Module 1 – Introduction to Accounting

Instructional Materials
in
Accounting Principles

Course Title: Basic Accounting

Couse Code: ACCO 20203/ACCO 001
Course Program: BSOA & 1BSENTREP

Compiled by:
ROSALINDA R. MADELO
Email Address: sallymadelo@yahoo.com
Cp# 09183716324
September 2023

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Module 1 – Introduction to Accounting

Module 1
Introduction to Accounting

Learning Objective:

After studying module 1, the students should be able to:

a. Recognize different accounting terminologies

b. Understand the nature, functions, and objectives of accounting
c. Identify the users of accounting information and its importance to their lines of business
d. Categorize the forms of business organizations and their engaged activities
e. Explain basic accounting concepts and principles
f. Understand the contents of the basic financial statements
g. Classify the elements of financial statements as to assets, liabilities, owner's equity, revenue and
expenses
h. Understand activities related to opening a service business organized as a proprietorship.

Businesses are involved in various financial activities or transactions or undertakings to

further the fulfillment of economic goals. Financial activities may include buying and selling of
products or assets, organizing and maintaining accounts, issuing stocks or bonds, arranging
loans, or other business activities with specific monetary objectives. Summary reports of these
financial activities are needed by groups of people who are interested in a business entity. These
reports provide the information to help the owners and managers make business decisions. How
much should be charged for the product or service? Are profits sufficient? Should new products
be sold? Should new services be provided? Can cost be decreased? This information needed
can best be provided through the understanding of accounting. Accounting is primarily vital in
every business organizations.

Definitions of Accounting
1. The Accounting Standards Council (ASC) defines accounting as follows: “Accounting is a
service activity. Its function is to provide quantitative information, primarily financial in nature,
about economic entities, that is intended to be useful in making economic decisions, in making
reasoned choices among alternative courses of action”.

In this definition, the service activity being referred to is the different transactions or events
happening in a day to day operations of a business. It also states the purpose of accounting,
that is, to provide quantitative information about a business for the basis of economic
decisions and resolutions.

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2. Accounting involves the processes of identifying, measuring, and communicating economic

information to permit informed judgments and decisions by users of the information.
Accounting provides information, financial in nature, about business entity used by interested
parties in making- an informed decision.

3. The American Institute of Certified Public Accountants (A.I.C.P.A.): "Accounting may be

defined as 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 financial character, and
interpreting the results thereof".

4. Taylor and Shearing: "Accounting may be defined as the art and science of recording business
transactions in a methodological manner so as to show: (a) the true state of affairs of a
business of a particular period of time and, (b) the surplus or deficiency which has accrued
during a specific period."

It appears from numbers two to four above- stated definitions of Accounting, it emphasizes
that Accounting is basically concerned with recording of the business transactions, designing
the types of records to be maintained, preparing the reports on the basis of those recorded
data and transactions and interpreting those reports. Finally, Accounting is concerned with
communication of the results of the recorded transactions in the form of financial accounts
consisting of the profit and loss account with different sections and the balance sheet with a
number of reports and statements affixed at the end.

The accounting process as stated in the definition of accounting numbers two to four
identifies the following functions:

a. Identifying - through accounting, economic activities are identified from the many events
in a business. These activities which are of financial character are called business
transactions.

b. Measuring - economic activities are measured in terms of money.

c. Recording or Bookkeeping
A systematic and chronological record of financial transactions is to be maintained.
The recording of transactions can either be manually or electronically and according to the
date of occurrence.

d. Classifying is the sorting or grouping of similar and interrelated transactions in their

respective class. For instance, all transactions involving cash are grouped to report a
single net cash figure. Classifying is accomplished by posting to the ledger.

e. Protecting of Properties
Accounting is to calculate the correct amount of depreciation on assets by choosing
the appropriate method applicable to any particular assets. Any wastage and loss of any asset
will bring the business to the onset of insolvency. Accounting is to design a desirable system
to protect the properties and assets of the business from unauthorized and unwarranted use.

f. Communicating - business transactions in a given period are recorded, classified into

groups and summarized. This process allows accountants to prepare reports called

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financial statements. In order to create useful reports, financial information must be

maintained in an organized way. A planned process for providing financial information that
will be useful to management is called an accounting system.

g. Meeting Legal Requirements

Accounting is to devise and develop such a system of keeping record and reporting the
results as will always meet and legal requirements to enable the proprietor or the authority
to file various statements like Income-Tax Returns and Sales-Tax Returns.

Accounting Functions can be divided into two distinct departments namely:

A. Historical or Stewardship Function

This part relates to the past transactions of the business firm, accounting records,
classifies, reports, analyses and interprets the transactions already effected. Accounting also
calculates the profit or loss made during the year and prepares other financial statements and
the Balance Sheet and reports and results to the proprietors, managers and other interested
parties.

B. Managerial Function

Accounting is to render such service to the management as to aid different levels of the
managerial staff to carry out the operations of the business efficiently. Accounting is to present
"information in such a way as to assist management in the creation of policy and in the day to
day operation of an undertaking".-M.E.Murphy, Managerial Accounting.

Accounting is an advisory service function and is concerned with furnishing such

information to the management as this will facilitate efficient planning, operational control and
coordination of future activities of the enterprise. Thus, Accounting is to "assist management
in establishing a plan for reasonable economic objectives and in making of rational decisions"-
Haynes and Massic, Management Analysis

In this, we can see that Accounting helps in budgetary control, cost control, material control
and operational control and also in minimizing wastage, losses and errors and frauds.

5. Accounting is actually an information system that measures business activities, process

information into reports and communicates the reports to decision makers. It is for this reason
that accounting has been called the “Language business”, because it serves as a
communication link between the business entity and the users of financial information. An
accountant’s primary task therefore is to supply financial information to statement users so
that they could make informed judgment and better decisions

THE HISTORY OF ACCOUNTING

Accounting traces its roots to the Middle East region, where as early as 8500 BC,
tradesmen use clay objects to represent commodities such as flocks of sheep, jars of spices and
oil, bolts of clothing and other goods. Some archeologists unearthed clay tablets marred with

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symbols and other writings and interpreted them to mean record of goods sold and other statistics
at those times.

The Ancient Civilization of Babylon, Greece and Egypt also used clay tablets. (In later
years, papyri were used as the medium for record keeping). These records show wage payments,
materials requisitions and costs of labor, which only shows that Accounting has already been in
used even during Biblical times.

In 1494, Friar Luca Pacioli wrote a book which contains discussions on the double-entry
bookkeeping system. The book was entitled summa de Arithmetica, Geometria, Proportioni et
Proportionalita (Everything about Arithmetic, Geometry, Proportions, and Proportionality). It
summarizes the existing mathematical knowledge at that time. Friar Pacioli was considered the
father of double-entry bookkeeping.

In the mid-18th to the mid-19th centuries, the Industrial Revolution altered the way goods
are produced from the artisan/craftsman method to the assembly-line method. Cost Accounting,
which deals with the assignment of costs to products, emerged during this period. Also, during
this period, the corporate form of business organization was created to accommodate the need
for the increasing large amounts of funds which was required to finance the expansion of
business.

THE ROLE OF ACCOUNTING IN BUSINESS

A business is an organization in which basic resources are applied to the activities involved
in the production and distribution of goods and services to customers or clients. The objective of
most businesses is to maximize profits. Of course, some businesses would operate with a
purpose other than to raise profits, like to provide benefits to society. Discussions in this text are
focused on businesses operating to earn profit. Although some of these concepts and principles
apply to not-for-profit businesses as well.

What is the role of accounting in business? In general, accounting as an information

system, provides reports about economic activities and condition of a business. Accounting is
used to record and report the financial effects of business activities and, that is why it is called the
“language of business.” Without accounting information, many important financial decisions would
be thoughtlessly made. It provides the necessary information needed in the formulation and
execution of business and non-business policies. For example, Accounting reports summarizing
the profitability of a product help management decide whether to continue selling a product or not.
Business must have an orderly way to keep tract of the countless and varied financial transactions
that occur. An accounting system allows them to develop financial records that can be used to
prepare reports on the financial state of the business. Managers can look at the summarized
information from the reports and determine if the business is operating at a profit. They can also
determine problems arising in the operations by studying these reports. Business establishments
and the government acknowledge accounting as an essential tool of management.

Accountants play two roles with regard to business activities.

• Measuring and reporting. Accountants measure and communicate (report) the results of
business activities—in other words, accountants keep tract. To measure these results
accurately, accountants follow a standard set of procedures referred to as the accounting

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cycle. The cycle includes several steps, which involve analyzing, recording, classifying,
summarizing, and reporting the transactions of a business.
• Advising. Accountants advise managers on how to structure these activities so as to
achieve the goals of the business, such as generating a profit, minimizing costs, providing
efficient services, etc.

Users of Financial Information

Two main categories:

1. Internal users

Internal reports like financial reports are used by those who direct the day-to-day
operations of a business enterprise. These individuals are collectively referred to as
“management,” and the related area of accounting is called management accounting.
Management accounting focuses on the information needed for planning, implementing plans,
and controlling costs. Managers use accounting information as the basis for making business
decisions. Accurate accounting records contributes to a business' success and help to avoid
failure and bankruptcy. Failure to understand accounting information can result in poor
business decisions. Training in accounting helps managers and owners make better business
decisions. Managers and executives who work inside a company have access to specialized
management accounting information that is not available to outsiders. For example, the
management of McDonald's Corporation has detailed management accounting data on
exactly how much it costs to produce each food and drink item on the menu. Further, if Burger
King or Wendy's starts a local burger price war in, say, Quezon City, McDonald's managers
can request daily sales summaries for each store in the area to measure the impact.

2. External users

External financial reports, included in the firm's annual report, are used by individuals
and organizations that have an economic interest in the business but are not part of its
management. Information is provided to these “external users” in the form of general-
purpose financial statements and special reports required by government agencies. The
general-purpose information provided by financial accounting is summarized in the
financial statements.

a. Lenders (creditors) are interested in one thing—being repaid, with interest. If you
were to approach a bank for a large loan, the bank would ask you for the following
types of information in order to evaluate whether you would be able to repay the loan:
• A listing of your assets and liabilities
• Payroll stubs, tax returns, and other evidence of your income
• Details about any monthly payments (car, rent, credit cards, etc.) you are
obligated to make
• Copies of recent bank statements to document the flow of cash into and out
of your account

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In essence, the bank would be asking you for a balance sheet, an income
statement, and a statement of cash flows. Similarly, banks use companies'
financial statements in making decisions about commercial loans. The financial
statements are useful because they help the lender determine the future ability
of the borrower to repay the loan.

b. Owners and Investors

Investors want information to help them estimate how much cash they can
expect to receive in the future if they invest in a business now. Financial statements,
coupled with knowledge of business plans, market forecasts, and the character of
management, can aid investors in assessing future cash flows. Furthermore, owners
and prospective investors use the financial report in assessing the stewardship or
accountability of management. It is used to assess how well the resources of the
business had been managed and used by persons to whom such resources had been
entrusted. Information on profitability and financial condition will be most useful for
this purpose.

Many companies have broad ownership with a few individuals owning a

large portion of the company's stock. Investing without looking at the financial
statements is like jumping off the high dive without looking first to see if there is
any water in the pool.

c. Suppliers and Customers

In some settings, suppliers and customers are interested in the staying

power of a company. On the supplier side, for example, if Boeing receives an order
from an airline for 30 new 747s over the next 10 years, Boeing wants to know
whether the airline will be around in the future to take delivery of and pay for the
planes. On the customer side, a homeowner who has foundation repair work done
wants to know whether the company making the repairs will be around long
enough to honor its 50-year guarantee. Financial statements provide information
that suppliers and customers can use to assess the long-run prospects of a
company.

d. Employees

Employees are interested in financial accounting information for a variety

of reasons. Financial statement data are used in determining employee bonuses.
In addition, financial accounting information can help an employee evaluate the
likelihood that the employer will be able to fulfill its long-run promises, such as
pensions and retiree health-care benefits. Financial statements are also
important in contract negotiations between labor unions and management.

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e. Competitors
If you were a manager at Pepsi Co, would you be interested in knowing the
relative profitability of Coca-Cola's operations in different locations? Of course you
would, because that information could help you identify strategic opportunities for
marketing efforts where potential profits are high or where your competitor is weak. One
can use information in financial statements to track its competitors and identify new
opportunities to grow and use its market share in retail to increase its revenues in other
ventures.

f. Government Agencies

The government requires that the business report financial information when it pays
taxes. Most government rely on taxes for its functions and operations.

g. The Press

Financial statements are a great place for a reporter to find background

information to flesh out a story about a company.

In summary, who uses financial accounting information? Everyone does, or at least every-
one should. External financial reports come within the area of accounting referred to as financial
accounting. Most of the data needed to prepare both internal and external reports are provided
by the same accounting system. A major difference between management and financial
accounting is the types of financial reports prepared. Internal reports are tailored to meet the
needs of management and may vary considerably among businesses. General-purpose financial
statements and other external reports, however, follow certain standards or guidelines and are
thus more uniform among companies.

Forms of Business Organizations

Ownership of a business varies depending on the number of owners or investors in a

business. These may be:

1. Single or Sole proprietorship - where the owner of the business is only one person and is
called a proprietor. It is the easiest form of business to organize as it does not need to comply
with many legal formalities and requires only a small amount of investment to start the
business, but you do need to obtain any necessary licenses and permits to operate legally. It
is less complicated to operate, and decisions are made faster since only one owner decides.
The owner entitled to all profits and are responsible of all business debts, losses and liabilities.

2. Partnership - where there are two or more investors who contributed money, property or
industry to a common fund with the intention of dividing the profits among themselves; owners
are called partners. The partners draw up and sign a formal business agreement called the
Articles of Co-Partnership. It tells the amount of the capital contribution or how much of the
business owned by each partner, their duties and responsibilities, and the terms of distribution
of profits and losses among them. A partnership is easier to organize than a corporation.
Better decisions are made since there are two or more owners.

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3. Corporation - a business owned by five or more persons where such business becomes an
artificial being created by the operation of law, having the rights of succession, and the powers
and attributes expressly authorized by law or incident to its existence. This means that the
corporation itself not the shareholders is held liable for the actions and debts the business
incurs. Thus, to organize a corporation, there are more legal requirements to comply with in
comparison with the other two forms of business organizations. Owners of a corporation are
called stockholders or shareholders.

The primary advantage of the corporate form is the ability to obtain large amount of
resources by issuing shares of stock. For this reason, most companies that require large
investments in equipment and facilities, like those into construction of high-rise buildings, are
organized as corporation.

4. Cooperative – a business organization owned by and operated for the benefit of those using
its services. They are common in healthcare, retail, agriculture, art, some schools,
universities, shipping industries (manpower pooling) and restaurant industries. Profits and
earnings generated by the cooperative are distributed among the members, also known as
user owners. Typically, an elected board of directors and officers run the cooperative while
regular members have voting power to control the direction of the cooperative. Members can
become part of the cooperative by purchasing shares, though the amount of shares they hold
does not affect the weight of their vote.

Types of Businesses

1. Service business - a business that performs an activity for a fee is said to be engaged in a
service business. Examples: car repair shop, a law office, dental clinic, dress shop, trucking
and delivery service

2. Merchandising business - a business that deals with buying and selling of goods. Examples:
a department store, a hardware store, a grocery, a sari-sari store, a drugstore

3. Manufacturing business - a business the buys goods to be converted to another form of

good to be sold. Examples: a toy factory, a car company, a meat processing plant, a furniture
company

The three types of business discussed which are the service business, merchandising and
manufacturing business may either be a sole proprietorship a partnership, corporation or even
a cooperative. Most manufacturing companies are organized as corporation because large
amount of resources is required to operate such type of business. Likewise, though most
service businesses are sole proprietorships, large service companies like Philippine Long
Distance Co. (PLDT) and Philippine Airlines (PAL), telecommunication companies like
GLOBE and SMART are organized as corporation.

THE GENERALLY ACCEPTED ACCOUNTING PRINCIPLES (GAAP)

Significant changes have taken place in accounting over the years accompanied by the
growing needs of society. As changes occur due to economic, technological and other
advancements, accounting profession has set guidelines and standards that will rule how
accountants will accumulate, measure, record and report the financial affairs and activities of the

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business and that recipient of financial reports will be able to understand and interpret these
reports. This set of guidelines in the accounting practice is known as the Generally Accepted
Accounting Principles (GAAP). They are like laws that must be followed.

The Financial Reporting Standards Council (FRSC) is the accounting standard setting
body created by the Professional Regulation Commission (PRC) upon recommendation of the
Board of Accountancy. The FSRC aims to develop a single set of high quality, understandable
and enforceable accounting standards that require high quality, transparent and comparable
information in financial statements and other financial reporting to help participants in the various
capital markets and other users of information in making economic decisions.

Some Generally Accepted Accounting Principles are:

Business entity concept. Under this concept, all forms of business organizations and types of
businesses is treated as separate and distinct from its owner/s and from the other business units.
This accounting concept is important because it limits the economic data in the accounting system
to data related to the activities of the business. A business financial information is recorded and
reported separately from the owner’s or owners’ personal financial information. Thus, the
accountant of a business with one owner (a proprietorship) would record the transactions of the
business only. The personal transactions of the owner should not be merged with that of the
business he owns. Likewise, if the proprietor owns several businesses, there must be separate
accounting for the assets, liabilities, capital, revenue and expenses for each business unit
because each is an independent entity.

Going concern or continuity assumption. This assumes that unless there is evidence to the
contrary, the business entity will continue to operate for an indefinite period.

Time period assumption. This assumption requires that the indefinite life of the business be
divided into time periods or accounting periods for the purpose of preparing financial reports on
the performance and financial position of the business. Financial reports covering an accounting
period has to be prepared because users of financial information need timely reports for them to
make economic decisions. It allows the accountant to divide up the complex, ongoing activities
of business into periods of a year or annual, semi-annual, quarter, month or week.

Financial statements may be prepared on a monthly basis (the shortest accounting

period), at the end of every three months (quarterly basis), six months (semi-annual basis) or one
year (annually). The annual accounting period of a company may be a calendar year, a fiscal year
or a natural business year. A calendar year begins on January 1 and ends on December 31 of
the same year. A fiscal year begins on any month (except January) and will end on the twelfth
month of the following year. An example is, if the company started the business on July 1, 2019,
the end of its accounting period covering one year of operation would be June 30, 2020. A natural
business year is a twelve-month period that ends on any month when the business is at the lowest
point or is experiencing slack season.

Unit of measurement assumption. This is also known as money measurement assumption.

This specifies that accounting should measure and report the results of a business’ economic
activities in terms of a monetary unit such as the Philippine Peso. This assumption recognizes
that the use of a standard monetary unit throughout all the financial statements is an effective
means for aggregating and communicating accounting information. It is a standard practice to
ignore changes in the purchasing power of a peso.

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Accrual basis. The accrual basis of accounting requires that revenue or income should be
recognized when earned regardless of when collection is received; and expense should be
recognized when incurred regardless of when payment is made. For a service company, revenue
is considered earned when services have been rendered even if no payment is received yet from
the customer or client.

In contrast, revenues and expenses may be accounted for on a ‘cash received or cash
paid basis’. This method of recognizing revenue and expense is known as the cash basis of
accounting.

Example: Doctor Randy, a dentist, rendered his service to a client in

September. He received the payment of P 60,000 in October. When
should Doctor Randy recognize the revenue? In September or
October?

Under the accrual basis, the revenue would be recognized in September because the
revenue is earned in September, the date when the services were rendered. Under the cash
basis, the revenue would be recognized in October, the date when the payment was received.

The Accrual Basis is the generally accepted method because it conforms to the “Matching
Principle”.

Matching principle. This principle requires that the expenses incurred during a period be
recorded in the same period in which the related revenues are earned. This recognizes that
businesses must incur expenses to earn revenues.

Depreciation is an example of the matching principle in action.

Depreciation is the “expensing” of a physical asset, such as a truck or
a machine, over its estimated useful life.

Reporting Financial Information

Periodically, a business reports the summaries of its financial activities in form of financial
statements which are used by owners, managers and other interested parties. Financial
statements is the end product of the accounting process. These statements provide information
about financial position, profitability of operations, sources and uses of funds of an enterprise that
will be useful in making an informed decision. These financial reports include:

1. Income Statement - is a summary of the income earned, expenses incurred and the resulting
profit or loss of a business within a given period of time. Profit results when income earned
exceeds expenses incurred, on the reverse, loss results when expenses incurred exceeds
income earned.

2. Statement of Changes in Owner's Equity - shows the summary of changes in the owner's
equity within a given period of time. Owner's beginning equity may be increased as a result of
the net income generated from operations and from additional. Investment from the owner. It
may be decreased on the other hand from the net loss resulting from operations and
withdrawals of investments by the owner.

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3. Statement of Financial Position - formerly known as Balance Sheet, list the assets, liabilities
and owner's equity of a business as of a given date.

4. Statement of Cash Flows - reports sources and uses of funds classified according to major
business activities namely: operating, investing, and financing. Cash balance appearing at the
end of the statement agrees with the balance of Cash appearing in the Statement of Financial
Position.

5. Notes to Financial Statements - a summary of significant accounting policies and other

explanatory notes pertaining to items shown in the various financial statements. This also
contain supplementary schedules relevant to the account, disclosures about the risks and
uncertainties affecting the entity and other relevant information not shown in the financial
statements.

QUALITATIVE CHARACTERISTICS OF FINANCIAL STATEMENTS

The qualitative characteristics of financial statements consists of the attributes or qualities
that make information provided in the financial statements useful to user. These are:

• Relevance. To be useful, accounting information represented by financial statements must be

relevant to the objectives of enterprise. Unnecessary and irrelevant information should not be
included in financial statements. The International Accounting Standards Board (IASB) says
that 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 relevance of information is affected by its nature and materiality. If an item or event is
material, it is probably relevant to the users of financial statements.

For Example: The information regarding the rate of dividend paid by a company in previous
years is relevant information for the investors since it provides a basis for forecasting future
dividends.

• Reliability implies that the information must be factual and verifiable. The accounting
information has said to have verifiability if such information can be verified from source
documents such as cash memos, purchase invoices, sales invoices, correspondence,
agreement, property deeds and other similar documents.

In order to be relied upon, the financial information requires the following attributes:

o Neutrality when it is free from errors and bias and can be depended upon by users to
represent faithfully what it purports to represent.
o Substance over form - used "to ensure that financial statements give a complete,
relevant, and accurate picture of transactions and events," that is accounting should
be based on financial reality and not merely on legal form.
o Prudence - ensures that the financial statements present the realistic and fair picture
of a company's revenue and liabilities. It helps in the minimization of losses. It helps in
not overestimating as well as not underestimating the financial risk of a company.

The rationale behind prudence is that a company should not recognize an asset at a
value that is higher than the amount which is expected to be recovered from its sale

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or use. Conversely, liabilities of an entity should not be presented below the amount
that is likely to be paid in its respect in the future.

o Completeness is an affirmation that the financial statements are thorough and include

every item that should be included in the statement for a given accounting period. An

omission can cause misleading and false information and therefore unreliable.

• Understandability. Accounting information should be presented in such a simple and logical

manner that they are understood easily by their users. A person who does not have any
knowledge of accounting terminology should also be able to understand them without much
difficulty.

This can be done by giving relevant explanatory notes to explain the information given in
financial statements. General topics which can be included in the explanatory notes are
method of depreciation, method of valuation of inventory, description of contingent liabilities,
explanation of reserves, disclosure of events occurring after balance sheet date and many
others. These explanatory notes make the financial statements more useful and
understandable.

• Comparability. The ability to bring together for the purpose of noting points of likeness and
differences. The financial statements should contain the figures of previous year along with
the figures of current year so that the financial position and performance can be compared.
Knowing the past trends, users can reasonably make more accurate predictions and
decisions. Comparison reveals the strong and weak points of the business entity.
Comparison is possible when the different firms in the same industry adopt the same
accounting principles from year to year.

For Example: If diminishing balance method of charging depreciation is selected,

it should not be changed from year to year. Similarly, the method of valuation
of stock should also be consistently the same from year to year.

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Relationship among the Financial Statements

Marge Gawa Repair Shop

Income Statement
For the Month Ended June 30, 2019

Revenue:
Repair Shop Income P 350,500-
Operating Expenses:
Salary Expense P 180,000-
Rent Expense 20,000-
Utilities Expense 15,000-
Supplies Expense 55,000-
Depreciation Expense 35,000-
Total Operating Expenses 305,000-
Net Income P 45,500-

Marge Gawa Repair Shop

Statement of Owner's Equity
For the Month Ended June 30, 2019

Marge Gawa, Capital, June 1, 2019 P 375,000-

Add: Net income P 45,500-
Additional investments 100,000-

P 145,500-
Less: Handy Manny, Drawings 10,000-
Net increase in capital 135,500-
Marge Gawa, Capital, June 30, 2019 P 510,500-

Marge Gawa Repair Shop

Statement of Financial Position
June 30, 2019

Assets Liabilities
Cash P 100,000- Accounts Payable P 35,200-
Accounts Receivables 20,000-
Shop Supplies 90,000- Owner's Equity
Shop Equipment (net) 335,700- Marge Gawa, Capital 510,500-
Total Liabilities and
Total Assets P 545,700- Owner's Equity P 545,700-

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Marge Gawa Repair Shop

Statement of Cash Flows
June 30, 2019

Cash Flows from Operations:

Net income from operations P 45,500-
Add: Depreciation Expense 35,000-
Net cash provided by operating activities P 80,000-

Cash Flows from Investing Activities:

Cash paid to buy Shop Equipment (100,000-)

Cash Flows from Financing Activities:

Additional investment by owner P 100,000-
Marge Gawa, Drawing (10,000-)
Net cash provided by financing activities 90,000-

Net increase in cash P 70,000-

Cash balance, June 1, 2012 30,000-
Cash balance, June 30, 2012 P 100,000-

Elements of Financial Statements

Financial Position:

1. Assets - any physical thing or intangible items owned by the business, as a result of past
events and has money value. They are resources of the business received of which will result
to economic benefits. They are classified as:

a. Current Assets – includes cash, assets that can easily be converted to cash or sold,
and that are consumed within a short period of time not more than one year. Most
common under this classification are:

1. Cash - any medium of exchange that the bank will accept at face value such
as currencies and coins, checks, bank deposits, money orders, bank drafts.

2. Accounts Receivable - claims against customers or debtors arising from the

sale of merchandise or rendering of service on account.

3. Notes Receivable - claims against debtors evidenced by a promissory note.

4. Merchandise Inventories - goods that are held and available for sale.

5. Supplies - consumable goods used in the operations of the business-like

paper, pens, tapes, USB or flash drive and many others. These are use in day
to day activities.

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6. Prepaid Expenses - advance payment made by the business for rent, interest,
taxes, insurance and advertising. These are assets which have future benefit.
Benefits expire with the passage of time.

b. Fixed Assets – long term assets also known as tangible assets or property, plant and
equipment (PP & E) that cannot be easily converted into cash. It indicates that these
assets will not be used up, consumed or sold in the current accounting year. Fixed
assets are capitalized which means cost is included in the value of an asset and
expensed over the useful life of that asset, rather than being expensed in the period
the cost was originally incurred. These are subject to depreciation except land. Under
this classification are:

1. Land - real property used in the business.

2. Buildings - structures where business is conducted.
3. Equipment - like computers, air conditioners, freezer, sewing machines, mixers
4. Furniture and Fixtures - chairs, tables, paintings, cabinets, dividers
5. Delivery Equipment and Automobiles

c. Intangible Assets - rights and privileges used in business like:

1. Franchise - a right given by the government or business entity for the use of public
or private property subject to governmental regulation.

2. Patents - a right granted to an inventor by the federal government that permits the
inventor to exclude others from making, selling or using the invention for a period of
time.

3. Trademark is a word, phrase, symbol, and/or design that identifies and distinguishes
the source of the goods of one party from those of others.

4. Copyright protects original works of authorship including literary, dramatic, musical,

and artistic works, such as poetry, novels, movies, songs, computer software, and
architecture.

5. Goodwill – patronage given by the public to the store because of location, quality of
goods, superiority of services, and many other Items included in goodwill are
proprietary or intellectual property and brand recognition, which are not easily
quantifiable. It is created when one company acquires another for a price higher than
the fair market value of its assets; for example, if Company A buys Company B for
more than the fair value of Company B's assets and debts, the amount left over is
listed on Company A's balance sheet as goodwill.

2. Liabilities - are amount owed by the business from creditors or suppliers and known as the
"creditors' equity". Liabilities are obligations or promises of a business entity given to others
that have arisen as a result of past transactions that will result to cash outflow of business
resources. They are usually followed by the word "payable". Liabilities are classified as:

a. Current Liabilities - amount owed to creditors and are expected to be paid within a
short period of time, usually not more than one year. Examples are:

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1. Accounts Payable - amounts owed or promises to pay later to suppliers for

goods or services that the company has purchased or rendered to them on
account.

2. Notes Payable - amount owed to creditors and financing institutions evidenced

by a promissory note (a written promise to pay).

3. Taxes Payable - amount of tax due to the government not yet paid.

4. Salaries Payable - unpaid salaries of employees as of end of the accounting

period.

5. Interest Payable - unpaid interest on notes payable.

b. Long-Term Liabilities - liabilities that will be due over a long period of time usually
more than a year.

1. Long-term Notes Payable - amounts owed to creditors which are evidenced by

a promissory note and will be due in more than one year.

2. Mortgage Payable - amounts owed to creditors or financing institutions to buy

real estate. The bank will take a mortgage on the real estate which means the
bank can foreclose and seize the property should the borrower be unable to
make the mortgage payments.

3. Owner's Equity - the right of the owner over the assets of the business. It is amount that
would remain to the owners after all liabilities had been paid. Ownership in a business appears
in the financial statement as:

a. For a sole proprietorship - Name of owner followed by the word Capital, thus, as an
example Marge Gawa, Capital

b. For partnerships - Name of partner followed by the word Capital and there will be as
many of these accounts as with the number of partners, thus in a partnership with two
partners will be: Santa, Capital; and Maria, Capital.

c. For corporations - ownership is in form of transferable units of ownership called

shares of stock, thus would appear as Ordinary Shares and Preference Shares.
Shareholders’ equity is the claim of stock on the resources of the organization.
Shareholders’ equity is divided into two parts:

▪ Common Stock represents the amount invested by owners of the business in

exchange for stock in the company. Common stockholders has the following
rights: 1. to vote for the Board of directors; 2. Receive dividends if declared by
the Board of directors, and; 3. Receive any residual assets left after creditors
are paid if the company is liquidated.

▪ Retained Earnings represent the amount of net income from all prior years that
had been retained in the business and not distributed to stockholders as
dividends.

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Income Statement:

4. Revenue or Income

Revenue or income is the gross inflow of economic benefits during the period in the form
of inflows or enhancements on assets or decrease in liabilities that result in increase in equity,
other than those relating to contributions from the owner or owners.

Commonly used revenue accounts are:

Sales Interest Income

Service Revenue Fees Earned
Professional Fees Subscription Revenue
Rent Income Commissions Earned

The use of appropriate revenue account title depends upon the source of the revenue.
Example is, if the revenue relates to rental the appropriate revenue account to use is rental
income, if it relates to interest, then interest income. The commonly used revenue account by
merchandising companies is Sales.

5. Expenses

Expenses is defined as the gross outflow of economic benefits during the period in the
course of ordinary activities when these outflows result in decrease in equity other than those
relating to distribution to owners. In simple terms, expenses are costs incurred to produce
revenue.

Expenses accounts may include the following:

Salaries & Wages Expense Transportation Expense

Taxes and Licenses Expense Supplies Expense
Rent Expense Utilities Expense
Advertising Expense Repair & Maintenance
Insurance Expense Uncollectible Accounts Expense
Depreciation Expense or Bad Debts Expense
Miscellaneous Expense

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Discussion Questions

1. Define accounting.
2. Describe accounting as an information system.
3. What are the four forms of business organizations? Explain each.
4. What are the three types of business as to operation? Describe each.
5. What are the Generally Accepted Accounting Principles (GAAP)? Give at least five Generally
Accepted Accounting Principles and explain each.
6. Differentiate accounting from bookkeeping.
7. Who are the users of financial information? Why do they need said information?
8. What are the basic financial statements? Explain each.
9. What are the basic elements of financial statements? Explain each and give examples.

Exercises for Understanding

1. Matching Type: Match column B with column C. In column A, write only the letter of the
best answer.

Column A Column B Column C

1. A business that performs an activity for a fee. A. Cash flows statement
2. Resources of a business use of which may result B. Business entity concept
to economic benefits. D. Notes receivable
3. Business transactions are recorded separately E. Partnership
from personal transactions. F. Equity
4. Financial report that determines profitability of G. Corporation
operations. H. Service business
5. Financial report that shows sources and use of I. Balance sheet
cash. J. Income statement
6. A written promise to pay received from K. Assets
customers for service rendered, L. Fixed assets
7. Financial rights over the resources of a business
8. Buildings, land, equipment, automobiles
9. A business owned by two or more persons
10. Lists the assets, liabilities and owner's capital
column

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2. For each of the business entity, classify as to (A) Service business, (B) Merchandising
business or (C) Manufacturing business. On the space provided for each number, write
only the letter of the best answer.

1. Garcia Dental Clinic 11. RRM & Associates, CPAs

2. Laging Bago Drug Store 12. 7/11 Convenience Store
3. Quicky Repair Shop 13. Mariwasa Tiles Factory

4. Mater Carmeli School 14. Unifast Driving School

5. Ang Tibay Shoe Factory 15. For You Gift Shop

6. Ace Hardware 16. Metro Department Store

7. Lucas Car Assembler 17. Makisig Internet Cafe
8. Sewgo Trading 18. Guapito Barber Shop
9. Sta. Rosa Medical Clinic 19. Garments Textile Mills
10. ACCRA Law Office 20. Borton Consultancy Inc.

3. Using the form provided, indicate the account title to be used for each and classify either
as an asset, liabilities or owner's equity.

Item description Account Title Classification

Example: Currency Cash Asset

1. money orders

2. can goods sold by a grocery

3. delivery trucks, vans
4. folders, typewriting, envelopes, clips
5.unpaid electric bills
6. advance payment for rent
7. promissory note to be paid in 3 years
8. investment of Hiraya Kita
9. checks
10. tailor’s chalk, needles, threads
used by sewer in a dress shop

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References

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