7 ( 12,000)

Net Income before Income Tax 8 81,000
Income tax expense (given) ( 21,000)
Net Income for the Year 9 60,000
Matalino Cadao Corporation

Statement of Financial Position
As at December 31, 2020
Assets Liabilities and Shareholders’ Equity

answers answers
Current assets 10 422,000 Current liabilities 13 322,000
Non-current assets 11 632,000 Non-current liabilities 14 150,000
Total assets 12 1,054,000 Total 15 472,000
Stockholders equity 18 582,000
Total liabilities and SHE 1,054,000
Answers:
1. Net Sales
Sales 600,000
Sales returns and allowances ( 40,000)
Sales discounts ( 20,000)
Net sales 540,000
2. Cost of Sales
Purchases 340,000
Freight In 2,000
Net cost of purchases 272,000
Merchandise inventory, Jan. 1 20,000
Total cost of goods available for sale 292,000
Merchandise inventory, December 31 ( 30,000)
Cost of goods sold 262,000
3. Other Income
Interest income 18,000

Rent income 30,000
Total 50,000
4. Selling or Distribution Expenses
Advertising Expense 12,000

Freight out 8,000
Salesmen commission 59,000
Total 79,000
5. Administrative Expenses
Office Utility expense 12,000

Depreciation expense – Bldg. 20,000
Insurance expense 8,000
Office Salary expense 92,000
Transportation expense 8,000
Total 154,000
6. Other Expense
Loss on Sale of Trading Securities – P2,000
7. Finance costs
Interest expense P12,000
8. Net income before tax P81,000
9. Net income after tax 60,000
10. Current Assets
Cash 40,000
Receivables:
Accounts receivable 240,000
Allowance for Bad Debts ( 12,000)
Notes receivable (trade) 80,000
Rent receivable 12,000
Total receivables 320,000
Merchandise inventory (end) 30,000

Prepaid Expenses:
Prepaid interest expense 8,000
Unused office supplies 4,000
Total prepaid expenses 12,000
Total Current Assets P 422,000
11. Non-current assets
Land 200,000
Building 400,000
Acc. Depreciation – Bldg. ( 34,000)
Acc. Depreciation – Furn. and Equipt. ( 6,000)
Total P632,000
12. Total Assets P1,054,000
13. Current Liabilities

Unearned interest Income 32,000
Accounts payable 180,000
Tax payable 4,000
Accrued interest expense 56,000
Bank loan – current portion 50,000
Total 322,000
14. Non-current Liabilities

Bank Loan Payable – non-current portion 150,000
15. 472,000
16 ,17, 18
Stockholders Equity
Share Capital:
Common 300,000
Preferrred 100,000
Total share capital 400,000 (16)
Reserves:
Premium on Share Capital- Common 12,000
Retained earnings, Dec.31 170,000* (See below)
Total Stockholders’ Equity 582,000 (18)
* Statement of Retained Earnings

For the year ending December 31, 2020
Retained earnings, Jan. 1 110,000

Add: Net income 60,000
Total 170,000
Less: Dividend 0
Retained earnings, Dec. 31 170,000* (17)
What are Notes to Financial Statements?

Notes to financial statements are used to explain information in the balance sheet and income
statements in order to enhance the understandability of the statements. Normally, a detailed breakdown
of line items are presented here.
Notes to financial statements are required to include a statement that the financial statements is in
accordance with generally accepted accounting principles (GAAP) and the various accounting policies
about inventory valuation, method of depreciation used, and other accounting policies. It should also
indicate components or break down of the financial statements. Each component should be explained
and be prepared carefully and presented in an orderly manner.
Students: This is the most comprehensive illustration that you will come across. Please study
carefully this solved problem and you will learn a lot. (CPA Board Examination)
Solved Comprehensive Problem

Income Statement and Statement of Financial Position of a Manufacturing Corporation
The accountant of Hilo Ka Corporation, a manufacturing company, became sick and you were required
to prepare the financial statements of the company in 3 hours because it is needed by the Board of
Directors.
Your were given the following adjusted trial balance as of December 31, 2020 which is not in proper
order:
(P000)
Debit Credit
Dividend payable 20
Accrued Rent Expenses 20
Office Equipment 200
Accumulated Depreciation – Office Equipment 50
Investment in associate 40
Foreign currency conversion gain 40
Freight out 20
Purchases – factory supplies 20
Store supplies inventory 10
Purchases – store supplies 20
Prepaid insurance 10
Land 1,300
Building 400
Acc. Depreciation – Bldg. 10
Tools 20
Acc. Depreciation – Machineries 36
Plant expansion fund 50
Patent 10
Goodwill 10
Long term refundable deposit 5
Idle land (to be sold 10 years from now) 50
Accounts Payable 100
Account Receivable 200
Allowance for Bad Debts 12
Notes Receivable ( collectible – P1 per month) 50
Interest Receivable 5
Subscription Receivable - Ordinary 35
Cash on Hand 100
Investment in bond (maturity 2023) 30

Cash surrender value 20
Trading Securities at cost 100
Advances to employees, to be collected January, 2021 5
Finished goods Inventory (Jan. 1) 200
Income Tax Expense 35
Subscribed Share Capital – Ordinary 100
Notes Payable ( 150 is due every July 30) 350
Accrued Interest Expense 18
Share premium ordinary shares 20
Sales return and allowances 160
Sales discounts 10
Office salaries 50
Taxes and licenses 10
Depreciation Expense – Office furniture and equipt. 10
Factory light, heat, and water 10
Long term advances to officers 15
Factory insurance 5
Office light, water and telephone 29
Share premium – Donated assets 8
Income Tax Payable 35
Goods in Process Inventory 200
Raw Material Inventory 100
Office supplies inventory 5
Purchases – office supplies 10
Factory supplies inventory 5
Bond Payable – ( P50 is due every quarter) 300
Ordinary Shares 1,000
Share premium – Treasury Stock 2
Retained Earnings – unappropriated (after dividend
(deduction was recorded) 120
Appropriated for plant expansion 20
Appropriated for contingencies 10
Revaluation increment in property - land 150
Land- appraisal increment 150
Appropriated for bond redemption 100
Sales 2,600
Purchase discount 10
Direct labor 500
Purchases - materials 1,000
Factory superintendence 50
10% Preference Share 500
Treasury Stock - Ordinary, at cost 10
Factory taxes 12
Depreciation Expense – Machineries 8
Machineries 120
Indirect labor 20
Gain on sale of equipment 8
Bad debt expense 2
Sales salaries 25
Advertising and Promotion 25
Depreciation expense – store equipment 12
Cash in Bank 50
Petty Cash fund 10
Purchase returns and allowances 100
BSP Treasury Bills (bought in December, 15, 2020;
P10 will mature Feb. 2021; P5 will mature

June, 2021 and the rest will mature April 30, 2022 30
Store equipment 120
Acc. Depreciation – Store equipment 39
Rent Expense 60
Interest Income on Notes receivable 20
Interest Expense on notes payable 30
Unrealized gain/loss on investment in associate 2
Unrealized foreign exchange gain/loss on foreign loan 2
_____ _____
Total 5,800 5,800
1.Inventory as of December 31, 2020
Finished Goods 50
Goods in Process 50
Raw materials 50
Office supplies 1
Store supplies 1
Factory supplies 1
4. Note receivable was the result of a sale on installment at P1 thousand a month for 60 months,
with interest. The customer issued a promissory note and have paid for 10 months already.
3. Authorized capital stock – 10,000 shares Ordinary @ P1,000 par value and
10,000 shares of 10% preferred @ P100 par value.
4. Retained earnings as of 1/1/2020 was P140,000, before recording the dividend declared in
12/15/2020 amounting to P20 thousand. (See no. 5 below)
5. Dividend payable of P20 thousand was due to a dividend declaration on December 15, 2020,
payable on January 15, 2021. (See no. 4 above.)
Required: Indicate on the blank, of the financial statements, the amount required with
corresponding breakdown as detailed in explanatory notes to financial statements.
Hilo Ka Corporation
Income Statement
Note (P000)
Income:
Net Sales 1 P ______________
Cost of Sales 2 ( ______________)
Gross Profit from sales ______________
Other Income 3 ______________
Total Income ______________
Expenses:
Selling Expenses 4 (______________)
Administrative Expenses 5 (______________)
Other Operating Expenses (______________)
Finance costs 6 (______________)
Total Expenses (______________)
Net Income Before Income Tax ______________

Income Tax Expense ______________
Net Income (Loss) ______________
Hilo Ka Corporation
As of December 31, 2020
(P000)
A S S E T S
Note
Current Assets
Cash and Cash equivalent 1 P ___________
Trading securities 2 ___________
Trade and non-trade receivables 3 ___________
Inventories 4 ___________
Prepaid expenses 5 ___________
Total current assets ___________
Non-current Assets
Plant, Properties and Equipment 6 ___________
Long term investments 7 ___________
Intangibles 8 ___________
Others 9 ___________
Total non-current assets ____________
Total Assets P ____________
LIABILITIES AND STOCKHOLDERS’ EQUITY

Liabilities
Current Liabilities 10 P ____________
Non-current Liabilities 11 ____________
Total Liabilities ____________
Shareholders Equity
(Authorized capital stock - 10,000 shares common @ P1,000
par value and 10,000 shares of 10% preferred shares @
P100 par value)
Capital stock 12 P ___________

Reserve 13 ___________
Retained earnings (Deficit) 14 ___________
Treasury Shares ___________
Total Shareholders’ Equity ___________
Total Liabilities and Shareholders Equity P ____________
Note: To learn and retain what you have learned, please answer without peeking at the solution.
Then check your answer. Solution is below !!!
SOLUTION:
Hilo Ka Corporation
Income Statement
Note (P000)
Income:
Net Sales 1 P 2,430
Cost of Sales 2 ( 1,869 )
Gross Profit from sales 561
Other Income 3 68
Total Income 629
Operating Expenses:
Selling expenses 4 ( 111)
Administrative expenses 5 ( 175)
Other Operating expenses -
Total operating expenses (286)
Operating income (EBIT) 343 (Earnings Before Interest and Taxes)
Finance Costs/interest expense 6 ( 30)
Net Income before Income Tax 313

Income Tax Expense ( 35)
Net Income (Loss) for the Year 278
Notes to Income Statement
Note 1 – Net Sales

Sales P 2,600
Sales return and allowances ( 160)
Sales discount ( 10)
Net Sales P 2,430
Note 2 – Statement of Cost of Goods Manufactured and Sold

Materials Used ( Schedule 1) P 940
Direct Labor 500
Factory Overhead (Schedule 2) 129

Total Factory Cost 1,569
WIP , beginning 200
Total cost in process 1,769
WIP, end ( 50)
Cost of goods manufactured 1,719
F.G. inventory beg. 200
Cost of goods available for sale 1,919
F.G. inventory end ( 50)
Cost of goods sold P 1,869
Schedule 1 – Material used

Purchases – Materials P 1,000
Purchase returns and allowances ( 100)
Purchase discounts ( 10)
Net cost of purchases P 890
Material inventory beg. 100
Total materials available for use 990
Material inventory end ( 50)
Material used P 940
Schedule 2 – Factory Overhead

Factory supplies used:
Purchases – factory supplies 20
F. Supplies, beg. 5
F. Supplies, end ( 1)
F. Supplies used 24
Factory light, heat and water 10
Factory insurance 5
Factory superintendence 50
Factory taxes 12
Depreciation Expense – machineries 8
Indirect labor 20
Total factory overhead P 129
Note 3 Other Income

Foreign currency translation gain 40
Interest Income 20
Gain on sale of equipment 8
Total P 68
Note 4 Selling Expenses

Freight Out 20
Store supplies used:
Purchases - Store supplies P 20
S. Supplies, beg. 10
S. Supplies, end (1)
Store supplies used 29
Sales salaries 25
Advertising and promotion 25
Depreciation expense – store equipment 12
Total selling expenses P 111
Note 5 Administrative expense

Rent Expense 60
Office supplies used:
Purchases – office supplies 10
O. Supplies, beg 5
O. Supplies, end (1)
O. Supplies used 14
Office salaries 50
Taxes and licenses 10
Depreciation expense – O. Furn. & Equipment 10
Office light, water and telephone 29
Bad debt expense 2
Total administrative expense P 175
Note 6 Finance Cost

Interest on Notes Payable 30
Hilo Ka Corporation
As of December 31, 20120
(P000)
A S S E T S
Note
Current Assets
Cash and Cash equivalent 1 P 170
Trading securities 2 105
Trade and non-trade receivables 3 210
Inventories 4 151
Prepaid expenses 5 12
Total current assets 648
Non-current Assets
Plant, Properties and Equipment 6 2,175
Long term investments 7 243
Intangibles 8 20
Others 9 20
Total non-current assets 2,458
Total Assets P 3,106
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current Liabilities 10 P 543

Non-current Liabilities 11 300
Total Liabilities 843
Shareholders’ Equity
(Authorized capital stock - 10,000 shares ordinary @ P1,000
par value and 10,000 shares of 10% preferred shares @
P100 par value)
Share capital 12 P 1,565

Reserve 13 310
Retained earnings (Deficit) 14 398
Treasury Stock ( 10)
Total Shareholders’ Equity 2,263
Total Liabilities and Shareholders’ Equity P 3,106
Notes to Statement of Financial Position (P000)
Note 1 Cash and Cash equivalents

Cash on hand P 100
Cash in bank 50
BSP Treasury bill due Feb. 2015 10 acquired within 3 months before maturity
Petty cash fund 10
Total P 170
Cash means that it must be readily available for use for payment of operational expenses and all current
obligations and therefore unrestricted in use. It includes the following: 1) cash on hand (cash in the
office vault, cash collections awaiting deposit); 2) cash in bank (savings and current deposit which are
unrestricted as to withdrawal and use; 3) cash fund, set aside for current purpose (petty cash fund,
change fund, payroll fund, dividend fund)
PAS 7 defines “cash equivalents” as short-term and highly liquid investments that are readily
convertible into cash and so near their maturity that they represent insignificant risk of changes in value
because of changes in interest rates. The standard also states that only highly liquid investments that
are acquired 3 months before maturity can qualify as cash equivalent.
Note 2 Trading securities
BSP Treasury bills due June, 2021 P 5 (more than 3 months from date of
acquisition but within 1 year, therefore
short term investment.)
Trading securities at cost 100
Total 105
Note 3 Trade and non-trade receivables Trade
Trade:
Accounts Receivable P 200
Allowance for Bad Debts ( 12)
Notes Receivable, current 12 (P1 per month x 12 months)
Sub-Total P 200
Non-trade:
Advances to employees 5
Interest receivable 5
Sub-Total 10
Total P 210
Note 4 Inventories
Finished goods inventory P 50
Goods in Process inventory 50
Raw material inventory 50
Factory supplies 1
Total inventory P 151
Note 5 Prepaid Expenses

Office supplies inventory P 1
Store supplies inventory 1
Prepaid insurance 10
Total P 12
Office supplies inventory and store supplies inventory, if there are any, are always classified as prepaid
expense because of materiality principle. Normally, all purchases of office supplies and store supplies
are expensed out immediately.
Note 6 Plant, Property and Equipment

Account Acc. Dep’n. Book Value
Land 1,300 P 1,300
Land, Appraisal increment 150 150
Building 400 ( 10) 390
Tools 20 20
Machineries 120 ( 36) 84
Store equipment 120 ( 39) 81
Office Equipment 200 ( 50) 150
Total P 2,175
Land-Appraisal increment (debit) is an additional value for land and therefore a non-current asset, in
Plant, property and equipment section, but the Revaluation increment in property-land (credit) is a
Shareholder Equity account to be included in Reserve.
Note 7 Long term investments

BSP Treasury Bill due April, 2022 15 (maturity is more than 1 year)
Investment in bonds P 30
Cash surrender value 20
Plant expansion fund 50
Idle land to be sold 10 years from now 50
Investment in associate 40
Note receivable long term portion 38
Total P 243
Cash surrender value is the amount that the insurance company will pay upon the surrender and
cancellation of the life insurance policy at the end of the third year or time thereafter. It is classified as a
long-term investment.
Plant expansion fund is a cash item but restricted for its use. It was set aside specifically for plant
expansion and cannot be use for other purposes. Therefore, not included as current asset but non-
current asset. It is classified as long term investment because it is directly related to PPE to be
constructed or built and not yet operational. PPE are included in the investing activities portion of Cash
Flow Statement. Other funds included in this category are: sinking fund, preferred stock redemption fund,
contingency fund, insurance fund, fund for acquisition of property.
Idle land, to be sold 10 years from now, is a non-current asset, but not included in the PPE because it is
not used in operation. It was acquired precisely for the purpose of investment and not for use in the
operation of the business.
Investment in associate is an investment by a corporation in another corporation through the acquisition

of shares of stock and the corporation (the inverstor) has acquired significant influence in the financial
and operating policies of such corporation. Significant influence means the investor has the power to
participate in the financial and operating policy decisions of the investee.
Note receivable, long term portion is a non-current trade receivable from customer. When working capital
is used to lend and earn interest, it is an investing activity in the cash flow statement and therefore
should be classified as long term investment.
Note 8 Intangibles
Patent P 10
Goodwill 10
Total P 20
Note 9 Other non-current assets

Long term refundable deposit 5
Long term advances to officers 15
Total P 20
Note 10 Current Liabilities

Dividend Payable 20
Accrued Rent Expense 20
Accounts Payable 100
Notes Payable, current portion 150
Accrued Interest Expense 18
Income Tax Payable 35
Bond Payable, current portion 200
Total P 543
Note 11 Non-current liabilities

Notes payable, non-current portion 200
Bond Payable, non-current portion 100
Total P 300
Note 12 Share Capital or Capital Stock

10% Share Capital – Preference P 500
Share Capital – ordinary P 1,000
Subscribed share capital – ordinary 100
Subscription receivable – ordinary (35)
Total share capital – ordinary P 1,065
Total share capital P 1,565
Note 13 Reserves
Share Premium:
Share premium - ordinary shares P 20
Share premium – donated assets 8
Share premium – treasury stock 2
Sub-Total 30
Appropriations from Retained Earnings

Appropriated for plant expansion 20
Appropriated for contingencies 10
Appropriated for bond redemption 100
Sub-total 130
Others
Revaluation increment in property – land 150
Unrealized gain on investment in associate 2
Unrealized foreign exchange loss on foreign loan ( 2)
Total P 310
Note 14 Retained Earnings, unappropriated / free

Retained earnings, unappropriated, Jan. 1

(Before declaration of dividend) P 140
Dividend declared ( 20)
Retained earnings balance per T/B 120
Net Income (Loss) 278
Retained earnings, unappropriated, Dec. 31 398
Chapter 4
Solve the following Exercises.
Easy
Problem 1 Net Sales
Unggoy Ka Manufacturing Corporation, a manufacturer of animal toys, gave you the following partial
financial information from the adjusted trial balance for the year ending December 31, 2020:
Sales P 2,600,000
Purchases – Materials purchases 1,000,000
Purchase returns and allowances 100,000
Sales return and allowances 160,000
Rent income 50,000
Purchase discounts 10,000
Freight in 5,000
Material inventory beg. 100,000
Freight out 20,000
How much is the net sales? P _____________
Medium
Problem 2 Cost of Sales
Unggoy Carin Manufacturing Corporation, a manufacturer of animal toys, gave you the following partial
financial information from the trial balance of the company, for its first year of operation, ending
December 31, 2020:
Direct Labor 500,000

Work in Process, Jan. 1 200,000
Finished goods inventory, Jan. 1 200,000
Purchase returns and allowances 100,000
Purchase discounts 10,000
Freight in 10,000
Material inventory, Jan. 1 100,000
Factory Supplies, Jan. 1 5,000
Factory light and water 10,000
Factory insurance 5,000
Depreciation Expense – machineries 8,000
Accrued salaries and wages – office 3,000
Indirect labor 20,000
Freight Out 20,000
Store Supplies, Jan. 1 10,000
Depreciation expense – store equipment 12,000
Factory superintendence 50,000
Factory taxes 12,000
Depreciation expense – delivery equipment 13,000
Store insurance expense 5,000
Prepaid office insurance expense 2,000
Salaries and wages – Store 10,000
Salaries and wages – Office 15,000
Store light and water expense 3,000
Office light and water expense 2,000
During the year the following purchases were made:
1. For factory supplies P20,000
2. For store supplies 20,000
3. For material inventory P1,000,000
The physical count at the end of the year showed the amount of inventories as of December 31, 2020:
Material inventory P 50,000
Work in Process inventory 50,000
Finished goods inventory 50,000
Factory supplies inventory 1,000
Store supplies inventory 1,000
Required: In good form, prepare the Statement of Cost of Goods Manufactured and Sold.
Problem 3 Selling Expense and Administrative Expense
Teddy Bear Manufacturing Corporation, a competitor manufacturer of animal toys, gave you the
following partial financial information from the adjusted trial balance for the year ending December 31,
2020:
Factory taxes 12,000

Depreciation Expense – machineries 8,000
Accrued office salaries 1,000
Depreciation Expense – Delivery equipment 5,000
Indirect labor 20,000
Freight In 10,000
Freight Out 20,000
Factory supplies expense 20,000
Sales salaries 25,000
Advertising and promotion 25,000
Depreciation expense – store equipment 12,000
Rent Expense - office 60,000
Office salaries 50,000

Taxes and licenses 10,000
Prepaid office rent expense 10,000
Depreciation expense – O. Furn. & Equipment 10,000
Office light, water and telephone 29,000
Impairment loss 2,000
1. The company is using the expense method for factory, office and store supplies.
2. Inventories at the end of the year:
Factory supplies P 10,000
Store supplies 1,000
Office supplies 1,000
How much is the total selling or distribution expense? P ____________

How much is the total administrative expense ? P ____________
Difficult
Problem 4 Current Assets
Malou Fit Manufacturing Corporation, a manufacturer of “Latigo” for boys, gave you the following partial
Cash on hand P 100,000

Cash in bank 50,000
Cash surrender value 50,000
BSP Treasury bill due Feb. 2021 (bought 12/15/20) 10,000
BSP Treasury bills due June, 2021 5,000
Trading securities at cost 100,000
Allowance for impairment loss 12,000
Notes Receivable (installment of P1,000 a month) 60,000
Petty cash fund 10,000
Advances to employees (due January, 2021) 5,000
Accrued rent income 10,000
Interest receivable 5,000
Finished goods inventory, Jan. 1 50,000
Goods in Process inventory, Jan. 1 20,000
Accrued light and water expense – factory 1,000
Raw material inventory, Jan. 1 50,000
Factory supplies inventory, Jan. 1 5,000
Direct material cost 600,000
Factory supplies expense 20,000
Subscription receivable – ordinary (due 2023) 50,000
Store supplies expense 15,000
Prepaid insurance factory 10,000
1. The company is using the expense method for factory, office and store supplies.
2. Inventories as at December 31, 2020:
Factory supplies P 10,000
Store supplies 1,000
Office supplies 1,000

Finished goods 150,000
Work in process 50,000
Material 100,000
How much is the total current assets as of December 31, 2020? P ___________
Problem 5 Current and Non – Current Liabilities
Mary Quit Manufacturing Corporation, a manufacturer of baby shirts, gave you the following partial
Patent P 10,000
Goodwill 10,000
Unearned interest income 2,000
Long term refundable deposit with Meralco 5,000
Long term advances to officers 15,000
Cash dividend payable, due January 15, 2021 200,000
Accrued Rent Expense 20,000
Installment Payable, (P10,000 payable every month) 300,000
Income Tax Payable 35,000
Bond Payable due 2024 500,000
20% Stock dividend payable, due February 1, 2021 400,000
Customers’ deposit (for goods to be delivered in January, 2021) 20,000
Deposit with suppliers (for equipment ordered, due for delivery
in March, 2021) 30,000
The total current liabilities should be P________________.

The total non-current liabilities should be P _______________.
Problem 6 Shareholders Equity
General Manufacturing Corporation, a manufacturer of police batons, gave you the following partial
10% Share Capital – Preference (50,000 shares at P10 par) P 500,000

Treasury shares, at cost (5,000 ordinary shares) 75,000
Share Capital – ordinary (100,000 shares at P10 par) 1,000,000
Subscribed share capital – ordinary 100,000
Retained earnings (free) 200,000
Premium on preference shares 10,000
Premium on ordinary shares 20,000
Share premium – donated assets 8,000
Share premium – treasury stock 2,000
Appropriated for plant expansion 20,000
Appropriated for contingencies 10,000
Appropriated for bond redemption 100,000
Revaluation increment in property – land 150,000

Unrealized gain on investment in associate 2,000
Unrealized loss on available for sale securities 2,000
Cash dividend payable, due January 15, 2021 100,000
Stock dividend payable- ordinary, due February 15, 20121
(a 20% stock dividend for ordinary share holders was
Declared on December 1, 2020 to be distributed on
February 14, 2021) 200,000
The total shareholder’s equity as at December 31, 2020 should be P _____________.
Multiple Choice Encircle the letter of the correct answer.
Balance Sheet 4
Easy
Problem 4-1 Current Asset
The Wonderful Corporation’s trial balance reflected the following account balances as of December 31,
2020:
Accounts receivable 1,600,000

Short term investments 500,000
Long term investments 1,000,000
Accumulated depreciation – equipment 1,500,000
Cash 1,100,000
Inventory of merchandise 3,000,000
Equipment 2,500,000
Patent 400,000
Prepaid expenses 100,000
Land held for future business site 1,800,000
Unearned rent income 50,000
In Wonderful’s December 31, 2020 balance sheet, the current assets total is
Medium
Problem 4-2 Current Asset – Current Liabilities = Working Capital
The following information pertains to Wowowie Corporation on December 31, 2020
Property, plant and equipment (net) 35,000,000

Prepaid insurance 2,500,000
Short-term notes payable 3,000,000
Long-term notes payable 5,000,000
Cash 5,000,000
Bond payable 40,000,000
Total assets 101,500,000

Land 20,000,000
Accounts payable 8,000,000
Allowance for doubtful accounts 1,000,000
Merchandise inventory, Dec. 31 13,000,000
Merchandise inventory, Jan. 1 12,000,000
Short term investments 7,000,000
Wages payable 2,000,000
Total liabilities 56,000,000
Premium on bonds payable 3,000,000
2.1 In Wowowie’s December 31, 2020 financial position, the current assets total is
2.2 In Wowowie’s December 31, 2020 financial position, the current liabilities total is
2.3 The working capital of Wowowie Corporation is

a. P10,500,000 b. P0 c. P3,000,000 d. P33,500,000 e. P33,000,000 f. None of these
4-3 Current Liabilities
The trial balance of Awesome Company included the following account balances at December 31, 2020:
Bonds payable, due 2021 2,500,000
Discount on bonds payable, due 2021 300,000
Cash dividend payable 800,000
Stock dividend payable 1,000,000
Notes payable, due 2022 2,000,000
The current liability section of Awesome’s December 31, 2020 balance should be
a.P5,500,000 b. P5,100,000 c. P6,500,000 d. P4,500,000 e. P7,800,000 f. None of these
Difficult
4-4 Current Assets and Current Liabilities
The following accounts and their balances appear in an unadjusted trial balance of Beautiful Company
as of December 31, 2020:
Cash 800,000
Inventory 1,000,000
Notes payable 400,000
Additional information for adjustment are as follows:
a. The cash account includes collection in January, 2021 of P400,000 account from
customer who was given cash discount of P20,000
b. The cash account also includes a January, 2021 cash sales of P100,000. Gross profit
on sale was 40%. Perpetual inventory method is being used by the company.
c. From the amount collected, the company paid a bank loan of P200,000 with interest
accruing January, 2021.
1. The correct amount of current assets on December 31, 2020 should be

2. The correct amount of current liabilities on December 31, 2020 should be

4-5 – Non-current Liabilities, Retained Earnings, Stockholders’ Equity
Darling Corporation provided the following balances on December 31, 2020:

Accrued taxes 100,000
Ordinary shares 5,000,000
Dividends – Ordinary 1,000,000
Dividends – Preference 500,000
Mortgage payable (P500,000 due in six months) 4,000,000
Bond payable, due January, 2023 2,000,000
Premium on ordinary shares 500,000
Preference shares 3,000,000
Income summary – credit balance 4,000,000
Retained earnings January 1, 2020 2,500,000
Unearned rent income 150,000
Premium on bond payable 200,000
Unamortized issue cost of bond payable 50,000
1. What is the amount of total long term liabilities on December 31, 2020?
2. What is the retained earnings balance on December 31, 2020?

3. What is the total stockholders equity on December 31, 2020?

Income Statement 3
4-6 Cost of Goods Sold (AICPA)
The following information pertains to Mahusay Corporation’s 20120cost of goods sold:
Inventory, January 1 4,500,000

2020 purchases 6,200,000
2020 write off of obsolete inventory 1,700,000
Inventory, December 31 1,500,000
The inventory written off became obsolete due to an unexpected technological advance by a competitor.
In its 2020 income statement, what amount should Mahusay report as cost of goods sold?
4-7 Cost of Goods Sold (Merchandising) (AICPA adapted)
The following information is available for Boondock Company for 2020:
Disbursements for purchases 5,800,000

Increase in trade accounts payable 500,000
Decrease in merchandise inventory 200,000
The cost of goods sold for 2020 was

4-8 Cost of Goods Sold (Manufacturing)
After its first year of operations, Super Corporation had the following data on its operations.
Manufacturing costs were distributed as follows.
Cost of goods sold 4,320,000

Material used 50%
Direct labor 30%
Manufacturing overhead 20%
Goods in process, December 31, were 10% of total manufacturing cost. Finished goods remaining in
stock were 20% of the total cost of goods manufactured.
The direct labor cost incurred was

4-9 Accounts Receivable
Laging Duling Corporation had the following accounts receivable and allowance for uncollectible
accounts at the end of 2020 before any adjusting entry:

Allowance for uncollectible accounts 800,000
Sales in 2020 totaled P80,000,000 (8% of sales were for cash) and write-offs of customer accounts
totaled P600,000. Allowance for uncollectible accounts is estimated to be 2% of trade receivable at the
end.
What is the balance of the allowance for uncollectible accounts at the beginning of 2020?
a. P200,000 b. P1,160,000 c. P1,400,000 d. P800,000 e. P240,000 f. None of these
4-10 Preparation of Income Statement and Balance Sheet
The adjusted trial balance of Crazy Love Corporation as of December 31, 2020, presented below, is not
in proper order.
Debit Credit
Unearned Interest Income 2,000
Utility Expense 12,000

Tax Payable ( payable in 4 months) 14,000
Purchase discount 40,000
Depreciation Expenses – Bldg. 10,000
Share Capital 450,000
Premium on share capital 12,000
Notes Receivable (trade) 65,000
Insurance Expense 8,000
Purchase returns 20,000
Allowance for Bad Debts 12,000
Purchases 350,000
Prepaid Interest Expense 2,000
Advertising expense 18,000
Salary Expense 92,000
Land 240,000
Interest Income 8,000
Building 400,000
Acc. Depreciation – Bldg. 34,000
Acc. Depreciation – Furniture and Equipt. 6,000
Unused Office Supplies 4,000
Accrued Rent Income 12,000
Sales returns and allowances 50,000
Merchandise inventory, Jan 1 20,000
Freight in 2,000
Freight out 8,000
Office Supplies Expense 14,000
Loss on sale of marketable securities 2,000
Tools 12,000
Cash 40,000
Rent Income 20,000
Transportation Expense 8,000
Salesmen commission 60,000
Bank loan payable (payable quarterly

P20,000) 200,000
Sales 700,000
________ ________
Total 1,766,000 1,766,000
Additional information: Merchandise inventory, December 31, 2020 – P30,000.

No dividends was declared in 2020
MULTIPLE CHOICE
Prepare the Income Statement and Statement of Financial Position for 2020 and indicate on the
blank, the amount of the correct answer.
___1 - The net sales is P __________________.

___2. - The other income is P ___________________.
___3. - The cost of goods sold is P ____________________.
___4. - The selling expense is P ____________________
___5. - The administrative expense is P _________________.
___6. - The finance cost is P ___________________.
___7.- The net income before tax is P _________________.
___8.- The net income after tax is P _____________________.
___9 – The total current assets is P ______________________.
___10 - The total non-current assets is P ___________________.
___11 - The total assets is P _____________________.
___12 - The total current liabilities is P ______________________.
___13 - The total non-current liabilities is P ____________________.
___14 - The total liabilities is P ______________________.
___15. - The retained earnings, 12/31/13 I P __________________
___16 - The total stockholders equity is P ____________________.

Chapter 5
Statement of Cash Flows
Learning Objectives
1. Prepare the cash flow statement using the direct method; and
2. Prepare the cash flow statement using the indirect method;
Philippine Accounting Standard (PAS) 7 - Cash Flow Statement
PAS 7 becomes effective for financial statements covering period beginning on or after January 1, 2005.
(Equivalent to International Accounting Standard 7)
The objective of this Standard is to require the provision of information about the historical changes in
cash and cash equivalents of an entity by means of a cash flow statement which classifies cash flows
during the period from operating, investing and financing activities.
Information about the cash flows of an entity is useful in providing users of financial statements with a
basis to assess the ability of the entity to generate cash and cash equivalents and the needs of the entity
to utilize those cash flows. The economic decisions that are taken by users require an evaluation of the
ability of an entity to generate cash and cash equivalents and the timing and certainty of their generation.
Cash flow statement is an integral part of an entity’s financial statements for each period for which
financial statements are prepared.
A cash flow statement is very useful when used in conjunction with the rest of the financial statements,
provides information that enable users to evaluate the changes in net assets of an entity, its financial
structure (including its liquidity and solvency) and its ability to affect the amounts and timing of cash
flows in order to adapt to changing circumstances and opportunities.
Definition of Terms
Cash comprises cash on hand and demand deposits (cash in bank).
Cash equivalents are short term, highly liquid investments that are readily convertible to known amounts
of cash and which are subject to an insignificant risk of changes in value. For purposes of measurement,
these are short term investments (trading securities) whose maturities is not more than 90 days.
Cash flows are inflows and outflows of cash and cash equivalents.
Inflow of cash means cash is received by the company or there is an increase in amount of cash
account. Inflow of cash is also called cash receipt.
Outflow of cash means cash is paid by the company or there is a decrease in the amount of cash
account. Out flow of cash also called cash payment or cash disbursement.
Cash flow statement was originally called the Statement of Sources and Uses of Cash.
Methods of Cash Flows
There are two methods in presenting operating activities: direct method and indirect method.
Direct Method
The direct method converts individual cash receipts and cash payments to cash inflows (sources of
cash) and cash outflow (usage of cash) only on OPERATING ACTIVITIES.
Indirect Method
The indirect method makes the necessary adjustments to net income to arrive at the net cash flow from
operating activities. The process necessitate the analysis of changes in balance sheet accounts.only on
OPERATING ACTIVITIES.
Classification of Cash Flow Activities

The inflow (sources) and outflow (uses) of cash are classified into three (3):
FINANCIAL STATEMENT COVERAGE
1. Cash flows from operating activities – Income Statement, Current Asset, Current Liabilities,
except on gain or loss on sale of short term investments (trading securities) and gain or loss on sale
of non-current asset or capital expenditures (CAPEX), in the current asset, except , trading
securities, in the current liabilities, except bank loan, current portion.
2. Cash flows from investing activities - Non-current asset or capital expenditures (CAPEX), and
short-term investment and long term investment.
3. Cash flows from financing activities – Non-current liabilities , Shareholders equity, bank loan,
short term and long term.
Cash flows from operating activities are the principal revenue-producing activities of the entity and
other activities that are not considered as investing or financing activities. This is essentially the
conversion of income statement items to inflow and outflow of cash. Operating activities are cash flows
that involves income statement accounts, current assets accounts (except cash and cash equivalents and
short term investments) and current liabilities accounts. This is the cash flow from the result of
operation.
Cash flows from investing activities are the acquisition and disposal of non-current assets and short
term and long term investments, not included in cash equivalents. Investing activities are cash flows that
involves, all investment accounts (short-term and long term), and buy and sell of all non-current assets.
Cash flows from financing activities are activities that result in changes in the size and composition of
the contributed equity and borrowings of the entity. Financing activities are cash flows that involve, all
non-current liabilities accounts, bank loans and equity accounts.
Direct Method - Specific Activity Classification:

The direct method shows where the cash comes from (inflows) and where the cash is used (outflows)
specifically as shown below:
Activities Inflows / Sources of Cash Outflows / Uses of Cash

__________ ____________________________ ______________________________
Operating 1. Cash receipts from customers / sales 1. Cash payments to suppliers / purchases
2. Cash receipts of dividend where the 2. Cash payment to employees
company is an investor 3. Cash payment for operating
3. Cash receipts of interest income expenses
where the company is the lender 4. Cash payment for interest
expense where the company is
the borrower/debtor
5. Cash payments for income taxes
_______________________________________________________________________
Investing 1. Cash receipts from sale of plant,

1. Cash payments for acquisition
property and equipment (NCA) plant, property, and equipment (NCA)
2. Cash receipts from sale of short-
2. Cash payments for the purchase
term and long-term investment of short-term and long-term
in securities investment in securities.
3. Cash receipts of principal loan 3. Cash payments to the borrower for
where the company is the lender principal of loan where the company
is the lender.
______________________________________________________________________
Financing 1. Cash proceeds from bank loan 1. Cash payments for the principal
where the company is the borrower of the loan where the company is the
borrower
2. Cash receipts from the sale of 2. Cash payments for dividends to
Of new shares of stocks the company’s own shareholders
( par value + premium)
3. Cash receipts from sale of 3. Cash payments for purchase of
treasury shares treasury shares. (buy back)
______________________________________________________________________
Illustration of How to prepare a Direct Method, Cash Flows Statement (SIMPLE)
Purchases is given; No Accrued Expenses; No loss on sale, and With Computation of Retained
earnings.
The Income Statement and comparative Statement of Financial Position of the Parisan Mo
Air Company, an industrial air company, are presented below:
Parisan Mo Company
Income Statement (Operating Activities)
For the Year Ended Dec. 31,2020
(P000)
INCOME:
Net Sales P291,600
Cost of Sales ( 145,800) Note 1 below
Gain on sale of trading securities 3,000 short term investment

Total income 148,800
EXPENSES:
Operating Expenses: (including depreciation
of P13,500) ( 114,600)
Finance costs: Interest expense ( 3,780)

Total expenses ( 118,380)
Net Profit before tax 30,420

Net Income P 21,294
Note 1: Cost of Sales

Purchases 140,400 ? 140,400
Add: Merchandise inventory, beg 56,700 ? 56,700
Total available for sale 197,100 ? 197,100
Less: Merchandise inventory, end 51,300 ? 51,300
Cost of Sales 145,800 ? 145,800
Note 2 Retained earnings 12/31/20
Retained earnings, 12/31/19 52,200 ? 52,200

Add: Net income for 2020 21,294 ? 21,294
Total 73,494 ? 73,494
Less: dividends paid 15,000 ? 15,000
Retained earnings, 12/31/20 58,494 ? 58,494
Parisan Mo Corporation
Comparative Statement of Financial Position
As of December 31, 2020 & 2019
(P000)
ASSETS 2020 2019
Current Assets (Operating Activities)
Cash and Cash Equivalents 25,254 27,360
Trading Securities (short term investment) 1,185 8,685 short term investment
Accounts Receivable 12,075 9,375
Merchandise Inventory 51,300 56,700
Total 89,814 102,120
Non-current Assets (Investing activities)

Furniture and equipment 133,200 91,440
Accumulated depreciation ( 40,500) ( 27,000)
Net 92,700 64,440
Total Assets P 182,514 P 166,560
LIABILITIES AND SHAREHOLDER'S EQUITY

Current Liabilities (Operating Activities)

Accounts Payable 2,520. 3,240
Income Tax Payable 2,400 1,350
Loan Payable (rolling loan) 7,500 5,580 (bank loan)
Total current liabilities 12,420 10,170
Non-Current Liabilities (Financing activities) - -
Shareholders’ Equity (Financing activities)

Share Capital 90,000 88,200
Share premium 21,600 15,990
Retained Earnings 58,494 52,200
Total Shareholders’ Equity 170,094 156,390
Total Liabilities and Shareholder's Equity P 182,514 P 166,560
Additional Information:
1. Furniture and equipment was purchased on December 28, 2020 for P41,760, COD. No
depreciation expense was charged in 2020 for this new acquisition
2. A portion of trading securities, a short-term investment, was sold with a cost of, P7,500.
3. Payment of a Loan payable that mature in November, 2020, P3,000.
4. A new loan was added in December, 2020.
5. A cash dividends was declared and paid in 2020.
MW 8:30 MW 10 MW 1 11/23/22 TF 7:00 11/25/00 TF 8:30 11/25/00 TF 10:00 11/25/22 TF 1:00

11/25
DIRECTION: Part 1: Answer all the questions below in a yellow pad and indicate your official
answers on the BLANK. Part 2: Prepare the Statement of Cash Flows in Good Form, (direct
method).
Part 1. Answer the following:

FROM OPERATING ACTIVITIES
1. How much is the cash receipts from sales? Answer: _______288,900
2. How much is the cash payment on purchases / supplier? Answer: _______(141,120)
3. How much is the cash payment for operating expenses? Answer: _______(101,100)
4. How much is the cash payment for interest expense? Answer: ________(3,780)
5. How much is the cash payment for income tax expense? Answer: ________(8,076)
6. How much is the net inflow (outflow) from operating activities? Answer: _______ 34,824x
FROM INVESTING ACTIVITIES (Non-current asset and investments)

7. How much is the cash payment for the acquisition of furniture? Answer: ______ (41,760)
8. How much is the cash proceeds from the sale of trading securities? Answer: __ 10,500
9. How much is the net inflow (outflow) from investing activities? Answer: _______(31,260) x
FROM FINANCING ACTIVITIES

10. How much is the payment for loan payable? Answer: ________(3,000)
11. How much is the proceeds from the new loan payable? Answer: ________ 4,920
12. How much is the cash receipt from the issuance of share capital? Answer: _______ 7,410
13. How much is the cash payment for dividend paid? Answer: _________ (15,000
14. How much is the net inflow (outflow) financing activities? Answer: _________ (5,670) x
CASH BALANCE
15. How much is the net inflow (outflow) for the whole year? Answer: _________(2,106) x
Add: Cash balance, beg 2019 27,360
Cash balance, end 2020 25,254
Part 2. Prepare the Statement of Cash Flows for the year ending December 31, 2020
Solution:
Part 1
1. Cash receipts from customers / sales
Sales 291,600
Account receivable, beg. 2019 9,375
Total be collected 300,975
Accounts receivable, end 2020 ( 12,075)
Cash received from customers/sales 288,900
2. Cash payment on purchases / suppliers

Purchases 140,400
Accounts payable, beg P 3,240
Total to be paid 143,640
Accounts payable, end ( 2,520)
Cash payment on purchases P141,120
3. Cash payment for operating expenses

Operating expenses P114,600
- Depreciation expense ( 13,500)
Operating expenses payable in cash P101,100
+ Prepaid, ending 0
+ Accrued, beg. 0
Total P 101,100
- Prepaid, beg. 0
- Accrued, end 0
Cash paid on operating expenses P 101,100
4. Cash payment for Interest expense

+ Interest payable, beg 0
total 3,780
- Interest payable, end 0
Interest expense paid P3,780
5. Cash payment for Income Tax Expense

Income taxes expense 9,126
+ Income tax payable, beg 1,350
Total 10,476
- Income tax payable, end ( 2,400)
Cash paid on income tax P8,076
6. Net Inflows (Outflows) from Operating Activities
Cash receipts from sales 288,900

Cash payment on purchases (141,120)
Cash payment on operating expenses (101,100)

Cash payment on interest expense ( 3,780)
Cash payment on income tax expense ( 8,076)
Net inflows (outflows) from operating activities 34,824
7. Cash payment for furniture and equipment (41,760) given
8. Proceed from sale of trading securities

Cost of trading securities 7,500
+ gain on sale of trading securities 3,000
Proceed from sale of trading securities 10,500
* All gain on sale of short term and long term investments (excluding cash equivalents) is included
in the investing activities.
9. Net inflows (outflows) from investing activities
Cash payment for furniture purchase (41,760)

Cash proceeds from sale of trading securities 10,500
Net inflows (outflows) from investing activities (31,260)
10. Payment for loan payable (given) ( P3,000)
11. Proceeds from new loan payable

Loan payable, (loan) December 31, 2019 5,580
Less: payments of notes payable, November, 2020 3,000
Loan payable balance before any new borrowings in 2020 2,580
Compared: Loan payable balance, December 31, 2020 7,500
Amount of new borrowings (loan) in Dec. 2020 4,920
12. Amount of dividends paid in 2020

Retained earnings, December 31, 2019 52,200
Add: Net income, 2020 21,294
Total retained earnings before payment of dividends 73,494
Less: Retained earnings, December 31, 2020 58,494
Dividends paid during 2020 / 15,000
13. Proceeds from issuance of shares of stocks

Share capital balance, 12/31/2020 90,000
Share premium balance, 12/31/2020 21,600
Total 111,600
Less: Share capital balance, 12/31/2019 88,200

Total 104,190
Proceeds from sale of shares of stocks in 20120 7,410
14. Net inflows (outflows) for financing activities

Payment for loan payable ( 3,000)

Proceeds from new loans payable 4,920
Payment of cash dividend ( 15,000)
Proceeds from issuance of share capital 7,410
Net inflows (outflows) financing activities ( 5,670)
15. Cash Flows for the Year ending December 31, 2020
Cash inflow (outflow) from operating activities 34,824

“ “ “ from investing activities ( 31,260)
“ “ “ from financing activities ( 5,670)
Net inflow (outflow) for the year 2020 ( 2,106)
Cash balance 12/31/19 27,360
Cash balance 12/31/20 end 25,254
Part 2
(Direct Method)
For the Year Ending December 31, 2020
Cash Flows from Operating Activities
Cash receipts from sales 288,900

Cash payment on purchases (141,120)
Cash payment on operating expenses (101,100)
Cash payment on interest expense ( 3,780)
Cash payment on income tax expense ( 8,076)
Net inflows (outflows) from operating activities 34,824
Cash Flows from Investing Activities
Cash payment for furniture purchase (41,760)

Cash proceeds from sale of trading securities 10,500
Net inflows (outflows) from investing activities (31,260)
Cash Flows from Financing Activities

Payment for loan payable ( 3,000)
Proceeds from new loans payable 4,920
Proceeds from issuance of share capital 7,410
Net inflows (outflows) financing activities ( 5,670)

Cash balance 12/31/19 27,360
Cash balance 12/31/20 end 25,254
12/5/22
Indirect Method
Indirect method may be used for cash flows from Operating Activities only. Indirect method is not used
for cash flows from investing and financing activities. The direct method is always used for cash flows
from investing and financing activities.
When indirect method is used, according to GAAP, it is called Reconciliation of net income to net
cash flows of operating activities. This reconciliation is called the indirect method of cash flow from
operating activities.
The indirect method is easier to prepare because it involves: 1) non-cash expenses, such as
depreciation expense, depletion expense, amortization expense of intangible assets, amortization of
premium on bond investment, amortization of discount on bond investment 2) gain on sale of an asset,
3) Loss on sale of an asset or investment and 4) changes (increase (decrease) in the balances of each
current assets and current liabilities account, except cash and current investments, from last year to this
year. All we have to do is to note down the increase or decrease of each accounts and we can now
prepare the indirect method of cash flows on operating activities.
Inflow or Outflow
Simple rules to follow to determine if the changes in balances of an account is an inflow or an outflow:
1. Rule on current assets.

An increase in current assets (except cash account and marketable or trading securities) is an
outflow. Consequently, a decrease in current assets (except cash account and marketable or
trading securities) is an inflow.
2. Rule on current liabilities

An increase in current liabilities is an inflow, while a decrease in current liabilities is an outflow.
Explanation:
1. Increase in current assets.
When the company bought merchandise inventory for cash, there will be an increase in
Merchandise inventory account, consequently, there will be payment, an out flow of cash.
2. Decrease in current assets
When the company collected its accounts receivable account, there was a decrease
in accounts receivable. Thus, there was be an inflow of cash.
3. Increase in current liabilities
When the company made a short-term borrowing (note payable, for example) from
the bank, the notes payable account will increase, consequently, the company have
received cash from the bank, an inflow.
4. Decrease in current liabilities

When the company paid its accounts payable to suppliers, the accounts payable
decreased, and thus, there was an outflow of cash.
5. Net result with the simultaneous increase in current assets and increase in current
liabilities
When the company bought merchandise inventory on account, there will be an increase in
merchandise inventory account. Since the term is on account, there will be an
increase in accounts payable account. The result is a simultaneous outflow and an
inflow resulting in a no cash flow at all because they will offset each other.
Proforma Indirect Method – Operating Activities
There are two presentations:

1. Presentation 1 – start with the net income before income tax expense.
This presentation is in accordance with the Philippine Financial Reporting Standard (PFRS) where
the computation start at net income before deducting the income tax expense. This presentation
should be used in reporting to the financial statement users of the company.
2. Presentation 2 – start with the net income after deducting income tax expense.
This presentation should be used in solving cash flow problem in school because it is easier to use.
Presentation No. 2 Pro-forma Presentation
Always use this Format to facilitate the Presentation of Statement of Cash Flows :
Remark
1) Net income after tax P xxx
Adjustments for:
2)+Depreciation expense xxx Non-cash expense
Depletion expense xxx Non-cash expense
Amortization expense – intangible assets xxx Non-cash expense
Amortization of premium of bond investment xxx Non-cash expense
Amortization of discount of bond investment ( xxx) Non-cash income
3)+ Loss on sale of a non-current asset xxx Investing activities
4)- Gain on sale of current and non-current investment (xxx) Investing activities
Operating cash income before changes in

Working Capital xxx
5)Changes in working capital (CA-CL)

Increase in current asset (except current investment) (xxx)
Decrease in current asset (except current investment) xxx
Increase in current liabilities (except loan payable) xxx
Decrease in current liabilities (except loan payable) ( xxx)
Net cash inflow (outflow) from operating activities P xxx
Illustration: Indirect Method

Using the same problem in the Direct Method (pp. 102-104), prepare the Cash flows from Operating
Activities using the INDIRECT METHOD
1st. Compute the increase (decrease) of Current Assets and Current Liabilities
Increase (Decrease) of Current Assets and Current Liabilities
2020 2019 Increase

Current Assets ( Decrease)
x Trading Securities (short term investment) 1,185 8,685 ( 7,500) investing x
Accounts Receivable 12,075 9,375 2,700 O

Merchandise Inventory 51,300 56,700 ( 5,400) I
Total 89,814 102,120
Current Liabilities
Accounts Payable 2,520. 3,240 ( 720) O
Income Tax Payable 2,400 1,350 1,050 I
x Loan Payable (rolling loan) 7,500 5,580 1,920 financing x
Total current liabilities 12,420 10,170
Note: Do not use the increase (decrease) of trading securities because it is included in investing activities.
Also, do not use the increase (decrease) of loan payable because it is included in financing
activities.
2nd Follow the format above and then fill up the amount.
(Indirect Method)

Remark
Net income after tax P21,294
Adjustments for:
Depreciation expense 13,500 Non-cash expense
Gain on sale of trading securities (3,000) Investing activities
______
Working Capital 31,794
Changes in working capital (CA-CL)

Increase in accounts receivable (2,700)
Decrease in inventory 5,400
Increase in income tax payable 1,050
Decrease in accounts payable ( 720)
Net cash inflow (outflow) from operating activities P34,824
Comprehensive Illustration: Purchases is not known, there is accrued expenses and

prepaid expenses, plant assets acquired is not known, trading securities acquired is not
known, the amount of new borrowing is not given, the amount of cash dividends is not
known.
The Income Statement and comparative Statement of Financial Position of the Majirup Itoh
Corporation are presented below: (In Thousands)
Majirup Itoh Corporation

Income Statement
(P000)
Income:
Net Sales P48,600
Cost of Goods Sold ( 24,300)
Gross Profit 24,300
Other Income:
Gain on Sale of trading securities 510

of P2,250) ( 18,600)
Other expenses: Loss on sale of plant assets ( 180)

Finance costs: Interest expense ( 630)
Total expenses (19,410)

Net Income P 3,900

Comparative Statement of Financial Position
(P000)
ASSETS 2020 2019

Current Assets
Trading Securities 3,225 2,895
Accounts Receivable 4,025.25 3,125.25
Inventory 8,550 9,450
Prepaid Expenses 630 540
Total 18,890.25 21,920.25
Non-current Assets
Plant, properties and equipment (net) 17,700 10,740
Total Assets P 36,590.25 P 32,660.25
LIABILITIES AND STOCKHOLDER'S EQUITY

Current Liabilities
Accounts Payable 840.0 1,080.0
Accrued Interest Payable 270.0 210.0
Accrued Expense Payable 652.5 862.5
Accrued Income Tax Payable 327.75 447.75
Non-trade Notes Payable (Loan) 1,500.0 1,860.0

Total current liabilities 3,590.25 4,460.25
Non-Current Liabilities - -
Total Shareholders’ Equity 33,000 28,200
Total Liabilities and Shareholder's Equity P 36,590.25 P32,660.25
Additional Information: (P000)

1. The book value of plant assets sold is P540
2. The cost of trading securities sold is P570
3. Partial payment of Notes Payable - P1,380
MULTIPLE CHOICE
INSTRUCTION: After preparing the Cash Flows Statement answer the following questions by writing the
letter of the correct answer on the blank before each number. (P000)
___1. The cash receipts from customers is

a. P 47,750.25 b. P47,700.00 c. P48,700d. P48,750.25 e. P47,500.25 f. None of these
___2. The cash payments to suppliers is

a. P 23,640.00 b. P22,640.00 c. P23,650.00 d. P22,650.00 e. P23,630.00 f. None of these
___3. The cash payment for operating expenses is

a. P 16,670.00 b. P15,640.00 c. P16,660.00 d. P16,640.00 e. P16,650.00 f. None of these
___4. Cash payment for interest expense is

a. P 555 b. P560 c. P565 d. P570 e. P575 f. None of these
___5. Cash payment for income tax is

a. P 1,619 b. P1,629 c. P1,620 d. P1,621 e. P1,622 f. None of these
___6. The net inflows (outflows) from operating activities is

a. P7,220 b. P5,220 c. (P7,220) d. (P5,220) e. P7,225 f. None of these
___7. The cash proceeds from sale of plant assets is

___8. The cash payment for the acquisition of new plant assets is
___9. Cash proceeds from the sale of marketable securities is

___10. Cash payment for the purchase of new marketable securities

a. P750 b. P900 c. P950 d. P850 e. P 920 f. None of these
___11. The net inflows (outflows) from investing activities is

a. (P 9,750) b. (P11,210) c. (P9,210) d. (P11,850) e. (P9,620) f. None of these
___12. Cash proceeds from new notes payable (new loan)

___13. Cash proceeds from issuance of new shares of stocks

___14. Cash payment for partial payment of notes payable (old loan)
___15. Cash payment for dividends to share holders is

___16. The net inflows (outflows) from financing activities is

___17. The working capital as of December 31, 2020 is

SOLUTION
(Direct Method)

Cash receipt from customers P 47,700
Cash payments to suppliers ( 23,640)
Cash payment for operating expenses (16,650)
Cash payment for interest expense ( 570)
Cash payment for income tax ( 1,620)
Net cash inflow (outflow) from operating activities P 5,220
Cash Flows from Investing Activities

Cash proceeds from sale of plant assets 360
Cash proceeds from the sale of marketable securities 1,080
Cash payments for additional plant assets ( 9,750)
Cash payment for purchase of marketable securities ( 900)
Net cash used in investing activities (9,210)
Cash Flows from Financing Activities

Cash proceeds from new notes payable 1,020
Cash proceeds from the issuance of shares of stocks 2,700
Cash payments for partial payments of notes payable ( 1,380 )
Cash payments for dividends ( 1,800 )
Net cash from financing activities 540
Net Decrease in Cash and Cash Equivalents for the year, 2020 (3,450 )
Cash and Cash Equivalents, at the beginning. 1/01/2020 5,910

Cash and Cash Equivalents, at the end 12/31/20 P 2,460
See computations below:
1. Cash receipts from customers

Sales 48,600.00
Account receivable, beg. 3,125.25

Total 51,725.25
Accounts receivable, end 4,025.25
Cash received from customers 47,700.00
2. Purchases
Cost of goods sold P24,300
Inventory, end 8,550
Total 32,850
Inventory, beginning 9,450
Purchases P23,40
3. Cash paid to suppliers

Accounts payable, beg P 1,080
Purchases 23,400
Total 24,480
Accounts payable, end 840
Cash paid to suppliers P23,640
4. Cash paid for operating expenses

Operating expenses P18,600*
- Depreciation expense 2,250
Cash operating expenses P16,350
+ Prepaid, ending 630
+ Accrued, beg. 862.5
Total P 17,842.5
- Prepaid, beg. 540
- Accrued, end 652.5
Cash paid on operating expenses P 16,650.0
* this amount do not include the loss on sale of plant asset amounting to P180 because it is
included in the investing activities.(see no. 7 below)
5. Interest expense paid

Interest expense 630
+ Interest payable, beg 210
total 840
- Interest payable, end 270
Interest expense paid P 570
6. Income Taxes paid

Income taxes expense 1,500.00
+ Income tax payable, beg 447.75
Total 1,947.75
- Income tax payable, end 327.75
Cash paid on income tax P1,620.00
7. Cash proceed from sale of plant assets

Book value 540
- Loss on sale of plant assets 180
Cash proceed 360
8. Proceed from sale of trading securities

Cost of trading securities 570

+ gain on sale of trading securities 510
Proceed from sale of trading securities 1,080
* All gain on sale of short term and long term investments (excluding cash equivalents) is included
in the investing activities.
9. Amount paid for plant, property and equipment acquired in 2020

Net, Plant property and equipment, December 31, 2019 10,740
Less: Book value of plant assets sold 540
Depreciation expense for 2020 2,250
Total 2,790
Net, Plant, property and equipment in 2020 before
any new acquisitions 7,950
Net plant, property and equipment, December 31, 2020 17,700
New acquisition of plant, property and equipment in 2020 paid 9,750
10. Amount of trading securities purchased and paid in 2016

Trading securities, December 31, 2019 2,895
Less: Cost of trading securities sold 570
Trading securities balance before any new acquisitions in 2020 2,325
Trading securities balance, December 31, 2020 3,225
Cost of newly acquired trading securities paid in 2020 900
11. Amount of new borrowings in 2020

Non-trade notes payable, (loan) December 31, 2019 1,860
Less: payments of notes payable 380
Notes payable balance before any new borrowings in 2020 1,480
Less: Notes payable balance, December 31, 2020 1,500
Amount of new borrowings (loan) in 2020 20
12. Amount of dividends paid in 2020

Retained earnings, December 31, 2019 8,700
Add: Net income, 2020 3,900
Total retained earnings before payment of dividends 12,600
Less: Retained earnings, December 31, 2020 10,800
Dividends paid during 2020 1,800
13. Proceeds from issuance of shares of stocks

Share capital balance, 12/31/20120 15,000
Total 22,200
Less: Share capital balance, 12/31/2019 14,700

Total 19,500
Proceeds from sale of shares of stocks in 2020 2,700
17. The working capital as of December 31, 2020
Current asset, 2020 P 18,890.25

Current liabilities, 2020 3,590.25
Working capital, 2020 P 15,300.00
Indirect Method
Indirect method may be used for cash flows from Operating Activities only. Indirect method is not used
for cash flows from investing and financing activities. The direct method is always used for cash flows
from investing and financing activities.
When indirect method is used, according to GAAP, it is called Reconciliation of net income to net
cash flows of operating activities. This reconciliation is called the indirect method of cash flow from
operating activities.
The indirect method is easier to prepare because it involves: 1) non-cash expenses, such as
depreciation expense, depletion expense, amortization expense of intangible assets, amortization of
premium on bond investment, amortization of discount on bond investment and 2) changes in the
balances of each current assets and current liabilities account, except cash and current investments,
from last year to this year. All we have to do is to note down the increase or decrease of each accounts
and we can now prepare the indirect method of cash flows on operating activities.
Rule - Inflow or (Outflow)
Simple rules to follow to determine if the account is an inflow or an outflow:
1. Rule on current assets.

An increase in current assets (except cash account and marketable or trading securities) is an
outflow. Consequently, a decrease in current assets (except cash account and marketable or
trading securities) is an inflow.
2. Rule on current liabilities

An increase in current liabilities is an inflow, while a decrease in current liabilities is an outflow.
Explanation:
1. Increase in current assets.
When the company bought merchandise inventory for cash, there will be an increase in
Merchandise inventory account, consequently, there will be payment, an out flow of cash.
2. Decrease in current assets
When the company collected its accounts receivable account, there was a decrease
in accounts receivable. Thus, there was be an inflow of cash.
3. Increase in current liabilities
When the company made a short-term borrowing (note payable, for example) from
the bank, the notes payable account will increase, consequently, the company have
received cash from the bank, an inflow.
4. Decrease in current liabilities
When the company paid its accounts payable to suppliers, the accounts payable
decreased, and thus, there was an outflow of cash.
5. Net result with the simultaneous increase in current assets and increase in current
liabilities
When the company bought merchandise inventory on account, there will be an increase in
merchandise inventory account. Since the term is on account, there will be an
increase in accounts payable account. The result is a simultaneous outflow and an
inflow resulting in a no cash flow at all because they will offset each other.
Proforma Indirect Method – Operating Activities
There are two presentations:

1. Presentation 1 – start with the net income before income tax expense.
This presentation is in accordance with the Philippine Financial Reporting Standard (PFRS) where
the computation start at net income before deducting the income tax expense. This presentation
should be used in reporting to the financial statement users of the company.
2. Presentation 2 – start with the net income after deducting income tax expense.
This presentation should be used to facilitate solving cash flow problem because it is easier to use.
Presentation No. 2 Pro-forma Presentation
Always use this Format in for the Proper Presentation of Statement of Cash Flows in the
preparation of Financial Statements.
Remark
Net profit before tax Pxxx
Adjustments for:
Depreciation expense xxx Non-cash expense
Depletion expense xxx Non-cash expense
Amortization expense – intangible assets xx Non-cash expense
Amortization of premium on bond investment xx Non-cash expense
Amortization of discount on bond investment ( xx) Non-cash contra-
expense
Loss on sale of non-current assets xxx Investing activities
Gain on sale of current and non-current
Investments (xxx) Investing activities

Working Capital xxx
Changes in working capital (CA-CL)

Increase in current assets (except current investment) (xxx)
Decrease in current assets (except current investment) xxx
Increase in current liabilities (except loan payable) xxx
Decrease in current liabilities (except loan payable) ( xxx)
Cash inflow (outflow) operating activities xxx

Illustration, Indirect Method
Procedure using Indirect Method – From Operating Activities

Using the information below, prepare the Cash Flow from Operating Activities using the Indirect
Method.

Income Statement
(P000)
Income:
Net Sales P48,600
Cost of Goods Sold ( 24,300)
Gross Profit 24,300
Other Income:
Gain on Sale of trading securities 510

of P2,250) (18,600)
Other expenses:
Loss on sale of plant assets ( 180)
Finance costs: Interest expense ( 630)

Net Income P 3,900
The steps to follow in the indirect method are:

1. Start with the net income.
2. Adjustments to reconcile net income to net cash that includes, a) additions: depreciation
expense, depletion expense, amortization expense of intangible assets, losses on sale of
investments and non-current assets; b) deductions: gains on sale of investments and non-
current assets.
3. Increase (decrease) of current assets and current liabilities.
Increase in current assets means outflow while a decrease in current assets means inflow.
Increase in current liabilities means inflow while a decrease in current liabilities means
outflow.
Compute the increase (decrease) of all current balance sheet accounts.
2020 2019 Increase

Current Assets (Decrease)
Trading Securities (investing activities) 3,225.00 2,895.00 330
Accounts Receivable, net 4,025.25 3,125.25 900
Inventory 8,550.00 9,450.00 ( 900)
Prepaid Expenses 630.00 540.00 90
Current liabilities
Accounts Payable 840.00 1,080.00 ( 240)
Accrued Interest Payable 270.00 210.00 60
Accrued Expense Payable 652.50 862.50 ( 210)
Income Tax Payable 327.75 447.75 ( 120)
Presentation 2 - Starting from the Net Income After Income Tax (The easier version)
(Indirect Method)
Cash Flows Statement
For the Year Ending December 31,2020
(P000)
Cash Flow from Operating Activities: Inflow

(Outflow)
Net income after income tax 3,900

Adjustments to reconcile net income to net cash:
Depreciation expense (non-cash expense) 2,250
Loss on sale of plant assets (investing activities) 180
Gain on sale of trading securities ( investing activities) ( 510)
Net cash operating income 5,820
Changes in working capital:

Increase in accounts receivable (current asset) ( 900)
Decrease in inventory (current asset) 900
Increase in prepayments (current asset) ( 90)
Decrease in accounts payable (current liabilities) ( 240)
Increase in interest payable (current liabilities) 60

Decrease in income tax payable (current liabilities) ( 120)
Decrease in accrued expense payable (current liabilities) ( 210)
Cash Inflow from Operating activities 5,220

Solve the following Exercises
Cash Flows
Easy
5-1 Classification of cash flows
Listed below are several transactions that typically produce either an increase or a decrease in cash.
Indicate by letter whether the cash effect of each transaction is reported on the statement of cash flows
as and operating (O), investing (I), or financing (F) activity.
______ ___________T R A N S A C T I O N S_____________

______ 1. Sale of common stock
______ 2. Sale of land
______ 3. Sale of merchandise
______ 4. Purchase of treasury stock
______ 5. Purchase of property and equipment
______ 6. Purchase of raw materials inventory
______ 7. Issuance of long term notes payable
______ 8. Issuance of trade notes payable
______ 9. Issuance of stock dividend to share holders
______ 10. Payment of principal of long term notes payable
______ 11. Payment of principal of trade notes payable
______ 12. Payment of employees’ salaries
______ 13. Payment of acquisition of bonds of another corporation
______ 14. Payment of semi-annual interest of bonds payable of the corporation.
______ 15. Payment of cash dividend.
______ 16. Collection of accounts receivable trade.
______ 17. Collection of principal of notes receivable where the corporation is
the lender.
______ 18. Collection of interest on notes receivable where the corporation is the
lender.
______ 19. Loan to another firm.
______ 20. Redemption of redeemable preferred stock.
______ 21. Gain on sale of plant, property and equipment.
______ 22. Loss on sale of long term investment.
______ 23. Loss on inventory due to flood.
______ 24. Loan from another firm.
______ 25. Income tax expense.
5-2 Indirect Method
The following items were taken from the records of Wang - Wang Company for 2020:
a. The profit after income tax expense of P780,000 was P1,820,000;

b. Payment for purchase of land, P400,000;
c. Payment for retirement of bonds, P600,000;
d. Depreciation expense, P750,000;
e. Proceeds from issuance of ordinary shares, P700,000;
f. Share of profit of subsidiary, P480,000;
g. Patent amortization expense, P270,000;
h. Interest expense, P100,000;
i. Increase in Accounts Receivable, P340,000;

j. Payment of dividends, P500,000;
k. Decrease in Accounts Payable, P26,000;
l. Increase in Interest Payable, P18,000; and
m. Increase in Income Tax Payable, P60,000.
Required: Prepare the operating activities section of Wang – Wang Company’s Statement
of Cash Flows, using the Indirect Method.
5-3 Direct Method
The following items were taken from the records of Wang – Wang Company for 2020:
a. Payment of interest, P82,000;

b. Proceeds from the sale of land, P79,000;
c. Payment of dividends, P121,000;
d. Depreciation expense, P24,000;
e. Collections from customers, P983,000
f. Payments of income taxes, P154,000;
g. Proceeds from issuance of ordinary share capital, P189,000;
h. Payments to suppliers and employees, P675,000; and
i. Increase in inventories, P46,000.
Required: Prepare the operating activities section of Wang – Wang Company’s Statement
of Cash Flows, using the Direct Method.
Medium 1
Multiple Choice Instruction: Circle the letter of the correct answer.
5-4 Indirect Method (PhilCPA)
The net income for the year ended December 31, 2020 for Roger Corporation was P3,520,000.
Additional data are as follows:
Purchase of plant assets 2,800,000

Depreciation of plant assets 1,480,000
Dividends declared 970,000
Net decrease in non-cash current asset 290,000
Loss on sale of equipment 130,000
What should be the cash flow provided by operating activities in Roger’s cash flow statement for the year
ended December 31, 2020 using the indirect method?
5-5 Indirect Method (PhilCPA)
The net income for the year ended December 31, 2020 for Home Corporation was P90,000.
Additional data are as follows:
Decrease in accounts payable 5,400

Depreciation of plant assets 54,000

Dividends paid on common stock 31,500
Loss on bonds retired 23,400
Home should report cash provided by operation in its 2020 cash flow statement at
Difficult
5-6 Investing and Operating (AICPA)
Karr Corporation reported net income of P3,000,000 for 2020.

Changes occurred in several balance sheet accounts as follows:
Equipment 250,000 increase
Accumulated depreciation 400,000 increase
Note payable 300,000 increase
 During 2020 Karr sold equipment costing P250,000, with accumulated depreciation of P120,000
for a gain of P50,000
 In December, 2020, Karr purchased equipment costing P500,000 with P200,000 cash and a 12%
note payable of P300,000
 Depreciation expense for the year was P520,000
1. In Karr’s 2020 cash flow statement, net cash used in investing activities should be
a. (P20,000) b. P120,000 c. P 20,000 d. (P120,000) e. P350,000 f. None of these
2. In Karr’s 2020 cash flow statement, the net cash provided by operating activities is
5-7 Cash Flow Statement 11/28/22 HW MW 8:30
Mr. Loco, the owner of Luco-moco Trading asked you to prepare the cash flow statement for 2020. You
were given the 2020 Income Statement and comparative Balance Sheets for 2019 and 2020 and are
presented below: (In Thousands)
Income Statement
For the Year Ended Dec. 31,2020 (P000)
Revenue:
Net Sales 194,400
Cost of Goods Sold (97,200)
Gross Income 97,200
Gain on Sale of marketable securities 2,040
Total Revenue 99,240
Operating Expenses (including depreciation

of P9,000) 74,400
Interest Expense 2,520
Income Taxes 6,000
Loss on sale of plant assets 720
Total expenses 83,640
Net Income P 15,600
Balance Sheet
(P000)
2020 2019
Marketable Securities 12,900 11,580
Accounts Receivable 16,101 12,501
Inventory 34,200 37,800
Prepaid Expenses 2,520 2,160
Plant, properties and equipment (net) 70,800 42,960
Total Assets P 146,361 P 130,641
LIABILITIES AND STOCKHOLDER'S EQUITY

Accounts Payable 3,360 4,320
Accrued Interest Payable 1,080 840
Accrued Expense Payable 2,610 3,450
Accrued Income Tax Payable 1,311 1,791
Notes Payable 6,000 7,440
Additional Paid-In Capital (Premium) 28,800 19,200
Total Liabilities and Stockholder's Equity P 146,361 P130,641
Additional Information: (P000)

1. The book value of plant assets sold is P2,160
2. The cost of marketable securities sold is P2,280
3. Partial payment of Notes Payable – P5,520
INSTRUCTION: Prepare the Statement of Cash Flows (direct method) and answer the following
questions by writing the letter of the correct answer on the blank.
___1. The cash receipts from customers is

___2. The cash payments to suppliers is

___3. The cash payment for operating activities is

___4. Cash payment for interest is

___5. Cash payment for taxes is

___6. The net inflows (outflows) from operating activities is

a. P19,180 b. P20,880 c. (P20,010) d. P21,080 e. P20,450 f. None of these
___7. The cash proceeds from sale of plant assets is

___8. The cash payment for the acquisition of new plant assets is
___9. Cash proceeds from the sale of marketable securities is

___10. Cash payment for the purchase of new marketable securities

___11. The net inflows (outflows) from investing activities is

a. (P 35,840) b. (P36,080) c. (P36,840) d. (P37,040) e. (P37,740) f. None of these
___12. Cash proceeds from new notes payable

___13. Cash proceeds from issuance of new shares of stocks

___14. Cash payment for partial payment of notes payable

___15. Cash payment for dividends is

___16. The net inflows (outflows) from financing activities is

5-8 Indirect Method of Cash Flows
From the information in 5-7, above, prepare the Reconciliation of Net Income to Net Cash Flows (Indirect
Method) for Operating activities of Luco-moco Trading.
5-9 Indirect Method to Direct Method
The income statement of Maalala Sana Corporation and the Schedule of Reconciliation of Net Income to
Net Cash Flows are provided below.
Maalala Sana Corporation

Income Statement
Sales P 305,000
Cost of goods sold ( 185,000)
Gross margin 120,000
Salaries and wages ( 41,000)

Insurance expense ( 19,000)
Depreciation expense ( 11,000)
Loss on sale of land ( 5,000)
Total expenses ( 76,000)
Net income before tax 44,000

Income tax expense ( 22,000)
Net income 22,000

Reconciliation of Net Income to Net Cash Flows from Operating Activities
Net income 22,000
Adjustments for non cash effects:

Depreciation expense 11,000
Loss on sale of land 5,000
Changes in current assets and current liabilities:

Decrease in accounts receivable 6,000
Increase in inventory (13,000)
Decrease in accounts payable ( 8,000)
Increase in salary payable 5,000
Decrease in prepaid insurance 9,000
Increase in income tax payable 20,000
Net cash inflow from operating activities 57,000
Required: Calculate each of the following for Maalala Sana Corporation.

Multiple Choice: Encircle the letter of the correct answer.
1. Cash received from the customers during the period is

2. Cash paid to suppliers of goods during the period is

3. Cash paid to employees during the period is

4. Cash paid for insurance during the period is

5.Cash paid for income taxes during the period is

a. P22,000 b. P20,000 c. P0 d. P2,000 e. None of these
5-10 Cash Receipt from Customers
The following was taken from the 2020 financial statements of Tulala Ka Company:
1. Total sales is P4,380,000 of which P3,380,000 is on credit.

2. Bad debts expense for 2020 was P10,000.
3. Accounts receivable: January 1 - P216,000; December 31 - P304,000
4. No accounts receivable were written off or recovered during the year.
5. Allowance for bad debts: January 1 – 100,000; December 31, P110,000.
What is the amount of cash collected from customers during 2020?

5-11 Operating Expenses

Guniguni Mo Corporation’s Prepaid Advertising was P500,000 as at December 31, 2020 and P250,000
as at December 31, 2019. Advertising Expense was P200,000 for 2020 and P150,000 for 2019.
What was the amount of cash disbursed for advertising reported in Guniguni’s Statement of Cash Flows
in 2020?
5-12 Depreciation Expense and Newly Purchased Machinery
Pasikut-sikot Corporation is preparing its Statement of Cash Flows for the year ending December 31,
2020. It has the following account balances:
December 31, 2019 December 31, 2020

Plant assets P2,500,000 P3,200,000
Accumulated depreciation 1,020,000 1,200,000
Loss on sale of plant assets 40,000
During 2020, Pasikut-sikut sold for P260,000, plant asset that cost P400,000 and purchased several
items of plant assets.
What is the depreciation expense for 2220?

How much is the cost of machinery purchased during 2020?

a. P340,000 b. P700,000 c. P960,000 d. P1,100,000 e. None of these
5-13 Indirect Method
Matalino Corporation’s statements of financial position as of December 31, 2020 and 2019 and
information relating to 2020 activities are presented below:
12/31/20 12/31/19
Cash and cash equivalents P 530,000 P 100,000

Accounts receivable (net) 510,000 510,000
Inventory 680,000 600,000
Long-term investments 200,000 300,000
Property, plant and equipment 1,700,000 1,000,000
Accumulated depreciation ( 450,000) ( 450,000)
Goodwill 90,000 100,000
Total assets P3,260,000 P3,160,000
Accounts payable P 705,000 P 680,000

Accrued expenses 120,000 40,000
Notes payable to bank 325,000 -
Ordinary share, P10 par 800,000 700,000
Retained earnings 940,000 490,000
Total liabilities and equity P3,260,000 P3,160,000
 The net income for the year was P690.000
 Cash dividends of P240,000 were declared and paid in 2020.
 Equipment costing P400,000 and having a carrying amount of P150,000 was sold for P150,000.
 A long term investment was sold for P135,000. There were no other transaction affecting these
investments in 2020.
What is the net cash flow from operating activities in 2020?

What is the net cash flow from investing activities in 2020?

a. P1,115,000 b. P895,000 c. P865,000 d. P815,000 e. None of these
What is the net cash flow from financing activities in 2020?

Chapter 6
BUDGETING
Learning Objectives
At the end of this chapter, the student should be able to:
a. define corporate planning, strategic planning, tactical planning, zero-base budgeting,

incremental budgeting, master budget, rolling budget, and other terms given in the chapter.
b. compute for expected value of sales estimates, and budgeted figures for
production volume, materials usage, materials purchases, materials cost, labor hours, direct labor
cost, fixed and variable factory overhead cost, inventories, cost of goods manufactured, cost of
good sold, operating expenses, and financing charges; and finally
c. state how budgeted financial statements are used in controlling operations activities.
Corporate Planning
In any task, to attain an objective, an intelligent forecasting is necessary to visualize what will happen in
the future. Also, in order to ascertain what one wishes to attain, the first thing to do is to determine the
activities and resources needed to achieve those intended results. The second thing to do is to determine
how much cash is needed and if there is a need to borrow. If the process is complex, the means to
achieve those results should be documented because of the human tendency to forget and the difficulty
of mentally processing many facts and relationship at the same time.
One of the most important tool of management of large and growing corporation is the PLANNING
PROCESS. Planning is the cornerstone of effective management, and effective planning requires that
managers must predict, with reasonable precision, the key variables that affect company performance
and condition. These predictions provide management a foundation for effective resource allocation and
effective control of operation.
Strategic Planning
Strategic planning is the process of making long term organizational goals. Managers who plan on a long-
range basis (5 to 10 years) are engage in strategic planning. During the strategic planning process,
managers agreed on a long-range organizational goals and objectives and on how to achieve them.
Normally, long term goals are stated in an abstract and qualitative achievements such as: 1. “To become
the market leader in 5 years”; 2. “To become the biggest company in the Philippines in terms of assets in
10 years”
An example is the San Miguel Corporation. In the nineties, San Miguel Corporation strategic plan was to
be the biggest food company in the Philippines. They were able to attain its goal. Last decade, San
Miguel Corporation strategic plan is to diversify into energy, infrastructure, telecommunications and
transportation industry. They are now in energy, expressways, airports, and even tried to buy the
Philippine Air Lines from Lucio Tan but failed. It seems they are doing good with their strategic plan. Their
bottom line is getting better and the market price of their shares of stocks are increasing in the stock
market. The stockholders are very happy with the performance of the present top management.
On the other hand, long term objectives are stated as desired quantifiable results to attain such long
term goals just like the following: 1. “To increase the production capacity of a particular product to
1,000,000 units per month within 5 years”; 2. “To increase our branches from 10 branches, at present, to
50 branches in 4 years.”
Tactical Plan
After setting up the strategic plan, the next step is to divide this period into short term period, normally a
year. Each year is the stepping stone toward the long-term goals and objectives, this is the tactical plan.
Tactical planning is the process of making short term organizational goals and objectives. During the
tactical planning process, managers will come up with a tactical strategy to attain its tactical plan. A
tactical plan is an annual strategy. It is an integration of all organization’s important marketing, operations
and financial policies and programs into a cohesive whole to attain its annual goals and objectives. The
tactical plan shall marshal and allocate the organization’s limited resources into a viable posture to best
achieve its objectives considering its weakness and strengths relative to expected opportunities and
potential threats in the immediate future. A tactical plan is adopted in anticipation of the potential acts and
responses of an intelligent competitor. According to Webster’s Ninth New Collegiate Dictionary, on page
1201, “tactical” means: “ (1) of or relating to small-scale actions serving a larger purpose; (2) made or
carried out with only limited or immediate end in view.”
The different levels of management in an organization are involved in tactical formulation for it is
imperative that each department’s strategy fits into the total organization’s tactical plan. Thus the Sales
department must have a marketing tactical plan, the Operations department must have a production
tactical plan for volume of production as well as product research and development, and finally, the
Finance department must have its cash tactical plan to determine the sufficiency of cash for the whole
year.
Budgeting
Budgeting is a process of forecasting of financial results and financial position of a company for one or
more years in the future. It involves computation of estimated future sales, future purchases, future
expenses, and future cash collections and payments.
When tactical plans are converted into a financial plan, or when all activities and transactions in the
tactical plan are translated into equivalent monetary income and expenses and cash collections and
payments, the process is called budgeting process.
Objectives of Budgeting
The objectives of budgeting are:
1. Planning. It is the process of estimating the cost of future activities of each department concerned
and its effect on the company’s profit plans, in the form of budgeted income statement.
2. Coordination. It brings about coordination and cooperation between sales department and
production department, production department and planning and control department, and among all
other departments.
3. Control. It gives management a method of measuring the performance of each responsibility

center when actual performance is compared against budgets and any variance is analyzed to
come up with the needed corrective actions.
Budget Manual
When the company is large and the budgeting process is complicated, a budget manual is desirable. The
budget manual is a set of written policies, instructions and guidelines to serve as a reference in the
implementation of an operating program. In general, it contains its objectives, definition of terms,
functions, authority, responsibility, and duties of those involved in the budget process, procedures of
budgetary preparation, budgeting time and schedule, and how to obtain budgetary approval.
The use of a budget manual helps in gaining the cooperation of the people in the different management
levels in an enterprise and promotes coordination of effort.
Budgeting Process
Two types of Budgeting Process
1. Zero-Base Budgeting
In the appraisal of a new corporate project such as the opening of a new branch or the formation of a
subsidiary corporation, or the introduction of a new product or product line, a technique in planning has
come into existence which is called the zero-base budgeting.
Zero-base budgeting (ZBB) has been defined as a management process, which provides systematic
consideration of all programs projects and activities from scratch. This is the process used in preparing
feasibility studies of a new business. It is research based. There is no historical basis for estimating future
revenues and expenses. In other words, it refers to the process of estimating the total project cost and
how to allocate these financial and human resources to arrive at the expected result. It identifies
marketing and operations activities, analyze them and decide the best way to do it,
The term “zero-base” connotes, the budget is prepared starting with clear slate or with a zero starting
point. The preceding year’s budget is not used as base in allocating resources for the current year. Thus,
the budget for advertising and promotion expense last year was zero because sales was assumed to be
zero and the budget for this year’s advertising and promotion expense should be based on the projected
sales revenue. Also, the budget for material cost last year was zero because production is assumed to be
zero. The budgeted material cost this year should be based on the projected production volume.
For example, assuming that budgeted sales revenue this year is P4,000,000, advertising and promotion
expense budget may be a fraction of sales revenue say 1% of sales or P40,000.. Advertising and
promotion expense may be estimated and directed toward various class of customers so P30,000 worth
of advertising will be spent towards C, D and E class of customers and only P10,000 of advertising will be
spent for class A and B.
Incremental Budgeting
Incremental budgeting is also called the traditional approach to budgeting . It is used by the majority of
small, medium and large companies, even by the government, and it uses the actual figures of the
current and previous years as the base or starting point in determining the budget for the following year.
Before the start of the budgeting process, all cost and expense items in the actual income statement
should be classified into fixed costs and expenses, variable costs and expenses and mixed costs
and expenses. It will facilitate the preparation of budgeted income statement. The variable costs and
expenses in the income statement are: 1) commission of salesmen and delivery expenses (the basis is
peso sales or quantity (units) sold), 2) direct materials, direct labor, and variable factory overhead (the
basis is production volume (units) ). The rest will be fixed costs and expenses. If there is a big amount of
mixed or semi-variable expenses, separate the variable portion and the fixed portion using the high and
low method. After separation, only the variable and fixed costs cost and expenses will remain.
Definition of terms:
Variable costs and expenses are costs and expenses that changes in direct proportion to the volume of
sales or volume of production as the case maybe. Salesmen’s commission is a variable expense based
on sales volume or amount, while direct materials and direct labor is a variable cost based on production
volume.
Fixed cost and expenses are costs and expenses that do not change regardless of the volume of sales
or volume of production within the relevant range. For example, depreciation expense using the straight
line method, real estate tax paid every year to the city hall, fixed security agency expense, rent expense
of the store, and others.
Mixed cost and expenses, (sometimes called semi-variable) are costs and expenses that contain both
fixed and variable element. An example is when the factory has only one electric meter used for
administrative and production expenses. The electricity for administrative expenses is almost fixed
because electricity is used every working day from eight o’clock in the morning to five o’clock in the
afternoon while electricity for production is variable because they use electricity only when they have
production activities. The two can be separated using several methods, the easiest of which is the High
and Low method. For our illustrations, we will use the High and Low Method.
Illustration of Incremental Budgeting
Arimunding-munding Enterprise is a merchandising concern. It buys its lone product “Sexy dress” from a
lone supplier and sells the same to the public for a profit.
Before preparing the budget for 2021, the following historical data are taken from the accounting records:
Actual Last Year (2020)
1. Last year’s - sale amount 10,000 units @ P200 = P2,000,000
2. Last year’s - variable cost and expenses are:
2.1 Buying price of the merchandise P95.00 per unit.
2.2 Operating expenses:

a. Salesmen’s commission is 4% of sales.
b. Delivery expenses for products sold is around 1% of sales.
3. Last year’s fixed operating expenses P500,000
4. There is no interest expense last year because no borrowing was made during the year.
Preparation of 2017 Budgeted Income Statement
For 2021 budget, the following assumptions will be followed:
1. The purchasing department projected that there will be no increase in the cost of merchandise that
will be purchased..
2. The sales department projected also that there will be no increase in the unit selling price of the
product.
3.The sales department projected an increase in its sales volume by 20%, from 10,000 units to
12,000 units.
4. The rate of variable cost and expenses will remain the same.
5. Fixed expenses will increase by P50,000 because of estimated increase in employees’ salaries and
wages.
6. No borrowings during 2021 so no interest expense.
7. Income tax rate is 30%.
Required: Prepare the Budgeted Income Statement for the year 2021.
Using the Incremental Budgeting Method
Using the accounting information and assumptions above, the budgeted Income Statement for
2021 is shown below:
Arimunding-munding Enterprises
Budgeted Income Statement
For 2021
Sales (12,000 units @ P200) P 2,400,000

Cost of sales (12,000 @ P95) (1,140,000)
Gross Income 1,260,000
Operating expenses:
Variable operating expenses :
Salesmen’s commission (2,400,000 x 4%) ( 96,000)
Delivery expense (2,400,000 x 1%) ( 24,000)
Total variable operating expenses ( 120,000)
Fixed operating expenses: ( 550,000)
Total operating expenses ( 670,000)
Net income from operations or (EBIT) 590,000
Interest expense 0
Income tax expense (P590,000 x 30%) ( 177,000)
Net income P 413,000
The Budgeting Process
Budgeting process follows the tactical plan with the end in view of translating those plans into a monetary
plan or financial plan.
The actual budgeting process of a medium or large corporation are shown below:
1. Future Economic Environment
The first step is to see the following year’s economic horizon. The company will invite a well known
economist for a lecture. The lecture process will be economic lecture about the economic scenario for the
following year first and then followed by questions from managers and corporate officers related to this
work and responsibility.
The lecture will focus on the following subject matter:
1.1. Inflation
The economist will discuss about the expected rate of inflation for the incoming year according to the
government and according to his personal opinion. Based on this rate of inflation, he will have to
estimate any rate of price increase of local materials and supplies to be used in budgeting. He, also,
will give an opinion about any increase in minimum wage pay.
1.2 Foreign exchange

The economist will discuss about the expected increase or decrease of the rate of foreign exchange.
Based on any increase or decrease in exchange rate, the company can now estimate any increase or
decrease in the cost of imported materials.
1.3. Rate of interest

The economist will discuss about the Central Bank’s policy on interest and the possible increase in
interest rate. This is very important for the Treasury and Finance Department.
1.4. Gross Domestic Product (GDP)

The economist will discuss about the rate of increase of our GDP and its effect on the increase of
employment and the consequence consumer spending habits. This will be the basis for the increase
in volume of sales of consumer products.
Questions and Answers

After the lecture, all managers may ask pertinent questions related to the preparation of budgets of
their respective departments.
2. Budgeted Sales Volume and Budgeted Unit Selling Price
The National Sales Manager will call a meeting with all of his Regional Sales Manager and tell them to
prepare the budgeted sales, of their regional area, volume only. (Why, volume only? Because they are
waiting for the result of costing of each products to determine if there will be any increase in cost and will
it warrant an increase in unit selling price.) As guideline; the budgeted quantity should increase by not
less than the rate of increase in GNP. Some large companies divide the Philippines into five (5) parts:
1) the National Capital Region (NCR); 2) the central and northern Luzon region; 3) the southern Luzon
region, including Bicol and Palawan; 4) the Visayas region; and 5) the Mindanao region.
The Regional Sales Manager will call all of his Salesmen and tell them to prepare their Sales Volume
Budget and indicate the same in the Sales Budget Form that will be given to each one of them. The Sale
Budget Form has the following information: 1. Name of current customer; 2. Actual quantity sold (to each
customer this current year); 3. The Sales Volume budget of each customer next year; 4. Increase in
volume; 5. Rate of increase in volume; 6. Name of new customers; 7. Sales volume budget for each new
customer.
The Salesmen are given more or less two months to prepare the Sales Volume Budget and submit it to
the Regional Sales Manager for approval.
Once the Sales Volume Budget of each Salesman is approved, the Regional Sales Manager shall
summarize the approved Sales Volume Budget and submit it to the National Sales Manager for approval
also.
Once the National Sales Manager had approved the Sales Volume Budget of each region, he will
summarize them into a National Sales Budget for the budget year that include already the unit selling
price. He will analyze the National Sales Budget (volume and amount) and submit the same to the
President for approval. The terms of sale is also submitted for approval. The terms of sale will be the
basis for the computation of the budgeted Accounts Receivable.
(Note: Even before the approval by the President of the National Sales Budget. The projected cost of
each products shall have been prepared by the Cost Accounting Department and submitted to the
National Sales Manager and the President as basis for approval of Units Selling Price for each product.)
Once the President approved the National Sales Budget, it is disseminated to all departments as the
basis for their own expense budgets.
Bottoms-up Sales Forecasting

The above method of sales forecasting is called bottoms-up sales forecasting method because the
sales forecast comes from all field salesmen and goes up the ladder until it reaches the president of the
company.
3. Expense Budget Form and Capital Expenditure Budget Form (CAPEX)
The Budget department is in charge of distributing budget forms to all departments. The Sales and
Marketing department, Operations’ department and all Administrative departments are given their
respective Expense Budget Form and Capital Expenditure Budget Form to be submitted within one
month from receipt.
4. Budgeted Production Volume (Production Plan)
Based on the approved Sales Budget, the Operations department prepares the Budgeted Production
Volume and the related desired finished goods inventory at the end of each month. The desired
material inventory at the end of each month is also prepared and submitted. The computation of the
desired finished goods inventory and the desired material inventory normally is based on a written
company policy such as: a) the ending inventory of all locally purchased supplies and materials inventory
should be good for, fifteen (15) days or half months’ usage. b) the ending inventory of all imported
materials from Japan should be good for forty five (45) days, the number of days before the materials
arrived c) the ending inventory of all imported materials from Europe and USA should be good for sixty
(60) days, the number of days before the materials arrive.
Based on their time and motion study of production processes, the Operations Department shall compute
the total direct labor hours based on Budgeted Production Volume and then prepares the Direct Labor
Cost Budget.
They will also compute all variable factory indirect expenses called Variable Factory Overhead Budget
or Variable Manufacturing Expense Budget. The Accounting department shall prepare and submit all
Fixed Factory Overhead Budget.
5. Budgeted Material Purchases (Purchasing Plan)
The Purchasing Department prepares the Budgeted Material Purchases (Purchasing Plan) based from
Budgeted Production Volume and desired inventory end. The Purchasing department shall indicate also
the related terms of payment to suppliers. The terms of payment will be the basis for the computation of
the budgeted Accounts payable account.
6. Submission of all Budget Forms to the Budget Department

All departments concerned should submit to the Budget department all fully completed budget forms on or
before the set deadline of submission. From all submitted budget forms, the budget department, prepares
the Master Budget.
7. The Preparation of the Master Budget by the Budget Department
Master Budget to be prepared by the Budget Department
The master budget is a consolidation of all the budgets of all the different sub-units in an enterprise and
is the management’s principal vehicle for coordinating the plans of the firm. As such, it consist of the
Operating Budget, Cash Flow Budget, Financial Resource Budget and the Capital Expenditure Budget
(CAPEX).
A. Operating Budget. This refers to plan of operations where details of revenues, expenses and net
income are shown and which takes the form of budgeted income statement. It is a consolidation of
the budgets for the different functions of the enterprise, namely the projections for:
For A Merchandising Concern:
1. Budgeted Sales (quantity, unit selling price, and total sales)

2. Budgeted Purchases (quantity, unit cost, and total purchases)
3. A corporate policy on inventory level for merchandise inventories.
4. Budgeted Cost of Goods Sold or Cost of Sales
5. Budgeted Selling expenses
6. Budgeted Administrative expenses
7. Budgeted Financing expenses or interest expense
8. Budgeted Income Tax
For A Manufacturing Concern:
1. Budgeted Sales (quantity, unit selling price, and total sales)

2. Budgeted Production Volume (in units)
3. A corporate policy on inventory level for finished products and for material inventories.
4. Budgeted Material cost (quantity used in production, unit cost, and total material cost)
5. Budgeted Material purchases ( quantity purchased, unit cost, and total material
purchases)
6. Budgeted Direct Labor Cost. (man-hours used, average direct labor rate per hour, total
direct labor cost)
7. Budgeted Factory Overhead (total fixed factory overhead plus total variable factory
overhead)
8. Budgeted Cost of goods manufactured.
9. Budgeted Cost of Goods Sold or Cost of Sales
10. Budgeted Selling expenses
11. Budgeted Administrative expenses
12. Budgeted Financing expenses or interest expense
13. Budgeted Income Tax Expense
B. Capital Expenditure Budget. This is a statement of the planned procurement and disposal of
of plant, property and equipment.
C. Financial Resources Budget. The refers to the projections of the effects of the planned
operating budget on the financial resources of the enterprise. It consists of the following:
1. Cash Budget. This shows the effects of management’s plans on cash inflows (cash receipts)
and cash outflows (cash disbursements).

2. Budgeted Statement of Financial Position (balance sheet). It shows the planned assets,
liabilities and equity levels.
3. Budgeted Cash Flow Statement. Convert the cash budget into a cash flow statement that
includes any plan of borrowings when cash balance at the end in the cash budget is negative
or below the required minimum cash balance.
8. Submission of the Master Budget to the MANCOM

After preparing the Master Budget by the Budget Department, it is submitted to the MANCOM
(Management Committee) headed by the President for approval as a whole or for disapproval as a whole
or for any modification/improvements of part/parts of the budget.
9. Approval by the Board of Directors.

The Budget Department prepares the MANCOM Approved Master Budget and submit it to the President
for signature. The President in a Board of Directors’ Meeting, called for the purpose, submits and explain
to the Board of Directors the Master Budget for final approval and implementation.
Planning and Control
For planning purposes, the budget department coordinates the efforts of those involved in the budget
preparation, prepares the master budget and all supporting schedules and distribute the approved
budgets to all responsibility centers concerned.
Use of Budgets for Control Purposes

The breakdown of the master budget as enumerated above emphasizes its integrated features
for purposes of reporting revenues and expenses of each responsibility centers and will be used for
control purposes.
At the start of actual operation, the budget department issues periodic reports on actual performance of
each responsibility center and compared it against the approved budget. The difference is called
variance. A variance maybe favorable or unfavorable. Favorable variance means it results to an increase
in the net income of the company. For example, if the actual sales amount is P4,600,000 and the
budgeted sales is P4,000,000, the variance is P600,000 favorable or a 15% favorable variance. Another
example; if the actual administrative expenses was P300,000 while the approved budgeted administrative
expenses was P250,000, the variance of P50,000 is an unfavorable variance because it will decrease the
net income. Unfavorable variance means it will tend to reduce the net income. The variance between the
budgeted figures and actual performances is reported to the president of the company and to all
concerned departments. All department heads explains the reason for the variances and recommends
remedial measures in case of unfavorable variances and how to maintain or how to still improve all
favorable variances.
Revisions of Budgets
If the management perceived that the budget is unrealistic, revisions are recommended and will be based
on immediate actual performance.
Sales Forecast and Sales Budget
The Sales Forecast is a passive statement of the expected volume of sales. It is the primary basis for the
preparation of the master budget so that it is considered as the cornerstone of budgeting. The
management approves the planned sales volume based on sales forecast by the Sales department and
this serves as basis in the preparation of the other budgets. The sales budget refers to the planned
volume and sales amount approved by management to serve as basis in the financial planning of all sub-
units in an enterprise.
Sales forecast may be made on the analysis of general business conditions, sales trend in the past and
market conditions. This analysis is supplemented by internal forecast whereby opinions of executives and
salesmen are considered. A company engaged in the manufacture of shoes may estimate its sales
volume based on the population and population of school children and students in a particular locality.
For Consumer Products

For old consumer products, the bottoms-up sales forecasting method is normally used.
For Services and New Products

For services, the management may use the regression analysis, while for new products it is better to
use the probability analysis.
Regression Analysis (old products and services)
In using regression analysis, sales of services forecast is made based on the cause and effect
relationship between sales and the variable factor assumed to be affecting sales volume.
Example: Based on accumulated data, the annual service income of a small hotel at Pagsanjan, Laguna
amounts to at least P1,000,000 a year and that a P0.50 increase may be expected for every foreign
tourist arrival in the country in excess of 2,000,000 tourist. According to the Department of Tourism the
projected arrivals of foreign tourists for the 2021 is 7,000,000 tourists.
The sales forecast for 2021 would be:
Let Y – budgeted sales of services

Let X = the number of foreign tourist arrival in the country.
The regression equation is as follows:

MINIMUM VARIABLE/ADDITION
Y = P1,000,000 + [P0.50 x (X-2,000,000) ]
Sales forecast for 2017 would be:
Y = P 1,000,000 + [P 0.50 x (7,000,000 tourist – 2,000,000 tourist)]

Y = P3,500,000
Probability Analysis (new product)

Probability analysis is normally used for new products or services.
In making sales forecast using the probability concept, the company uses the expertise of industry
experts in making estimates based on their experience.
The expected value of sales estimates is arrived at by multiplying the different sales estimates by their
corresponding probability percentages.
For example: A manufacturing concern is launching a new product “”Product X in the market. The sales
department stated in its estimate that the sales volume (units) would be between 11,000 unit and 15,000
units. They invited 2 product experts and ask them the percentages of sales probability of the new
product. This is the result of their expert opinion:
PERCENTAGE OF PROBABILITY
VOLUME OF SALES Expert No. 1 Expert No. 2 Average
(Units)
11,000 10% 0% 5%
12,000 20% 20% 20%
13,000 30% 40% 35%
14,000 30% 30% 30%
15,000 10% 10% 10%
100% 100% 100%
The expected volume of the sales estimates is arrived at as follows:
Sales Volume Probability Expected

Value
11,000 5% 550
12,000 20% 2,400
13,000 35% 4,550
14,000 30% 4,200
15,000 10% 1,500
13,200
=====
BOP Method (Best, Optimistic, Pessimistic) (new product)
When it comes to new products, the sales estimates for the first year is an educated guess and estimates
are opinion or gut feel of persons who know the business. Sometimes sales estimates are made using the
BOP (best or most likely, optimistic and pessimistic estimates) method. Based on the normal curve
distribution, most likely or best estimates are given a weight of four (4) so that a devisor of (6) is used.
Example: The president of the company ask the sales manager, “Using the BOP Method, which is the
Best or most likely, most optimistic, and most pessimistic if you choose figures between 10,000 units and
20,000 units to be sold.
The sales manager said,” We will be very lucky if we can sell 16,000 units. It is unlikely or very
unfortunate if we can sell only 10,000 units and in my best estimate, the sale would be around 14,000
units.
Sales Volume Weight

Optimistic (O) 16,000 - 1 point
Best (B) 14,000 - 4 points
Pessimistic (P) 10,000 - 1 point
The expected value of these estimates must be 13,667 , computed as follows:
Expected value O + 4B + P
of sales = ----------------
6
16,000 + [4(14,000)] + 10,000

= -------------------------------------- = 13,667 units
6
The sales forecast of 13,667 units may be rounded off to 13,700 units. This planned level of sales shall be
the basis in the preparation of the master budget.
How to Estimate Costs and Expenses
Just like in the incremental budgeting, first, let us classify cost and expenses according to its behavioral
pattern:
1. Variable costs and expenses

Variable costs and expenses are those costs and expenses that change in direct proportion to the volume
of production or volume of sales. Examples are direct materials and direct labor with regards to
production volume and salesmen commission with regards to sales volume or sales amount.
2. Fixed costs and expenses

Fixed costs and expenses are costs and expenses that do not change regardless of volume of production
or volume of sales, within a relevant range. Relevant range refers to the range of volumes or activity
within which the expected behavior of cost is valid. Examples of fixed costs related to production are the
depreciation expense of a factory building, of furniture, fixtures, equipment and machineries using the
straight line method; agency contracts of janitors and security guards in a place; real state tax of the land
and improvements, and insurance expense of the factory building. Examples of fixed costs related to
selling expense and administrative expenses are the store rent expense, insurance expense of head
office building, and depreciation expense of office equipment.
3. Mixed or Semi-variable costs

Mixed costs or semi-variable costs are costs that includes the element of both variable cost and fixed
cost. In other words, a cost is a mixed cost when it is partly fixed and partly variable. Since it is partly
variable, then it changes in amount but not in direct proportion to the level of activity. It is, therefore,
necessary to separate the fixed cost portion and the variable cost portion in order to be accurate in cost
projection.
Fixed Cost and Relevant Range.
A company, with its current plant facilities and personnel is capable of producing a maximum of 100,000
units a month and incurs total fixed costs and expenses of P80,000 a month. The relevant range for this
amount of fixed costs and expenses is from 1 to 100,000 units a month. Beyond that volume, the
company must increase its production capacity by acquiring additional fixed assets and hire additional
employees and these will give rise to additional fixed costs.
Variable Cost and Budgeted Total Cost at Various Activity Levels
Assuming that the company’s fixed cost a month is P80,000 while its variable cost rate and expenses per
unit of finished product is P3. The relevant range or maximum capacity is 100,000 units.
Determine the budgeted total cost at various levels of production: 1) at 20,000 units, 2) at 40,000 units,
3) at 75,000 units and 4) at 90,000 units.
Solution: The format for computation of budgeted total cost
Total variable cost and expenses

Production Units Fixed costs + (quantity x variable cost per unit) = Budgeted Total Cost
1. 20,000 P 80,000 + ( 20,000 x P3) = P140,000
2. 40,000 80,000 + ( 40,000 x P3) = P200,000
3. 75,000 80,000 + ( 75,000 x P3) = P305,000
4. 90,000 80,000 + ( 90,000 x P3) = P350,000
Splitting Mixed Costs or Semi-variable Costs
As shown above, it is easy to compute total cost if total fixed cost, variable rate and quantity of production
is given.. However, there are some costs and expenses that are considered as mixed or semi-variable
costs. In this regard, the mixed costs should be split into fixed and variable expenses. The split fixed cost
will be added to other given fixed cost and expenses while the split variable cost and expenses will be
added to other variable costs and expenses. By then, we will know the total fixed cost and expenses, and
the total viable cost and expenses. From the total variable costs and expenses, we can now compute the
variable rate per unit, how?, by dividing the total variable costs and expenses by the normal production
volume. Some examples of mixed costs are: 1) cleaning material used, both in production and in
administrative offices; 2) The electricity consumed, when there is only one electric meter and the building
housed both the administrative office and factory or production department. The different methods of
splitting semi-variable costs are (a) high and low point method, (b) least square method and (c) use of
scatter-graph. Only the high and low method will be taken up in this book because of its simplicity.
High and Low Method

First, determine which is the high point and which is the low point during a given period of production or
sales. Assuming, that from January to December, 2020, the highest point of production is in November,
2020 at 120,000 units while the lowest point was in February, 2020 at 20,000 units. (Normally, production
in November is sold in December, the Christmas month, while production in February is sold in March,
where the purchasing power of the people is very low.)
Second, determine in those months, the amount of mixed costs and expenses. Assuming the total mixed
cost in the factory in the month of November, 2020 is P440,000 while in February, 2020, the total mixed
cost is P140,000.
To illustrate the high and low point method, use the above mentioned data about the mixed cost of a
factory supplies:
Production Mixed
volume (units) cost (P)
-------------------- -----------------
High 120,000 P440,000
Low 20,000 140,000
Required: 1. Compute the variable cost rate per unit – P3.00

2. Compute the total variable cost at 120,000 units – P360,000
3. Compute the total variable cost at 20,000 units – P60,000
4. Compute the total fixed costs at 120,000 and at 20,000 units.
P80,000 80,000
1. Compute for variable cost rate per unit first, using the format below: the answer is P3.00
Variable Rate
Quantity Amount per unit
High 120,000 P440,000
Low 20,000 140,000
Difference 100,000 P300,000 = P3.00
Steps:
a. Fill in the data from the problem.
b. Deduct the low quantity and amount from the high quantity and amount to get the difference.
1. Divide the difference in amount (P300,000) by difference in quantity (100,000 units) and the answer
is the variable rate per unit (P3.00)

2. Compute the total variable cost at 120,000 units = 120,000 x P3 = P360,000.
3. Compute the total variable cost at 20,000 units = 20,000 x P3 = P 60,000
4. Compute the fixed cost @ 120,000 units @ 20,000 units

Total cost P 440,000 P 140,000
Less: Total variable 360,000 60,000
Total fixed cost P 80,000 80,000
Take note: the fixed cost of P80,000 is the same for both 120,000 unit level and 20,000 unit level.
At any level of production, the fixed cost will be P80,000.
Master Budget of a Trading Enterprise

Computations for Budgeted Figures of a Trading Concern
(After Budgeted Income Statement, Budgeted Statement of Financial Position is prepared and the
last is the Budgeted Cash Flows, Indirect Method)
Nila Moon Trading, a non-VAT business, is making its master budget for 2021.
The Operating Budget:

1. The sales department budgeted 60,000 units @ P20.00 per unit
2. Merchandise inventory:
Beginning - the cost accounting department reported – merchandise inventory January 1, 2021 –
4,500 units with a cost of P10.00 per unit.
Desired ending inventory is 9,000 units. (Use First In – First Out Method (FIFO))
3. The Purchasing department projected the cost to increase to P12.00 per unit.
4. Last year, the fixed operating expenses was P110,000 (including depreciation expense of P58,500).
For 2021, they expect it to remain the same.
5. Variable operating expenses per unit – P3.00
6. Interest expense is budgeted at P54,000 (P900,000 loan x 6%)
7. Income tax rate is 30%
Capital Expenditure Budget

1. Acquisition of additional property and equipment to be bought December, 2021 - 500,000
No depreciation expense is budgeted for this acquisition. (Useful life is 10 years, no salvage value.)
Financial Resource Budget

1. Loan amortization, excluding interest, is P660,000 and paid at the end of December, 2021. The
balance is due in December, 2023.
2. Budgeted to issue 2,400 shares @ P120 per share. Of the P120 issue price, the par value is P100
per share and the premium is P20 per share. (This is common shares.)
3. The terms of sale:
40% of sales is cash sales
60% of sales is sales on credit and strictly 30 days. Uncollected accounts receivable at the end
of 2021 is the sale for December amounting to P120,000. X 60% = P72,000.
4. All purchases are on account. The terms of purchases is strictly 30 days. The balance of accounts
payable at the end of 2021 is P72,000. .
5. Budgeted cash dividends declared and paid – P50,000
6. Budgeted payment of operating expenses – P224,000.
(With accrued operating expenses)
7. Payment for budgeted interest expense – P54,000. (P900,000 x 6%) No accrued interest expense.
8. Unpaid income tax – P12,000. (For the 4th quarter, 2020 ITR)
9. The desired cash balance at the end is minimum of P20,000. The company may obtain a 12% loan
in multiple of P10,000 should it need additional funds.
Last Year (2020):

1. The Statement of Financial Position, 2020 showed:
Assets:
Current Assets
Cash 675,000
Accounts receivable, net 240,000
Merchandise inventory 45,000
Total current assets 960,000
Property and equipment, net 585,000

Total Assets 1,545,000
Liabilities and Shareholders’ Equity

Current liabilities
Income tax payable 10,000
Loans payable, current portion 660,000 (due 2017)
Total current liabilities 730,000
Non-current liabilities
Loans payable, non-current portion 240,000 (due 2019)
Total Liabilities 970,000
Shareholders’ equity
Share capital, par P100 540,000
Total shareholders’ equity 575,000
Total Liabilities and Shareholders’ Equity 1,545,000
Required: Prepare the : 2017 Budgeted Income Statement

2017 Budgeted Statement of Financial Position (Balance Sheet)
2017 Budgeted Statement of Cash Flows ( Use Indirect Method)
Solution:
Budgeted Income Statement

2021
Sales (60,000 units @ P20) P 1,200,000

Cost of Sales ( 711,000) (Note 1)
Gross income 489,000
Operating expenses ( 290,000) (Note 3)
Net income from operation 199,000 (Also called Earnings Before Interest
and Taxes [EBIT])
Interest expense (P900,000 x 6%) ( 54,000) given
Net income before income tax 145,000
Income tax (P145,000 x 30%) ( 43,500)
Net Income (Loss) P 101,500
Note 1: Budgeted Cost of Sales FIFO

Quantity Unit Cost Amount
Merchandise inventory, beg 4,500 P10.00 P 45,000
Purchases ? 64,500 12.00 774,000 (Note 2)
Total available for sale ? 69,000 819,000
Merchandise inventory, end ( 9,000) 12.00 ( 108,000)
Cost of Sales 60,000 P 711,000
Note 2 Budgeted Purchases

Quantity (units)
Sold 60,000
Desired merchandise inventory, end 9,000
Total available for sale 69,000
Merchandise inventory, beg. 4,500
Purchases 64,500
Times: Unit cost P12.00
Equals purchase amount P774,000
Note 3 Budgeted Operating Expenses
Fixed operating expenses (including depreciation, P58,500) P110,000

Variable operating expenses (60,000 units x P3.00) 180,000
Total operating expenses P 290,000
Budgeted Statement of Financial Position (Balance Sheet)

2021
Assets
Current Assets
Cash P 39,500 (Note 11) (See Cash Flow also)
Accounts receivable 72,000 given
Merchandise inventory, end 108,000 (see Note 1)
Non-current Assets
Properties and Equipment 1,026,500 (Note 4)
Total Assets P 1,246,000
Liabilities and Shareholder’s Equity
Current Liabilities
Accounts payable P 72,000 given
Income tax payable 12,000 given
Accrued operating expenses 7,500 (Note 5)
Non-current Liabilities
Loans payable (due, 2023) 240,000 (Note 7)
Share capital (7,800 shares @ P100 par) 780,000 (Note 8)
Share premium (2,400 @ P20) 48,000 (Note 9)
Retained earnings 86,500 (Note 10)
Total Liabilities and Shareholders’ Equity P 1,246,000
Note 4 Budgeted Properties and Equipment
Properties and equipment, beg. (net) P 585,000

Acquisition of additional PE 500,000
Total Properties and equipment before depreciation expense 1,085,000
Depreciation expense for 2021 ( 58,500)
Properties and equipment, end (net) 1,026,500
Note 5 Budgeted Accrued Operating Expense

Operating expenses (including depreciation) 290,000
Net cash operating expenses 231,500
Payment of Operating expenses ( 224,000)
Unpaid Operating Expenses P 7,500
Note 6 Budgeted Accrued Interest expense

Interest expense paid ( 54,000)
Unpaid interest expense 0
Note 7 Budgeted Loans payable

Loans payable, beg. (660,000 + 240,000) 900,000
Amortization of loans payable ( 660,000)
Loans payable, end P 240,000
Note 8 Budgeted Share capital

Share capital, beg. (5,400 shares @ P100) 540,000
New issuance (2,400 shares @ P100) 240,000
Share capital, end (7,800 shares @ P100) 780,000
Note 9 Budgeted Share premium

Share premium, beg 0
Share premium new issuance (2,400 shares x P20) 48,000
Share premium, end 48,000
Note 10 Budgeted Retained earnings

Retained earnings, beg. 35,000
Net income 101,500
Total 136,500
Dividends declared and paid ( 50,000)
Retained earnings, end 86,500
Note 11 Budgeted Cash (using the Accounting Equation Principle)

Total Shareholders’ Equity 914,500
The accounting equation states, “Total Assets equals the total of Liabilities and Equity. Therefore, if the
total liabilities and equity equals P1,246,000, then, the total assets should also be P1,246,000.
To compute the amount of cash:

Properties and equipment (1,026,500)
Merchandise inventory ( 108,000)
Accounts receivable ( 72,000)
= Cash balance end P 39,500
2021 Budgeted Statement of Cash Flows (Indirect Method)

The pro-forma statement for preparing statement of cash flows indirect method is as follows:
Inflow (Outflow)
From Operating Activities:
Net income P xxx
Add: Non-cash expenses:
Depreciation expense xxx
Depletion expense xxx
Changes in working capital:

Increase in current assets (except investments) ( xxx)
Decrease in current assets (except investments) xxx
Increase in current liabilities (except loans) xxx
Decrease in current liabilities (except loans) ( xxx)
Inflow (Outflow) Operating Activities xxx
Cash Inflow and (Cash Outflow)
To prepare the cash flow we need to compare the 2016 statement of financial position and the 2017
budgeted financial position and compute the difference as an increase or as a decrease and determine if
it is an inflow or an outflow. An outflow has a parenthesis. An outflow means negative.
To determine if it is an inflow or an (outflow), the following rules should be observed:
1. An increase in assets means outflow. An increase in assets means acquisition of additional

assets which eventually will be paid.
2. A decrease in asset means inflow. A decrease in an asset means a sale of an asset for which
cash will eventually be received.
3. An increase in liabilities means inflow. When you borrow from a bank, loan payable will
increase and cash will be received.
4. A decrease in liabilities means outflow. When accounts payable decrease, it means it has
been paid.
5. An increase in an equity account means an inflow while a decrease in an equity account
means an outflow.
Comparison to determine it cash inflow or (cash outflow):
Account Title 2020 2021 Increase Inflow

(Decrease) (Outflow)
Operating Activities
Accounts receivable 240,000 72,000 (168,000) Inflow
Merchandise inventory 45,000 108,000 63,000 outflow
Accounts payable 60,000 72,000 12,000 inflow
Income tax payable 10,000 12,000 2,000 Inflow
Accrued operating expenses - 7,500 7,500 Inflow
Investing Activities
Properties and equipment, net 585,000 1,026,500 441,500 (Outflow)
Financing Activities
Loans payable 900,000 240,000 (660,000) (Outflow)
Share capital 540,000 780,000 240,000 Inflow
Share premium - 48,000 48,000 Inflow
2021 Budgeted Statement of Cash Flows (Indirect Method)

From Operating Activities
Net income 101,500 IS (Income Statement)
Depreciation expense 58,500 IS
Total cash net income 160,000
Changes in Working Capital:
Decrease in Accounts receivable 168,000 BS (Balance Sheet)

Increase in Merchandise inventory ( 63,000)
Increase in Accounts payable 12,000 BS
Increase in Income tax payable 2,000 BS
Increase in accrued operating expenses 7,500 BS
Inflow (Outflow) in operating activities 286,500
From Investing Activities

Acquisition of new properties and equipt. ( 500,000)
From Financing Activities

Payment of loans payable (660,000)
Issuance of new shares capital 240,000
Premium 48,000
Payment of dividends ( 50,000)
Inflow (Outflow) (422,000)
Net Inflow (Out flow) for budget year, 2021 ( 635,500) ( 589,500 – 500,000 – 422,000)
Add: Cash balance, beg. 675,000
= Cash balance, end 39,500
Please take note; Cash balance, end above (P39,500) is the same as the Cash in the 2021 Budgeted
Statement of Financial Position (Balance Sheet).
Also, the amount of P39,500 is more than the minimum cash balance needed, so need to borrow.
Comprehensive Illustration: With Budgeted Borrowings because Cash balance at

the end of the year is Below the Desired Cash Balance.
Illustration: Budget of a Trading Company

( After Budgeted Income Statement, prepare the Budgeted Statement of Cash Flows (Direct
Method) and last prepare the Statement of Financial Position)
Maru Nong Marketing is making its 2021 budget. It is the sole distributor of tiny naked dolls, with the
brand name “ SEXY DOLL”, in the Philippines. The owner can put on a dress, pants, shoes, hat and even
hair on the doll. The product is imported from China and being sold locally at whole sale price.
1. The sales department submitted its budgeted sales –100,000 units @ P20.00 per unit
2. The warehouse department submitted the following information:
Merchandise inventory, beginning 7,500 units @ P10.00 per unit
Desired merchandise inventory, end 15,000 units
3. The purchasing department indicated that the unit purchase cost will be P12.00 per unit.
4. a) The total fixed operating expenses per annum (including depreciation expenses of P75,000) is
P250,000
b) The variable operating expense per unit is P4.00
5. The finance department estimated that the interest expense of all loans and other obligations will
be P22,500.
6. The income tax rate is 30%
7. The finance department had budgeted the following cash receipts and cash payments:
a) Collection on sales - P 1,825,000
b) Payments of purchases - 1,050,000
c) Payments of operating expenses - 540,000
d) Payments of interest expense 22,500

e) Payment of income tax 50,000
f) Payment of addition al equipment bought 250,000
g) Payment of loan principal, excluding interest 110,000
h) Payment of cash dividend 50,000
i) Sale of old furniture at book value 60,000
j) Issuance of shares of stock ( 80 shares @ P600) 48,000
8. The desired cash balance at year end is minimum of P20,000. The company can obtain a
12% loan in multiples of P10,000 should it need additional funds.
9. Your 2020 balance sheet showed the following accounts:
ASSETS
Cash 60,000
Accounts receivable (net) 40,000
Property and equipment (net) 197,500
Total assets 375,500
LIABILITIES AND SHAREHOLDERS’ EQUITY

Accrued expenses -
Loans payable 150,000
Share premium 15,000
Total liabilities and s. equity 372,500
Task:
Prepare the: 1. 2021, Budgeted Income Statement
2. 2021, Budgeted Statement of Cash Flows (Direct Method)
3. 2021, Budgeted Statement of Financial Position.
Budgeted Income Statement (Initial)

2021
Sales (100,000 units @ P20) P 2,000,000

Cost of sales ( 1,185,000) Note 1
Operating expenses (including depreciation
expense of P75,000) ( 650,000) Note 2
Net income from operation (EBIT) 165,000 (Earnings Before Interest & Tax)
Interest expense ( 22,500) given
Income tax expense (142,500 x 30%) ( 42,750)
Net income 99,750
Note 1 Cost of sales

( units )
Purchases 107,500 P 12.00 1,290,000
Merchandise inventory, beg. 7,500 10.00 75,000
Total available for sale 115,000 1,365,000
Merchandise inventory, end ( 15,000) 12.00 ( 180,000)
Cost of sales 100,000 1,185,000
Explanation:
a. The quantity of cost of sales is always the quantity of sales account, therefore, 100,000 units.
To compute the quantity of purchases: cost of sales (units) plus desired merchandise inventory,
end (units) minus merchandise inventory, beg. (units) equals purchases (units)
(100,000 units + 15,000 units – 7,500 units = 107,500 units)
b. Indicate the unit costs. Purchases – P12.00; Merchandise inventory, beg. – P10.00;
merchandise inventory, end – P12.00. ( using FIFO)
c. Multiply the quantity by the unit cost.
Note 2 Operating expenses

Fixed operating expenses (given) P 250,000
Variable operating expenses (100,000 x P4) 400,000
Total P 650,000
Cash Budget (Direct Method) (Initial)

Collection on sales P 1,825,000
Payment of purchases ( 1,050,000)
Payment of operating expenses ( 540,000)
Payment of interest expense ( 22,000)
Payment of income tax ( 50,000)
Net inflow (outflow) 162,500
Payment of additional equipment ( 250,000)
Sale of old furniture at book value 60,000
Net inflow (outflow) ( 190,000
Payment of loan principal ( 110,000)
Issuance of share of stocks (80 @ P600) 48,000
Net inflow (outflow) ( 112,000)
Cash balance, beg. 60,000
Cash balance, end ( 79,500) negative cash balance

Since the cash balance end is negative of P79,500 and the minimum cash balance requirement is
P20,000, it is imperative for the company to borrow from a financial institution.
To compute the amount of loan:

Amount of cash balance, end (negative) 79,500
+ Minimum cash balance 20,000
Total cash needed before interest 99,500

+ Interest expense (99,000 x 12%) 11,440
Total cash needed 111,440
Amount of Loan: But the company can borrow only with multiple of P10,000, so the amount of loan
should be P120,000.
Adjustments
Because of this P120,000 loan, adjustments have to be made as follows:
To budgeted Income statement:

1. Interest expense will increase by P14,400. (P120,000 x 12%). The interest expense will be
P36,900 (22,500 + 14,400)
2. Net income before tax will decrease and the Income tax expense will be affected as well as the
net income after tax.
Budgeted Cash Flows

1. Payment of interest expense will increase to P36,900. (22,500 + 14,400)
2. Loans payable will increase by P120,000.
3. Cash balance end will be 26,100.
Budgeted Income Statement (Adjusted)

2017
Sales P 2,000,000
Cost of sales ( 1,185,000)
Operating expenses ( including depreciation expense
amounting to P75,000) ( 650,000)
Net income from operation 165,000
Interest expense (22,500 + 14,400) ( 36,900)
Income tax expense (P128,100 x 30%) ( 38,430)
Net income 89,670
Budgeted Statement of Cash Flows (Adjusted)

2021
Collection on sales P 1,825,000
Payment of purchases ( 1,050,000)
Payment of operating expenses ( 540,000)
Payment of interest expense ( 36,900)
Payment of income tax ( 50,000)
Payment of additional equipment ( 250,000)
Sale of old furniture at book value 60,000
Net inflow (outflow) ( 190,000
Payment of loan principal ( 110,000)
New loan from the bank 120,000
Issuance of share of stocks (80 @ P600) 48,000
Cash balance, beg. 60,000
Cash balance, end 26,100)
Budgeted Statement of Financial Position (Balance Sheet)

2021
Assets
Cash P 26,100 (See Statement of Cash Flows)
Accounts receivable (net) 215,000 (Note 3)
Merchandise inventory, end 180,000 (Note 1)
Property and equipment 312,500 (Note 4)
Total assets P 733,600

Accounts payable P 280,000 (Note 5)
Accrued operating expenses 35,000 (Note 6)
Income tax payable 38,430 (Note 7)
Loans payable 160,000 (Note 8)
Share capital 98,000 (Note 9)
Share premium 55,000 (Note 10)
Retained earnings 67,170 (Note 11)
Total Liabilities and Shareholders’ Equity P 733,600
Note 3 Accounts receivable

Accounts receivable, beg. 40,000
Sales 2,000,000
Total collectibles 2,040,000
Collection on sales (1,825,000)
Accounts receivable, end P 215,000
Note 4 Property and equipment (net)

Property and equipment, beg. (net) 197,500
Additional equipment bought 250,000
Sale of old furniture at book value ( 60,000)
Depreciation expense 2021 ( 75,000)
Property and equipment, end (net) P 312,500
Note 5 Accounts payable

Accounts payable, beg. 40,000
Purchases 1,290,000
Total payables 1,330,000
Payments on purchases ( 1,050,000)
Accounts payable, end P 280,000
Note 6 Accrued operating expense

Accrued operating expenses, beg. 0
Operating expenses, including depreciation 650,000
Net cash operating expense to be paid 575,000
Payment of operating expense ( 540,000)
Accrued operating expense P 35,000
Note 7 Income tax payable

Income tax payable, beg. 50,000
Total 88,430
Payment of income tax payable ( 50,000)
Income tax payable, end 38,430
Note 8 Loans payable

Loans payable, beg. 150,000
Payment of loan payable ( 110,000)
New loan 120,000
Loan payable, end. 160,000
Note 9 Share capital

Share capital, beg. (900 @ P100) 90,000
Issuance of shares (80 @ P100) 8,000
Share capital, end (980 @ P100) 98,000
Note 10 Share premium

Share premium, beg 15,000
Share premium on newly issued shares (80 x (P600 – P100) 40,000
Share premium, end 55,000
Note 11 Retained earnings

Retained earnings, beg. 27,500
Net income 89,670
Total 117,170
Dividends declared and paid ( 50,000)
Retained earnings, end 67,170
Journal Entry Method
Another way of preparing the above Budgeted Financial Statements is the Journal Entry Method.
By preparing the journal entry for all transactions above, you can prepare the Budgeted Income
Statement, the Budgeted Statement of Cash Flows and Budgeted Statement of Financial Position.
Here are the complete journal entries, and if you post them in a T-account and compute the balance of
each account, you will find that all balances are the same as that in the Budgeted Income Statement,
Budgeted Statement of Cash Flows and Budgeted Statement of Financial Position.
Income Statement accounts:
1) Accounts receivable 2,000,000

Sales 2,000,000
To record the total sales.
2) Purchases 1,290,000
To record total purchases.
3) Operating expenses 650,000

Accumulated depreciation 75,000
Accrued operating expense 575,000
To record the total operating expenses including depreciation expense.
4) Interest expense 22,500

Accrued interest expense 22,500
To record the total interest expense for the loans payable and other obligations.
5) Income tax expense 38,430

To record the income tax expense for 2021.
Cash Flows:
6) Cash 1,825,000
To record collections of accounts receivable.
7) Accounts payable 1,050,000

Cash 1,050,000
To record payments of accounts payable to suppliers.
8) Accrued operating expenses 540,000

Cash 540,000
To record payments of operating expenses for the whole year.
9) Accrued interest expense 22,500

Cash 22,500
To record payment of interest expense for the year.
10) Income tax payable 50,000

Cash 50,000
To record income tax that accrue last year.
11) Property and equipment 250,000

Cash 250,000
To record the acquisition of new equipment.
12) Loans payable 110,000

Cash 110,000
To record partial payment of principal of loans payable.
13) Retained earnings 50,000

Dividends payable 50,000
To record the declaration of dividends to shareholders.
14) Dividends payable 50,000

Cash 50,000
To record payment of dividends.
15) Cash 60,000

Properties and equipment (net) 60,000
To record the sale of old property at book value.
16) Cash (80 shares @ P600) 48,000

Share capital (80 @ P100) 8,000
Share premium (80 @ P500) 40,000
To record issuance of 80shares @ P600..
Adjustments:
17) Cash 105,600

To record the new loan to avoid negative cash balance at the end of the year.
Closing entries
18) Sales 2,000,000

Income summary 2,000,000
To close sales account.
19) Cost of Sales 1,185,000

Merchandise inventory, end 180,000
Merchandise inventory, beg 75,000
Purchases 1,290,000
To close purchases and merchandise inventory accounts to cost of sales.
20) Income summary 1,185,000

Cost of Sales 1,185,000
To close cost of sales account.
21) Income summary 725,330

Operating expenses 650,000
To close operating expenses, interest expense and income tax expense.
22) Income summary 89,670

To record the net income to be added to the retained earnings account.
Post Closing Trial Balance

After posting the beginning balances from the 2020 Statement of Financial Position and posting all the
transactions above, you will arrive at the following Post Closing Trial Balance:
Debit Credit
Cash 26,100
Accounts receivable 215,000
Properties and equipment (net) 312,500
Accrued operating expenses 35,000
Share capital 98,000
Share premium 55,000
Retained earnings _______ 67,170
Total 733,600 733,600
Master Budget for a Manufacturing Firm

The preparation of master budgets for manufacturing firms is similar to that for a trading firm. The only
difference is in the computation of the budgeted cost of sales or cost of goods sold.
Before the budgeted cost of sales or cost of goods sold can be computed, you should prepare first the
statement of cost of goods manufactured.
Before you can prepare both budgeted cost of sales and budgeted cost of goods manufactured, the
following accounting information should be available:
1. Budgeted sales xxx units @ Pxx
2. Assumed terms of collection for the purpose of computing the budgeted Accounts receivable at the end
of the year as well as the total collection for the whole year..
Actual Desired
3. Inventories: Beginning Ending Ending
Qty UC Qty Unit Cost
Material inventory xxx @ Pxx xxx Using FIFO method, it is assumed
that the unit cost is the same as the
purchasing projected cost for the
following year
Work in process inventory xxx @ Pxx xxx for budgeting purposes, this
inventory is assumed to be zero
and no cost
Finished goods inventory xxx @ Pxx xxx use unit cost from the budgeted
Cost of goods manufactured.
4. Projected unit cost of each direct material used – Pxx/ unit of measure (from purchasing department)
Terms of payment should be stated also to be able to compute the Accounts payable amount in the
balance sheet as at the end of the budget year.
5. Quantity of direct materials per unit of finished product - xxx /unit (from production department)
6. Average direct labor rate per hour – Pxxx/ direct labor hour (data from HRD)
7. Direct labor hours per unit - man-hours/ unit (data from a time and motion study)
8. Factory overhead
(Various factory overhead expenses are list down in details and classified into fixed and variable.
Variable factory overhead is divided by the production quantity to arrive at the variable rate per unit.)
Total Fixed factory overhead Pxxxx
Total Variable factory overhead (production volume x rate) xxxx
Total factory overhead Pxxxx
Divided by production volume xxx units
Factory overhead rate per unit P xx
9. From the above information, we have to compute the following:
9.1. Production plan (in units).

Production plan is a detailed computation of how many finished products should be manufactured
during a given period of time after considering the desired finished goods at the end.
Budgeted sales volume xxx units

Desired finished goods inventory, end xxx “
Total available for sale xxx “
Finished goods inventory, beg ( xxx) “ .
Budgeted production volume xxx units
9.2. Budgeted material needed = Budgeted production volume x standard material needed
9.3 Budgeted material cost = Budgeted materials needed x material unit cost
9.4 Budgeted direct labor hour needed = Budgeted production volume x standard direct labor
Hours
Standard direct labor hours are measured in terms of man-hours. Man-hours means the number
of hours a man can complete the task of production of a finished product.
Example: 1 hour direct labor hour = 1 man-hour
30 minutes direct labor hour = 0.50 man-hour
1 hour and 15 minutes = 1.25 man-hour
9.5 Budgeted direct labor cost = Budgeted direct labor hours needed x Budgeted direct labor rate
9.6 Budgeted variable factory overhead cost = Budgeted production volume x budgeted variable
factory overhead per unit
9.7 Budgeted factory overhead cost = budgeted variable factory overhead cost + budgeted fixed
factory overhead cost.
9.8 Budgeted factory cost or manufacturing cost = budgeted material cost + budgeted direct labor
cost + budgeted factory overhead cost.
9.9 For budgeting purposes, it is assumed that work in process is zero.

9.10 Budgeted factory cost will the same as the budgeted cost of goods manufactured.
9.11 Budgeted manufactured finished product cost per unit = cost of goods manufactured divided by
the total production planned volume.
9.12 Budgeted quantity of material purchases = production volume + desired material inventory,
end – material inventory, beg.
9.13 Unit buying cost of direct materials
9.14 Budgeted amount of material purchases = quantity of material purchases x unit buying cost
10. We can now present the standard variable cost of each unit of production.
Purpose: this is to facilitate computation of cost of goods manufactured and sold.
Standard variable cost of one unit of product:

Direct materials cost = xx kg. Pxx/kg Pxxxx
Direct labor cost = xx man-hour Pxx/ man-hr xxxx
Factory overhead = xx man-hour Px/man-hr. xxxx
Total standard cost per unit Pxxxx
The pro-forma statement is shown below:
Statement of Cost of Goods Manufactured
Direct material cost Pxxx (Note 1)

Direct labor cost xxx (Note 2)
Factory overhead cost xxx (Note 3)
Total Factory Cost/ cost of goods manufactured xxx
Divided by: Budgeted production quantity xxx units
Budgeted unit cost of finished product P xxx / unit
Budgeted Cost of sales (FIFO)

( units )
Cost of goods manufactured xxx Pxx Pxxxx (See above)
Finished goods, beg. xx xx xxx
Cost of goods available for sale xxx xxxx
Desired Finished goods, end ( xx) xx ( xxx)
Cost of sales xxx P xxxx
Note 1 Budgeted direct material cost = Budgeted production volume x standard unit cost
Note 2 Budgeted direct labor cost = Budgeted production volume x standard direct labor rate
Note 3 Budgeted factory overhead

1. Budgeted variable factory overhead
(Budgeted production volume x standard variable factory overhead rate) P xxxxx
2. Budgeted fixed factory overhead for the period xxxxx
Budgeted total factory overhead for the period xxxxx
Illustration Problem
The following data are given on the planned operations of Darna Manufacturing Co., for the whole year of
2021. It is a manufacturer of product, Darna, a super hero toy for teenagers,
A. Budgeted sales volume ……………… 23,000 units @ P150.00
B. Inventories:
Finished goods inventory, beginning 5,000 units @ P75.00
Direct materials inventory, beginning 3,000 kgs.
Desired ending inventory of finished goods ………………………. 2,000 units
Desired ending inventory of direct materials……………………… 5,000 kgs.
C. Summary of Other Budget Information:
1. According to the Production Department:

1.1 Direct material needed for one unit of finished product is 2 kilograms.
1.2 According to a time and motion study, a finished product requires 0 .25 man-hours (15 minutes or
0.25 direct labor hour) to complete.
1.3 The variable factory overhead rate is P20.00 per direct labor hours.
2. According to purchasing department, the projected unit cost per kilogram of material for 2021 is
P12.00
3. According to the Department of Human Resource, the average direct labor cost for 2021 is around
P480 per day (eight hours work) .
4. According to the Cost Accounting Department, the fixed factory overhead for one month in 2021 is
P50,000.
6. Based form the above budgeting information, the Standard variable cost per unit:
Direct materials……………………… 2 kgs. @ P12 P 24.00

Direct labor 0.25 man- hour @ P480…… 120.00
Variable factory overhead…… 0.25 man-hour @ P20 5.00
Total variable cost per unit 149.00
Fixed factory overhead: for one month 2021 ………………… P50,000 or

for one year P600,000
7. The inventory of work in process is considered insignificant, therefore zero.
Required: 1) Prepare the 2021 Budgeted Statement of Cost of Goods Manufacture and Cost of Sales
with corresponding detailed computations.
2) Compute the gross profit and gross profit rate.
Solution:
The computations would be as follows:
Note 1 Budgeted production volume: units

Budgeted sales volume 23,000

Add: Desired ending inventory of finished units 2,000
Total to be available 25,000
Less: Beginning inventory of finished units ( 5,000 )
Budgeted production volume 20,000
=====
Note 2 Budgeted materials needed in production: kilograms
Budgeted production volume 20,000
Multiply by: Materials allowed per unit 2 kgs.
Budgeted materials usage 40,000 kgs.
======
Note 3 Budgeted materials cost:
Budgeted materials needed 40,000 kgs.
Multiply by: Material cost per kilo P 12.00
Budgeted materials cost P480,000
=======
Note 4 Budgeted quantity of materials to be purchased in 2021
Budgeted materials needed 40,000 kgs.
Desired materials inventory, end 5,000
Total materials available 45,000
Less: Materials inventory, beginning ( 3,000 )
Budgeted quantity of materials purchases 42,000 kgs.
=====
Note 5 Budgeted materials purchases (peso amount)
Budgeted quantity of materials purchases 42,000 kgs.
Multiply by: Cost per kilo P 12.00
Budgeted materials purchases P 504,000
Note 6 Budgeted direct labor hours

Budgeted production volume 20,000 units
Multiply by direct labor hours allowed per unit 0.25 man-hour
Budgeted direct labor hours 5,000 man-hour
======
Note 7 Budgeted direct labor cost

Budgeted direct labor hours 5,000 man-hour
Multiply by: Labor rate per hour (P480/8 hours) P60 / hour
Budgeted direct labor cost P 300,000
=========
Note 8 Budgeted factory overhead
Fixed factory overhead for one year P 600,000
Add: Variable factory overhead
( 5,000 man-hours x P20) 100,000
Budgeted factory overhead P 700,000
========
Note 9 Budgeted cost of goods manufactured: 20,000 units
Budgeted materials cost P 480,000 Note 3
Budgeted direct labor cost 300,000 Note 7
Budgeted factory overhead 700,000 Note 8
Budgeted cost of goods manufactured P 1,480,000
= =======
Budgeted production volume 20,000 units
Unit cost P 74.00 / unit
Note 10 Budgeted cost of goods sold: (FIFO)

(units) P P
Budgeted cost of goods
manufactured 20,000 74.00 1,480,000 (see above)
Add: Finished goods
invty. beginning 5,000 75.00 375,000
Goods available 25,000 1,855,000
Less: Desired ending invty. 2,000 74.00 ( 148,000 )
Budgeted cost of sales 23,000 74.2174 1,707,000
========
Note 11 Budgeted gross profit and gross profit rate
Sales 23,000 units @ P150 P 3,450,000

Cost of sales (23,000 @ (P74.2174) ( 1,707,000 ) Note 10
Gross profit P 1,743,000
========
Gross profit rate (1,743,000 / 3,450,000) 51%
ASSIGNMENT MATERIAL
Theory
I. Questions
1. Planning requires awareness of current developments, expected changes in the environment,
and possible reaction of competitors. Explain.
2. Management accounting plays in major role in performance of planning and control functions of
management. Explain.
3. What is the difference between incremental budgeting and zero-base budgeting.
4. What are the major components of master budget and what must be the objective in preparing
each of them?
5. State the procedure followed in preparing a master budget.
6. How are budgets used in controlling operations?
II. Matching Type
Match the following terms with the statement given below. Indicate the letter on the blank:
_____Strategic planning _____Corporate planning
_____Project planning _____Operational planning
_____Budget manual _____Master budget
_____Zero-base budgeting _____Budgetary control
_____Rolling budget _____Incremental budgeting
_____Sales budget _____Sales forecast
_____BOP method _____Probabilities
a. A set of written instructions and information to serve as a reference in the implementation of the
budget program
b. Optimizing the organization’s future position despite changes in the future environments.
c. The cornerstone in budgeting.
d. Forward planning of existing operations.
e. Optimistic, pessimistic and most likely estimates are made before choosing a planned level operations.
f. It always for the next twelve-month period.
g. The sum of the weighted figures considering probability percentages.
h. The total approach in the planning process requiring the involvement of all levels of management.
i. The consolidation of all the budgets of different sub-units in an enterprise.
j. The budget for the next year is based on current year’s budget considering the planned changes in the
level of operations
Exercises Problem: (A required Home Work to facilitate learning.)

(Use the illustrations as pattern.)
Exercise 1 Incremental Budgeting
Nila Muk Marketing is a merchandising concern. It buys its lone product “Insecticide” from a lone
supplier and sells the same to the public for a profit.
Before preparing the budget for 2021, the following historical data are taken from the accounting records:
Actual Last Year (2020)
1. Last year’s - sale amount 20,000 units @ P100 = P2,000,000
2. Last year’s - variable cost and expenses are:
2.1 Buying price of the merchandise P50.00 per unit.
2.2 Operating expenses:

a. Salesmen’s commission is 3% of sales.
b. Delivery expenses for products sold is around 2% of sales.
3. Last year’s fixed operating expenses P400,000
4. There is no interest expense last year because no borrowing was made during the year.
Preparation of 2021 Budgeted Income Statement
For 2021 budget, the following assumptions will be followed:
1. The purchasing department projected that there will be no increase in the cost of merchandise that
will be purchased..
2. The sales department projected also that there will be no increase in the unit selling price of the
product.
3.The sales department projected an increase in its sales volume by 10%, from 20,000 units to
22,000 units.
4. The rate of variable cost and expenses will remain the same.
5. Fixed expenses will increase by P100,000 because of estimated increase in employees’ salaries
and depreciation expense due to store building expansion and acquisition of new equipment.
6. No borrowings during 2021 so no interest expense.
7. No inventory beginning and ending.
8. Income tax rate is 30%.
Required: Prepare the Budgeted Income Statement for the year 2021 using the incremental budgeting
method. Use a 6 column journal.
Required Home Work No. 2
Vina Tucan Trading, a non-VAT business, is making its master budget for 2021.
The Operating Budget:

1. The sales department budgeted 30,000 units @ P20.00 per unit
2. Merchandise inventory:
Beginning - the cost accounting department reported – merchandise inventory January 1, 2021 –
2,250 units with a cost of P10.00 per unit.
Desired ending inventory is 4,500 units. (Use First In – First Out Method (FIFO))
3. The Purchasing department projected the cost to increase to P12.00 per unit.
4. Last year, the fixed operating expenses was P55,000 (including depreciation expense of P29,250).
For 2021, they expect it to remain the same.
5. Variable operating expenses per unit – P3.00
6. Interest expense is budgeted at P27,000 (P450,000 x 6%)
7. Income tax rate is 30%
Capital Expenditure Budget

1. Acquisition of additional property and equipment to be bought December, 2021 - 250,000
No depreciation expense is budgeted for this acquisition. (Useful life is 10 years, no salvage value.)
Financial Resource Budget

1. Loan amortization, excluding interest, is P330,000 and paid at the end of December, 2021. The
balance is due in December, 2023.
2. Budgeted to issue 1,200 shares @ P120 per share. Of the P120 issue price, the par value is P100
per share and the premium is P20 per share. (This is common shares.)
3.The terms of sale: all sales are on credit and strictly 30 days. Assume that the sales for December,
2021 is P 60,000
4. The terms of purchases is strictly 30 days. The balance of accounts payable at the end of 2021 is
P36,000.
5. Budgeted cash dividends declared and paid – P20,000
6. Budgeted payment of operating expenses – P120,000.
(With accrued operating expenses)
7. Payment for budgeted interest expense – P27,000.
8. Unpaid income tax – P12,000. (For the 4th quarter, 2021 ITR)
Last Year (2020):

1. The Statement of Financial Position, 2020 showed:
Assets:
Current Assets
Cash 540,000
Accounts receivable, net 240,000
Properties and equipment, net 292,500


Current liabilities
Loans payable, current portion 330,000 (due 2017)
Non-current liabilities
Loans payable, non-current portion 120,000 (due 2019)
Shareholders’ equity
Required: Prepare the : 2021 Budgeted Income Statement

2021 Budgeted Statement of Financial Position (Balance Sheet)
Exercise 3: Sales estimates
Mando Rugas Shirt Corporation, located in Cebu City is making estimates of its sales volume of T-shirts
for tourist for 2021.
Historical sales showed the following:

1) The minimum quantity of sales is 50,000 units;
2) The sales volume increases at the rate of one units for every ten tourist arrival in Cebu.
3. The estimated number of tourist arrival in Ceby for 2021 is 1,500,000.
4) Unit selling price is P100.
Tasks: Compute using:

a. Regression equation for sales volume (units).
b. Estimated sales amount for 2021.
Exercise 4: Expected value of sales using probability

Determine the expected value based on the following estimates:
No. of units
of sales Probability
10,000 2%
11,000 8%
12,000 20%
13,000 30%
14,000 20%
15,000 15%
16,000 5%
Exercise 5: Budgeted purchases, cost of sales and operating expenses.

The Walang Vujok Corporation, a trading company, is finalizing financial plans for 2021 based on the
following:
Desired inventory, Dec. 31, 2021 ………………………… 30,000 units

Planned level sales……………………………………….. 400,000 units @ P4.60
Merchandise inventory, January 1, 2021……………….. 20,000 units @ P2.95
Estimated purchase cost in 2021…………………… P3.00

Variable operating expenses per unit……………… P1.00
Fixed operating expenses per annum………………… P250,000
Income tax rate
Required: compute in detail:
a. Budgeted purchases
b. Budgeted cost of sales
c. Budgeted operating expenses
d. Budgeted earnings before interest and taxes
e. Budgeted net income after income tax
Exercise 6: Classification of activities for budgeted statement of cash flows.

Determine how the following are to be classified in the statement of cash flows: as Operating activities, as
Investing activities, and as Financing activities. Indicate on the blank letter O, if an operating activity, I, if
an investing activity, and F, if a financing activity.
_____a. Depreciation expense

_____b. Collections on sales
_____c. Interest expense payments
_____d. Acquisition of land for speculative purposes
_____e. Acquisition of additional computers
_____f. Payments for selling, gen. and administrative expenses
_____g. Sale of equipment
_____h. Loan amortization (principal only)
_____i. New loans obtained
_____j. Payments for dividends
_____k. Net income
_____l. Lending cash to another corporation to earn interest.
_____m. Collection of principal from borrowers where the company is the lender.
_____n. Loss on sale of old equipment.
_____o. Gain on sale of land
Exercise 7: Cash Budget

Fe Rah Corporation has requested you to prepare its 2021 cash budget and has provided you with the
following information:
Sales on account……………………………………………….. 1,000,000

Purchases on account 500,000
Payments for purchases…………………………………………… 450,000
Payments for operating expenses………………………………….. 200,000
Payments for income taxes………………………………………… 48,000
Dividends to be paid……………………………………………….. 50,000
Payments for interest on existing loans……………………………. 10,000
Collection on sales 900,000
Cash balance, Jan. 2021……………………………………………. 42,000
Desired cash balance, Dec. 31, 2021 (minimum)………………….. 20,000
Sales of land (cost P400,000)……………………………………….. 750,000
Acquisition of equipment………………………………………… 100,000
Annual installment payment on loan, excluding interest………….. 50,000
In case of cash deficiency, the company can obtain one-year, 12% loans in multiples of P5,000.
Exercise 8: Budgets – Manufacturing Divisions

Baby Bing Ca Corporation has provided you with the following information on its sole product:
Standard variable cost per unit:

Direct materials cost………… 2 kgs. @ P100 200
Direct labor cost…………….. 3 hours @ P15 45
Variable factory overhead… 3 hours @ P 10 30
Total variable cost per unit 275
Fixed Factory overhead per annum………………………… P200,000
Planned sales volume, Jan. – March, 2021……… 100,000 units
Inventories, January 1, 2021:

Finished goods……………………………. 10,000 units @ P272.50
Raw materials…………………………….. 9,000 kgs. @ P 100
Desired inventories, March 31, 2021:

Finished goods……………………………. 5,000 units
Raw materials…………………………….. 12,000 kgs.
Required: Budgeted figures, first quarter of 2021, for:

Budgeted production volume (units)
Budgeted material cost
Budgeted direct labor cost
Budgeted factory overhead
Budgeted cost of Goods Manufactured and Sold
Exercise 9
Items 1 to 4: High and Low Method
The factory overhead and operating expenses based on the following production and sales figures
are given on the sole product of Violet Manufacturing Corp.:
Low High
Production volume (units) 100,000 300,000
Sales volume (units) 100,000 200,000
Factory overhead P200,000 P440,000

Operating expenses P280,000 P 440,000
Production
1.The variable rate of factory overhead is P _________________/ unit.. P1.20
2.Total variable cost at 100,000 units and at 300,000 unit? P____120,000 and P _P360,000___
3. The fixed portion of factory overhead is P _________________. P80,000
Sales
2.The variable rate of operating expenses is P _______________/ unit. P1.60
3. Total variable cost at 100,000 units and at 200,000 units? ___P160,0000___ and P ____P320,000_
4. The fixed portion of the operating expenses is P _______________. P120,0000
5. After considering the fixed factory overhead and the variable rate of factory overhead, , the budgeted
allowance for factory overhead based on 200,000 units must be P ________________.
6. After considering the fixed operating expenses and the variable rate of operating expenses, , the
budgeted allowance for operating expenses based on 250,000 units must be P ________________.
7 Budgeted volume of sales is 100,000. Desired ending inventory is 10,000 units are there are 15,000
units in the beginning inventory. How many units are to be purchased? Answer: _____________ units
8. The following information is taken from a budgeted statement of cash flows:

Cash inflow from operating activities…………………. P100,000
Cash outflow from investing activities……………….. ( 50,000)
Increase in cash balance……………………………….. 20,000
How much is the cash inflow (out flow) from financing activities? Answer: P _________________
9. Indirect Method
Budgeted net income for 2021 is P97,500. Included in the budgeted income statement is
depreciation charge of P60,000. The changes in the trade current accounts as follows:
Accrued expenses – decrease 10,000

Increase in bank loan payable 50,000
Decrease of trading securities 20,000
Accounts receivable – decrease P50,000
Merchandise inventory – increase 27,000
Accounts payable – increase 60,000
Budgeted cash inflow (outflow) from operating activities must be P _______________.
10. Budgeted production volume is 800,000 units. There are 80,000 units in the beginning inventory
of finished goods and desired ending inventory is 100,000 units.
What is the budgeted sales volume? Answer: ______________ units
11-12 The planned increase in inventory of raw materials is 10,000 units. Budgeted quantity of raw
materials purchases is 150,000 units. Material unit cost is expected to be P5, same as last year’s.
11. The budgeted materials cost should be P _________________.
12. The and budgeted materials purchases should be P _______________.
Items 13 to 15
Planned sales volume for 2021 is 20,000 units and each unit requires the following prime costs:
Direct materials 3 lbs. @ P5 P15.00
Direct labor 2 hrs. @ 5 10.00
Factory overhead variable 2 hrs. @ 2.50 5.00
Fixed factory overhead for 2021 is P100,000
Budgeted inventory end of the finished product is 300 units. There are 200 units in finished goods
inventory beginning costing P35.
13. How much is the total production cost for the period? Answer: P _________________
14. How much should be the budgeted cost of goods sold? Answer: P _______________
15. How much should be the budgeted finished goods inventory, end? Answer P ______________
THE END

Financial Accounting

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R. Z.

Palma Financial Accounting 1

After reading this chapter, the student should be able to:

Objectives of a Business Enterprise

Businesses Should Be Solvent

Types of Business Enterprises

Unlike a trader or a merchandiser, a manufacturer, also called a producer, manufacturer, assembler,

Forms of Business Ownership

Accounting Principles and Processes

What is accounting and its relation to individual activities and business?

Personal Accounting of an individual activities

Business Accounting of its activities

Accounting as the Language of Business

Accounting is often called the “language of business”.

“Accounting is a service activity. Its function is to provide quantitative information, primarily

Data-Users of Accounting Information

Business Owners and Shareholders of the Business.

Officers and Managers

Lenders and Creditors.

General Public and Consumers

Financial Statements (PAS 1)

Accordingly, the financial statement objective of reporting is to provide information:

The Distinction Between Accounting and Bookkeeping

Accounting as the Basis for Business Decisions

The primary responsibility of management covers the following areas:

 Planning and organizing the operating activities of the business enterprise,

Officers and managers

Corporate Financial Accounting

Answer the following questions:

Exercise 1.1 True or False

1) Which of the following is not true?

2) Which of the following statements is not correct?

4) The common types of business are engaged in:

6) Which of the following is mechanical aspect of accounting?

7) Which of the following statements is not true?

_____a) Accounting and bookkeeping are synonymous.

Laws on the Formation of a Corporation

After studying Chapter 2, the students should be able to:

Real World Example

Why Corporation is the Better Business Organization?

Laws on the Formation of A Corporation in the Philippines

“SECTION 2. Corporation defined. - A corporation is an artificial being created by operation of

The Corporation as an Artificial Being.

A Corporation is Created by Operation of Law.

A Corporation has a Right of Succession (continuity of existence)

A Corporation has Powers, Attributes, and Properties.

A corporation by means of its creation can exercise the following powers:

Nationality or Citizenship of a Corporation

Stock and Non-Stock Corporation

Corporators and Incorporators

“SECTION 5. Corporators and Incorporators, Stockholders and Members.

Preferred and Common Shares

Accounting Account Titles

Common shares is also called ordinary shares.

Restrictions on Shares Issued

Required Minimum Authorized Capital Stock and Minimum Paid-up Capital

The owners of the corporation are called corporators, members or stockholders.

The management of a corporation is delegated to a board of directors duly elected by the

Advantages and Disadvantages of a Corporation Compared to Other Forms of Business

1. Capacity to act as a juridical person with legal personality.

1. A corporation is subject to greater government control.

8. Credit of corporation is limited on account of limited liability of stockholders.

_ Province of ___Philippines;