FUNDAMENTALS OF ACCOUNTING

“Accounting is the process of IDENTIFYING, RECORDING, and COMMUNICATING economic events of an organization to interested users.”

 Identifying - this involves selecting economic events that are relevant to a particular business transaction.

 Recording - this involves keeping chronological diary of events that are measured in pesos.

 Communicating - occurs through the preparation and distribution of financial and other accounting reports.

Nature of Accounting

• Accounting is a service activity - accounting provides assistance to decision makers by providing them financial reports that will guide
them in coming up with sound decisions.

• Accounting is a process - a process refers to the method of performing any specific job step by step according to the objectives or targets.

• Accounting is both an art and discipline - accounting is the art of recording, classifying, summarizing and finalizing financial data.

• Accounting is an information system - accounting is recognized and characterized as a storehouse of information.

History of Accounting

• The Cradle of Civilization - Around 3600 B.C., record-keeping was already common from Mesopotamia, China and India to Central and
South America.

• 14th Century - Double-Entry Bookkeeping - the most important event in accounting history is generally considered to be the
dissemination of double entry bookkeeping by Luca Pacioli ('The Father of Accounting') in 14th century Italy.

• French Revolution - the thorough study of accounting and development of accounting theory began during this period.

• The Industrial Revolution (1760-1830) - Mass production and the great importance of fixed assets were given attention during this
period.

• The present - the accounting profession in the 20th century developed around state requirements for financial statement audits.

Accounting Users

Internal users of accounting information -refers to those individuals inside a company who plan, organize, and run the business.

 Management - they analize the organization's performance and position and take appropriate measure to improve the
company results.

 Employees - they need the financial status of the organization to consider staying in the employ of the company or look
for other employment opportunities.

 Owner - shaping decisions about when to borrow or invest company resources.

External users - they are individuals and organizations outside a company who want financial information about the company.

 Investors - for analyzing the feasibility of investing in the company.

 Creditors - for determining the credit worthiness of an organization.

 Tax Authorities - for determining the credibility of the tax returns filed on behalf of a company.

 Customers - for assessing the financial position of its supplier which is necessary for them to maintain a stable source of supply in the long
term.

Accounting Principles

• Business entity principle - a business enterprise is separate and distinct from it's owner or investor.

• Going concern principle - business is expected to continue indefinitely.

• Time period principle - financial statements are to be divided into specific time intervals

• Monetary principle - amounts are stated into a single monetary unit.

• Objectivity principle - financial statements must be presented with supporting evidence.

• Cost principle - accounts should be recorded initially at cost.

 • Accrual Accounting Principle - revenue should be recognized when earned regardless of collection and expenses should be recognized
when incurred regardless of payment.

• Matching principle - cost should be matched with the revenue generated.

• Disclosure principle - all relevant and material information should be reported.

• Conservatism principle - also known as prudence. In case of doubt, assets and income should not be overstated while liabilities and
expenses should not be understood.

• Materiality principle - in case of assets that are immaterial to make difference in the financial statements, the company should instead
record it as an expense.

The Financial Statements

• Statement of Financial Position or Balance Sheet - it shows the financial condition/ position of a business as of a given period. It consists
of the assets, liabilities and capital.

• Income Statement or Statement of Comprehensive Income - it shows the result of operations for a given period. It consist of the
revenue, cost and expenses.

• Statement of Cash Flows - it summarizes the cash receipts and cash disbursements for the accounting period.

• Statement of Changes in Owner's Equity or Statement of Owner's Equity - it shows the changes in the capital or owner's equity as a
result of additional investment or withdrawals by the owner, plus or minus the net income or net loss for the year.

Typical Account Titles Used (Balance Sheet)

• Assets - an economic resource owned by the business expected for future gain. They are property and rights, or value owned by the
business.

• Liabilities - it includes debt, obligations to pay, and claims of the creditors on the assets of the business.

• Owner's Equity or Capital - it includes the interest of the owners on the business; claims of the owners on the assets of the business; and
the investment of the owner plus or minus the results of operations.

The Fundamental Accounting Equation

Major Types of Accounts

• Assets - these are the resources owned and controlled by the firm.

• Liabilities - these are obligations of the firm arising from past events which are to be settled in the future.

• Equity or Owner's Equity - these are the owner's claims in the business.
 • Income - this is the increase in economic benefits during the accounting period in the form of inflows of cash or other assets or decreases
of liabilities that result in increase in equity.

• Expenses - these are decreases in economic benefits during the accounting period in the form of outflows of assets or incidences of
liabilities that result in decreases in equity.

Types of Assets

• Current Assets - these are assets that can be realized one year after year-end date.

 Cash - this is money on hand, or in banks, and other items considered as medium of exchange in business transactions.
 Accounts Receivable - these are amounts due from customers arising from credit sales or credit services.
 Notes Receivable - these are amounts due from clients supported by promissory notes.
 Inventories - these are assets held for resale.
 Supplies - these are items purchased by an enterprise which are unused as of the reporting date.
 Prepaid Expenses - these are expenses paid in advance.
 Accrued Income - this is revenue earned but not yet collected.
 Short-term investments - these are the investments made by the company that are intended to be sold immediately.

• Non-current Assets - these are assets that cannot be realized one year after year-end date.

 Property, Plant and Equipment - these are long-lived assets which have been acquired for use in operations.
 Long term Investments - these are the investments made by the company for long-term purposes.
 Intangible Assets - these are assets without a physical substance.

• Tangible Assets - these are physical assets such as cash, supplies etc.

• Intangible Assets - these are non-physical assets such as patents and trademarks.

• Current Liabilities

 Accounts Payable - these are amounts, due, or payable to, suppliers for goods purchased on account or for services received on
account.
 Notes Payable - these are amounts due to third parties supported by promissory notes.
 Loan Payable - this is a liability to pay the bank or other financing institution arising from funds borrowed by the business from
these institutions payable within twelve months or shorter.
 Utilities Payable - this is an obligation to pay utility companies for services received from them.
 Accrued Expenses - these are expenses that are incurred but not yet paid.
 Unearned Income - this is cash collected in advance; the liability is the services to be performed or goods to be delivered in the
future.
 Mortgage Payable - these is a long-term debt of the business with security or collateral in the form of real properties.

• Owners’ Equity

 Capital - this is the value of cash and other assets invested in the business the owner of the business.
 Drawing - this is an account debited for assets withdrawn by the owner for personal use from the business.

• Income and Expense

 Service income - this includes revenues earned or generated by the business in performing services for a customer or client.
 Salaries or wages expense - it includes all payments made to employees or workers for rendering services to a company.
 Utilities expense - this is an expense related to the use of electricity, fuel, water, and telecommunication.
 Insurance expense - this is the expired portion of premium paid on insurance coverage such as premiums paid for health or life
insurance, motor vehicles, or other properties.
 Depreciation expense - this is the annual portion of the cost of tangible assets such as buildings, machineries, and equipment
charged as expense for the year.
 Uncollectible accounts expense/ doubtful accounts expense/ bad debts expense - this means the amount of receivables charged as
expense for the period because they are estimated to be doubtful of collection.
 Interest expense - this is the amount of money charged to the borrower for the use of borrowed funds.

Accounting Cycle

• Identifying and analyzing the events to be recorded - this is the process of identifying and analyzing the transactions to be recorded
through the business documents.

• Recording transactions in the journal - this is known as journalizing. It is the process of recording the transaction in the first book of
account known as the journal.

• Posting journal entries to the ledger - this is known as posting. It is the process of transferring the information found in the journal into
the book of final entry known as the ledger.
• Preparing the trial balance - these are the list of accounts found in the ledger together with the account's balance or total.

• Preparing the worksheet and adjusting entries - the worksheet is a common tool used by accountants to assemble on a sheet of paper all
the information needed to prepare the financial statements, adjusting entries, closing entries, and the post-closing trial balance.

• Preparing the financial statements - this is where the statement of financial position, income statement, statement of changes in owner's
equity, and a statement of cashflows are prepared to provide useful information to parties interested in the financial information of the
business.

• Journalizing and posting of adjusting journal entries - adjusting entries are prepared at the end of the accounting period to update the
accounts for internal transactions because they affect more than one accounting period.

• Journalizing and posting of closing journal entries - closing entries are prepared at the end of the accounting period to update the
owner's capital account.
Journal Entry

• Date. Write the month on the first transaction unless there is a change in month for the succeeding transactions or a new page is used.

• Account Titles and Explanation. Write the debit account on the extreme left of the first line and indent the credit account half-inch on the
next line.

• P.R. (Posting Reference). Write the corresponding account number here once the entry is posted.

• Debit. Under this column, write the debit amount for each debit account.

• Credit. Under this column, write the credit amount for each credit account.

Journalizing and Transaction

• Journalizing - it is the process of recording a transaction in the journal after it has been recognized and measured.

Accounting Equation

A = L + OE

Expanded Accounting Equation

A = L + OE + I - E