E s s e n ti a l s o f A c c o u n ti n g

ESSENTIALS OF ACCOUNTING

MODULE

Prof: Mr. Allan Jay Evangelista, CPA

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FUNDAMENTALS OF ACCOUNTING MODULE

SESSION I ACCOUNTING AND BRIEF HISTORY

ACCOUNTING - ‘language of business’

A. Accounting is a service activity. The function is to provide quantitative financial information useful to decision making. – Accounting
Standards Council (ASC)

B. Accounting is the process of identifying, measuring and communicating economic information to permit informed judgment and decision
by users of the information – American Accounting Association (AAA)

C. Accounting is the art of recording, classifying and summarizing in a significant manner and in terms of money, transactions and events
which are at least a financial character and interpreting the results thereof. – Committee on Accounting Terminology of the American Institute f
Certified Public Accountants (AICPA)

Objective of Accounting
- To provide information to statement users so that they could make informed judgment and better decision

Brief History
A. Premitive
- origin can be traced back to 8500 B.C. account records date back to ancient civilizations of China, Babylonia, Greece and Egypt. At around
8600 B.C. in Babylonia, clay tablets recorded the payments of wages.

-The rulers of these civilizations used accounting to keep track of costs of labor and materials used in building structures as in the case of
Pharaohs of Egypt in building their great pyramids.

B. Middle Ages

-During the 14th to 15th centuries, merchants and bankers in Florence, Venice and Genoa developed a formal account keeping methods.

-In Genoa in 1340 A.D., the double entry records first appeared. Double entry bookkeeping is not a discovery of science; it is the outcome of
continued efforts to meet the changing necessities of trade.

-In 1494 Venice, Fra Luca Pacioli, one of the most celebrated mathematicians of his day, wrote the first treatise on the art of systematic
bookkeeping entitled ‘Everything about Arithmetic, Geometry, Proportions and Proportionality’

C. Industrial Revolution and Corporate Organization

-In England, the industrial revolution started from the mid-18th and mid-19th century that changed the method of producing commercial goods
from the handicraft method to the factory system. With this change came the problem of costing large volume of products. The specialized field
of cost accounting emerged.

-The industrial revolution resulted to the development of the corporate form of organization

D. Information Age

-advent of ‘internet’ along with e-commerce brought huge change in the field of accounting from manual to automation.

-Tasks that are time consuming when done manually can now be done with speed, consistency, precision and reliability by computers.

-introduction of cloud based accounting softwares

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SESSION II THE ACCOUNTING PROFESSION, CAREERS AND SPECIALIZED SERVICES

Characteristics
A. All members of accounting profession are Certified Public Accountants (CPAs)
B. CPAs have their own body of knowledge
C. CPAs adhere to Code of Professional Ethics
D. CPAs are members of a national organization – PICPA (Philippines Institute of Certified Public Accountants)

Note! The Republic Act No. 9298 ‘Philippine Accountancy Act of 2004 – is the law regulating the practice of accountancy in the Philippines.

CAREERS
A. Education – employed as full time or part time professors, reviewers or researchers. Considered as the modern day heroes that make others
understand the accounting knowledge. They prepare candidates for tough CPA board exams.

B. Commerce and Industry – employed in private companies as Vice President for Finance, Chief Accountant, Cost Accountant, Controller,
Internal Auditor or Budget Officer.

C. Government Service – employed in government units as accountant, budget officer or consultant. CPAs can be employed in the Bureau of
Internal Revenue (BIR), Congress, Commission on Audit (COA), Department of Finance (DOF), Department of Budget and Management
(DBM), Bangko Sentral ng Pilipinas (BSP) and local government units. The Philippine National Police (PNP) and National Bureau of
Investigation (NB) hire CPAs for fraud investigations.

D. Public Practice – mainstay of accountants who render services (e.g. financial statements audits and tax audits) on a fee basis and staff
accountants employed by public accounting firms.

SPECIALIZED ACCOUNTING SERVICES

A. Auditing – independent examination of fairness of financial statements

B. Cost Accounting – involves the collection, allocation and control of cost of producing specific goods and services

C. Financial Accounting – focused on recording the business transactions and the preparation of financial statements

D. Internal Auditing – examination of operations to ensure effectiveness and efficiency

E. Government Accounting – involves identification and uses of resources within the provisions of laws

F. Tax Accounting – preparation of tax returns and consideration of tax consequences of proposed business transactions

G. Management Consulting – providing advice to clients in any area of business or accounting such as installation of accounting software,
merger, advice on budgeting and general planning

USERS OF FINANCIAL STATEMENTS

a. Owners – interested for returned of profits

b. Investors – interested in the risk and return of investments
c. Creditors/suppliers – for information of collectability of their claims
d. Lenders – interested whether their loans and interest will be paid
e. Customers – for information of sustained supply for their purchases
f. Employees – for benefits and remuneration
g. Government – taxes and regulations
h. Public – general welfare

WRAP UP QUIZ: TRUE OR FALSE

1. Management consulting is examination of financial statements as to fairness in accordance with the accounting standards
2. Work in the education sector includes being a Chief Accountant of a school providing accountancy programs
3. CPAs are not allowed to work in two sectors e.g. education and public practice at the same time
4. Only CPAs are bound by the Code of Professional Ethics.
5. PICPA is the only national accredited organization of CPAs.
6. Accountancy Act of 2014 is the act regulating the practice of Accountancy in the Philippines

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SESSION III THE INTERNATIONAL FINANCIAL REPORTING STANDARDS AND THE CONCEPTUAL FRAMEWORK

International Accounting Standards Committee (IASC) – based in London, UK that set the standards called ‘International Financial Reporting
Standards (IFRS) replaced International Accounting Standards Board (IASB)

Composition of IFRS
a. International Accounting Standards (IAS)issued by IASB
b. International Financial Reporting Standards issued by IASC
c. Interpretations

What are Standards?

Standards are authoritative statements of how particular types of transactions and other events should be reflected in the financial statements.

Note! In the Philippines, Financial Reporting Standards Council (FRSC) developed the GAAP that will be promulgated in the country. Approved
statements are known as Philippines Financial Reporting Standards (PFRS)

UNDERLYING ASSUMPTIONS
Accounting assumptions
- basic notions or fundamental premises on which the accounting process is based. Also known as postulates
-this serves as the solid foundation and building block to avoid misunderstanding but rather enhance understanding and usefulness

GOING CONCERN ASSUMPTION

- that the business will continue for an indefinite period of time

Implicit in the Going concern assumption

A. Entity Concept – owners and business are separate and distinct economic unit
B. Periodicity/Time Period – Entity’s life can be subdivided into equal time periods for reporting purpose
C. Monetary Unit Concept – Philippine peso is a reasonable unit of measure and that purchasing power of money is stable

CONCEPTUAL FRAMEWORK
- is a summary of the terms and concepts that underlie the preparation of the financial statements (FS)
- attempt to provide an overall theoretical foundation for accounting which will guide accountants in preparing FS.

Authority
-in case of conflict with IFRS and conceptual framework, IFRS prevails

Scope
a. objective of financial reporting
b. qualitative characteristics of useful financial information
c. definition, recognition and measurement of the elements
d. concepts of capital and capital maintenance

a. OBJECTIVE
-- To provide information to statement users so that they could make informed judgment and better decision

b. QUALITTATIVE CHARACTERISTICS
-- attributes/qualities that make financial accounting information useful to the users

Fundamental qualitative characteristics

1. Relevance – capacity of the information to influence a decision
2. Faithful representation – the information must reflect what really existed

Ingredients of Relevance
1. Confirmatory value – confirm/correct past decisions or expectation
2. Predictive value – used to make predictions
3. Materiality – information is material if its omission or misstatement could ‘influence’ the decision of the users

Ingredients of Faithful representation

1. Completeness – information that should have been recorded or disclose have been recorded and disclosed. This is the result of principle of
adequate disclosure standard
2. Neutrality – free from bias and does not favour any party
3. Free from error – no material errors or omissions

Substance over form

- inherent in the term faithful representation
- transactions are accounted for in accordance with their substance rather than the legal form

Conservatism
-not included as ingredient of faithful representation due to conflict with ‘neutrality’ though worth discussing

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-caution in the exercise of judgment need in making estimates.

-to anticipate no profits and to provide for all probable and estimable losses.
-don’t count your chicks until the eggs hatch

Enhancing qualitative characteristics

-these relates to the presentation and form of the financial information

a. Comparability
-users must be able to compare the financial statements through time in order to identify trends in its financial position and performance

b. Understandability
- FS is that it is readily understandable by users. Users are assumed to have a ‘reasonabe knowledge’of accounting

c. Verifiability
– information can be verified by independent observers and could reach consensus not necessarily complete agreement

d. Timeliness
– financial information must be available or communicated early enough when a decision is to be made

c. RECOGNITION OF ELEMENTS

Elements
- quantitative information reported in the statement of financial statements

1. Assets
-resources controlled by the entity as a result of past events and which future economic benefits are expected to flow to the entity

2. Liabilities
-present obligations arising from past events the settlement of which is expected to result in an outflow of resources embodying economics
benefits

3. Equity
-residual interest in assets after deducting liabilities

4. Income
-increase in economic benefit during the accounting period in the form of inflow or increase in asset or decrease in liability that result to increase
in equity, other than contribution from equity participants

5. Expense
- decrease in economic benefit during the accounting period in the form of outflow or decrease in asset or increase in liability that result to
decrease in equity, other than distribution from equity participants

Recognition
- means reporting of an asset, liability, income, expense or equity in the FS

Recognition Principles
1. Asset Recognition principle – recognized asset when a. probable that economic benefits will flow in the future b. measured reliably
- Cost Principle is inherent in this recognition which is to recognize assets at historical cost

2. Liability Recognition principle - recognized asset when a. probable that an outflow of economic benefits will be
required in the future b. measured reliably

3. Income recognition principle - Income recognition principle states that income is recognized when ‘earned’ regardless of receipt.

4. Expense recognition principle - states that expense is recognized when ‘incurred’ regardless of payment.
-this is the result of the application of the matching principle

Matching Principle – generation of revenue is not without any cost ‘ No pain no gain’. This requires that cost and expenses incurred in earning
revenue shall be reported in the same period.
Application

1. Cause and effect association - expense is recognized when the revenue is already recognized e.g. Cost of Sales

2. Systematic and rational allocation – some costs are expensed by simply allocating them over the periods benefited e.g. depreciation

3. Immediate recognition – cost is expense outright because of the uncertainty of future economic benefits e.g. loss on fire, admin and selling
expenses, loss from disposal

Measurement of Element

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1. Historical cost – purchase price paid at the time of acquisition (PAST)

2. Current cost – purchase price today (PRESENT)
3. Realizable value – if an asset will be disposed today, the amount of cash that will be received (PRESENT)
4. Present value – discounted value of future net cash inflows - future exchange price (FUTURE)

d. CONCEPT OF CAPITAL AND CAPITAL MAINTENANCE

Financial performance can be determine using two approach

1. Capital Maintenance – net income occurs only after the capital used from the beginning of the period is maintained
2. Transaction approach – traditional preparation of the income statement

Capital Maintenance
1. Financial capital – based on historical cost
2. Physical capital - based on current cost

WRAP UP QUIZ: TRUE OR FALSE/IDENTIFICATION/MULTIPLE CHOICE (MC)

1. Going concern justifies the usage of accruals and deferrals

2. Materiality is the ability to bring together for the purpose of noting similarities and dissimilarities
3. The financial information must not be intelligible to become useful
4. Conservatism supports the recognition of immediate loss
5. Relevance is the degree of confidence users place upon the truthfulness of the financial statements
6. Accounting is a service activity
7. Most members of the accounting profession are Certified Public Accountants
8. Accounting is often characterized as the ‘language of business’
9. Audit is the examination that ensures fairness of the financial statements
10. The concepts of accounting is applicable whenever accounting is involved

IDENTIFICATION: Identify the principle, concept or assumption that is most clearly violated by the accounting practice in each statement below

1. A company charges the cost of the new office equipment to expense in the year of purchase
2. A company changes from weighted average method to FIFO when accounting for inventory without any reason
3. A company reports in the currency of a hyperinflationary economy in preparing the financial statements
4. A company records the sales after inventory has been produced but before it is sold
5. A company decides to publish financial statements only in years when it has good news to report
6. A company reports inventory and property and equipment at the current cost in the balance sheet.
7. An electronics company owned by Ken Francis reports the cost of Ken Francis’s swimming pool as an asset on the balance sheet
8. A company having 150 accounts payable lists each account among the liabilities on the balance sheet.
9. A company does not report the major details about its equity
10. A company follows a policy of recording an item as an asset when the company is in doubt whether the item is asset or expense

SESSION IV ACCOUNTING CYCLE

1. Analyze transactions – If the transaction affects any of the elements (assets, liabilities, equity, income and expense) proceed
journalizing
2. Journalize
3. Posting
4. Prepare Trial Balance
5. Adjusting entries
6. Prepare Financial Statements
7. Post closing entries
8. Prepare Post closing trial balance
9. Reversing entries

JOURNALIZING
Normal Balances – whenever an element INCREASES it should be debited/credited according to its normal balance
REVENUE
ASSETS DEBIT S CREDIT
LIABLIITI
ES CREDIT EXPENSES DEBIT
EQUITY CREDIT

Rules of Double entry bookkeeping

-Two or more accounts are affected by each transaction

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-Debits and Credits are equal

-Assets = Liabilities + Equity (accounting equation) should be maintained at all times

Sample: Normal Balance

Accounts payable Accounts Receivable
Prepaid Insurance Cash
Bomba, Capital Equipment
Utilities expenses Accumulated Depreciation
Supplies expenses Allowance for doubtful accounts
Bomba, Withdrawal Revenues from services

Sample: Journal Entries

Mr. Ronnel Vinuya established the Vinuya Super Master Data Encoders on May 1,2014. The following transactions occurred during the month.
a. Mr. Vinuya invested cash P157,000 to establish the business
b. Bought office desks and filling cabinet for cash, P15,150
c. Vinuya invested in the business his personal computer with a value of P57,500
d. Bought computer software for use in the business from De La Torre Computer Center for P39,000, paying P15,000 down; the balance
is due in thirty days.
e. Paid rent for the month, P5,300
f. Received cash for services rendered, P5,160
g. Ordered a panaflesign for P9,000 from Royal Bright Enterprises, with P5,000 as down payment and the balance due when installed
h. Received bill for advertising from Buy and Sell Newspaper, P3,230
i. Bought print paper and stationery on account, P2,290
j. Received and paid electric bill, P1,240
k. Paid bill for advertising recorded previously in transaction (h)
l. Received cash for services rendered, P10,900
m. Paid salaries to employees, P8,400
n. Mr. Vinuya withdrew cash for personal use, P4,500

REQUIRED:
Prepare journal Entries

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SESSION V POSTING

Posting
– transfer journal entries from the journal to the ledger accounts.

Sample
REQUIRED: Post transactions of Vinuya Company.
Cash Accounts Receivable Supplies Office Equipment

Computer Software Signage Accounts Payable Vinuya, Capital

Vinuya, Drawings Service Revenues Salaries Expense Advertising Expense

Rent expense Utilities Expense Miscellaneous Expense

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SESSION VI PREPARE TRIAL BALANCE

Trial Balance
- a list of all accounts with their respective debit or credit balances.
-It is prepared to verify the equality of debits and credits in the ledger
-the equality does not indicate that there no errors in the journal entries

REQUIRED: Prepare Trial balance of Vinuya Company

Trial Balance
Debit Credit
Cash
Accounts Receivable
Supplies
Office Equipment
Computer Software
Signage
Accounts Payable
Vinuya, Capital
Vinuya, Drawings
Service Revenues
Salaries expense
Advertising expense
Rent expense
Utilities expense
Miscellaneous expense

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SESSION VII ADJUSTING ENTRIES

Adjusting entries
– to update accounts

Concepts:
a. Periodicity – to provide timely information during the life of the business
b. Income and Expense recognition principles – Income recognition principle states that income is recognized when ‘earned’ regardless
of receipt. Expense recognition states that expense is recognized when ‘incurred’ regardless of payment.

Accounting period – generally a month, quarter or year.

Calendar year – Annual year ending on December 31
Fiscal year – annual year ending any month end other than December 31

Adjusting entries

A. Prepayments
B. Deferrals
C. Accrual of income and expense
D. Depreciation
E. Doubtful accounts expense

A. Prepayments

ASSET METHOD - 'used/expired portion' EXPENSE METHOD - 'unused/unexpired portion'

Pro forma entry Prepayment xx Pro forma entry Expense xx
Cash xx Cash xx

Adjusting entry Expense xx Adjusting entry Prepayment xx

Prepayment xx Expense xx

B. Deferrals - postponement

LIABILITY METHOD - 'earned/expired portion' INCOME METHOD - 'unearned/unexpired portion'

Pro forma entry Cash xx Pro forma entry Cash xx
x x
Unearned/Deferred x Earned income x

Adjusting entry Unearned/Deferred xx Adjusting entry Earned income xx

x x
Earned income x Unearned/Deferred x

C. Accrual of income and expense

C.1 Accrual of Income

Adjusting entry: Receivable xx

Income xx

C.2 Accrual of Expense

Adjusting entry: Expense xx

Payable xx

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Sample
MJ Pedernal Company presented the following information pertaining to accounts that will need adjustments for its November 30,2014 year end
financial statements
a. Oct 1, 2014, MJ paid P10,800 for 6-months’ insurance premiums
b. The balance in the ledger account Office Supplies amounted to P32,000. A count of the office supplies on November 30,2014 totaled
P12,800
c. MJ Pedernal Company received P22,800 on November 1,2014 from a customer for services to be rendered during the months of
November, December, January, and February.
d. November 30,2014 is a Saturday and that MJ Pedernal pays its employees a total of P87,500 on Fridays.
e. Invested in cash in time deposit of P100,000 that paid 5%interest annually on November 1,2014.

REQUIRED: Adjusting entries

D. Depreciation – allocation of cost over useful life

Straight line method – wear and tear through passage of time

FORMULA
Depreciation per year = (Cost – Residual/Salvage value) / Useful life

Cost – purchase price and other directly attributable cost

Residual/Salvage value – value that can be recovered at the end of useful life

Useful life – estimated number of years that the asset can be used

Adjusting entry: Depreciation expense xx

Accumulated Depreciation – ‘this is a contra asset account’ xx

Sample
Andy Water systems purchased a machine for P400,000 on April 1, 2014. The machine has expected useful life of 4 years and a salvage value of
P100,000.

REQUIRED.
a. What is the depreciation for years 2014, 2015, 2016 and 2017?
b. Assuming the machine was sold in October 1, 2015 for P200,000, how much is the gain or loss on sale?

Doubtful accounts
Methods of estimating doubtful accounts
a. Aging method – the required balance is the should be balance of the allowance for doubtful accounts (Note! This method is required
by the standard)
x
Required balance x
x
Allowance for doubtful accounts unadjusted x
x
Doubtful accounts expense x

b. Percent of receivables -- the required balance is the should be balance of the allowance for doubtful
accounts
x
Required balance (Ending AR x % uncollectible) x
x
Allowance for doubtful accounts unadjusted x
x
Doubtful accounts expense x

a. Percent of credit sales – the amount computed is the amount of doubtful accounts expense.
Doubtful accounts expense = Credit Sales x percentage of uncollectible accounts

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Samples
Presented below are series of unrelated situations. Answer the following questions relating to each of the independent cases as requested.

Ronnel Company’s unadjusted trial balance at December 31, 2014, included the following
Case I
accounts:
Debit Credit
Accounts receivable P1,000,000
Allowance for doubtful accounts 40,000
Sales P15,000,000
Sales returns and allowances 700,000

Ronnel Company estimates its bad debt expense to be 1 ½ % of net sales.

REQUIRED: Determine the bad debt expense for 2014

Case II JAMES Company provides for doubtful accounts based on 3% of credit sales. The following data are available for 2014.

Credit sales for 2014 21,000,000

Allowance for doubtful accounts 1/1/2014 170,000
Collection of accounts written off in the prior years (customer credit was reestablished) 80,000
Customer accounts written off as uncollectible 300,000

REQUIRED: How much is the balance of allowance for doubtful accounts?

Case III At the end of its first year of operations, December 31, 2014, BABY KHO, reported the following
information:
Accounts receivable, net of allowance for doubtful accounts 9,500,000
Customer accounts written off as uncollectible 240,000
Bad debts expense for 2014 840,000

REQUIRED: How much is the balance of accounts receivables at December 31, 014, before subtracting the allowance for doubtful accounts?

Case IV The following accounts were taken from MAHAL KHO Inc. statement of financial position at December 31, 2014.
Debit Credit
Accounts receivable 4,100,000
Allowance for doubtful accounts 100,000
Net credit sales 7,500,000

REQUIRED: If doubtful accounts are 3% of accounts receivable, determine the bad debt expense to be reported in 2014.

Case VAt December 31,2014, Robledo Tires analysed the details of the Accounts receivable balance and
arrived at the aged receivables below along with the estimated loss percentages.
Loss
Age Category Balance %
Current 100,000 1
30-60 days past due 200,000 2
61-90 days past due 300,000 5
Over 90 days past due 400,000 25
1,000,000

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The allowance for doubtful accounts has a credit balance of P5,000

REQUIRED: Prepare the adjusting entry

SESSION VIII PREPARE FINANCIAL STATEMENTS AND CLOSING ENTRIES

Financial statements
a. Statement of financial position – Assets, liabilities and equity
b. Statement of Comprehensive Income – Revenues and expenses
c. Statement of Cash Flows – Cash inflows and Outflows
d. Statement of Changes in Equity – Capital, net income/loss, investments and withdrawals
e. Notes to the financial statements – summary of significant accounting policies and explanatory notes

Objective of Financial Statements

-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.

STATEMENT OF FINANCIAL POSITION

A Statement of Financial Position is formal statement showing the three elements comprising financial position, namely assets, liabilities and
equity.

Usage of Financial Position: Investor, creditors and statement users analyse the statement of financial position to evaluate such factors such as:

Liquidity is the ability of the entity to meet currently maturing obligations.

Solvency is the availability of cash over the longer term to meet the maturing obligations.

Elements of Financial Position:

1. Assets – are resources controlled by the entity as a result of past events and from which future economic benefits will flow to the
entity.
2. Liabilities – are present obligations of the entity arising from past events, the settlement of which are expected to result in an outflow
from the entity of resources embodying economic benefits.
3. Equity – is the owners’ residual interest in the assets of an entity that remains after deducting

The essential characteristics of an asset are: C P F M

a. The asset is controlled by the entity.
b. The asset is the result of a past transaction or event.
c. The asset provides future economic benefits.
d. The cost of the asset can be measured reliably.

Current Assets
PAS1, provides that an entity shall classify an asset as current when:
 The asset is cash or a cash equivalent unless the asset is restricted from being exchanged or used to settle a liability for at least twelve
months after reporting period.
CASH AND CASH EQUIVALENTS
shall be unrestricted – meaning available for the payment of current obligations

Definition under Standard: PAS 1, “cash equivalents” as short term, highly liquid investments that are readily convertible
into known amount of cash and which are subject to an insignificant risk of changes value.
For an investment to >> and the date of purchase which
qualify as cash should be three months or less before
equivalent maturity
Equity securities cannot qualify as cash equivalent because share do not have a maturity date.

SAMPLE BOARD PROBLEM:

Mapera Company reported a total cash and cash equivalent of P6,325,000 on December 31, 2014, which includes the
following information.
a. Two certificates of deposit, each totalling P500,000. These certificates of deposit have a maturity of 120 days.
b. A check that is dated January 12, 2015 in the amount of P125,000.
c. A commercial paper of P2,100,000 which is due in 120 days.
d. Currency and coins on hand amounted to P7,700.
How much is the correct amount of cash and cash equivalent that Mapera should report in its December 31, 2014 statement
of financial position?

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 The entity holds the asset primarily for the purpose of trading.
PFRS 9, provides that a financial asset is classified as held for trading when:
a. It is acquired principally for the purpose of selling it in the near term.
b. On initial recognition, it is part of a portfolio of identified financial instruments that are managed together and for
which there is evidenced of a recent actual pattern of short term profit taking.
c. It is a derivative, except for a derivative that is financial guarantee contract or a designated and an effective hedging
instrument.

SAMPLE BOARD PROBLEM:

Trader Company has a business model of trading all debt security for the purpose of making profit. Trader reported the
following investments before the preparation of its December 31, 2014 statement of financial position:
Equity investment to profit or loss P500,000
Equity investment through OCI 2,500,000
Debt investment at fair value 3,500,000
Debt investment – convertible bonds, at cost 2,000,000
The current fair value of the convertible bond is P2,400,000 on December 31, 2014. What amount of the investment to
profit or loss should the company report in its December 31, 2014 financial position?

 The entity expects to realize the asset within twelve months after the reporting period.
This category refers to short term nontrade receivables.

 The entity expects to realize the asset or intends to sell or consume it within the entity’s normal operating cycle.
This category refers to trade receivables, inventories and prepayments.

PRESENTATION OF CURRENT ASSETS

Current assets are usually listed in the statement of financial position in the order of liquidity.
PAS 1, provides that as a minimum line items under current assets are: C F T I P

Noncurrent Assets
PAS1, simply states that “an entity shall classify all other assets not classified as current as noncurrent assets”
Accordingly, noncurrent assets include the following:
a. Property, Plant and equipment
b. Long term investments
c. Intangible assets
d. Other noncurrent assets

Property, Plant and Equipment

PAS16, defines property, plant and equipment as “tangible assets which are held by an entity for use in production or supply of goods
and services, for rental to others, or for administrative purposes, and are expected to be used during more than one period”

Long Term Investment

IASC, defines investment as “an asset held by an entity for the accretion of wealth through capital distribution, such as interest,
royalties, dividends and rentals, for capital appreciation or for other benefits to the investing entity such as trading relationship”

Intangible Assets
PAS 38,“An intangible asset is an identifiable nonmonetary asset without physical substance”

Other noncurrent asset

Other noncurrent assets are those assets that do not fit into the definition of the definition of the previously mentioned noncurrent
assets.

LIABILITIES
The essential characteristics of a liability are: P P O
a. The liability is the present obligation of a particular entity.
b. The liability arises from past transaction or event.
c. The settlement of liability requires an outflow of resources embodying economic benefits.

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Current liabilities
PAS 1, provides that an entity shall classify liability as current when:
a. The entity expects to settle the liability within the entity normal operating cycle.
b. The entity holds the liability primarily for the purpose of trading
c. The liability is due to be settled within twelve months after the reporting period.
d. The entity does not have an unconditional right to defer the settlement of the liability for at least twelve months after the reporting
date.

Long term debt currently maturing

PAS 1, provides that a liability which is due to be settled within twelve months after the end of reporting period is classified as current, even if:
a. The original term was for a period longer than twelve months.
b. An agreement to refinance or to reschedule payment on a long term basis is completed after the end of reporting period and before the
financial statements are authorized for issue.
However, if the refinancing on a long term basis is completed on or before the end of the reporting period, the refinancing is an adjusting event
and therefore the obligation is classified as noncurrent.

Moreover, if the entity has the discretion to refinance or roll over an obligation for at least twelve months after the reporting period under an
existing loan facility, the obligation is classified as noncurrent even if it would otherwise be due within a short period.

SAMPLE PROBLEM:
Mautang Company has the following three loans payable scheduled to be repaid in next year. The company’s accounting year ends on December
31.
10% note payable issued on October 1, 2012,
maturing October 1, 2014 2,000,000
12% note payable issued on March 1, 2012,
maturing on March 1, 2014 4,000,000
15% note payable issued on March 1, 2012,
maturing on April 1, 2014 5,000,000

The 2013 financial statements were issued on March 31, 2014.

On December 31, 2013, the entire P2,000,000 balance of the 10% note payable was refinanced on a long term basis. The 12% note was
refinanced on March 20, 2014 on a long term basis. The entity has the discretion to refinance the 15% note payable for at least twelve months
after December 31, 2013. What amount of the notes payable should be classified as current on December 31, 2014?
What amount of the notes payable should be classified as noncurrent on December 31, 2014?

Covenants
Are often attached to borrowing agreements which represent undertakings by the borrower

Under these covenants, if certain conditions relating to the borrower’s financial situation are breached, the liability becomes payable on demand.
>> current liability!!

The liability is classified as current because at reporting date the borrower does not have an unconditional right to defer payment for at least
twelve months after the end of reporting period.

Exception:
However, if the lender has agreed on or before the end of the reporting period to provide a grace period ending at least months after the end of
reporting period. >> noncurrent liability

Estimated liabilities
Are obligations which exist at the end of reporting period although
 Their amount is not definite.
 Date when it is due or payable is not also definite
 Exact payee cannot be identified or determined.

Recognition of Provision/Estimated Liabilities

 The enterprise has a present obligation, as a result of past event
 It is probable that an outflow of resources embodying economic benefits will be required to settle the obligation
 The amount of the obligation can be measured reliably.

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Contingent Liability
A contingent liability is a present obligation that arises from past event but is not recognized because it is not probable that an outflow that an
outflow of resources embodying economic benefits will be required to settle obligation OR the amount of the obligation cannot be measured
reliably.

Contingent Asset
PAS 37, defines a” possible asset that arises from past event and whose existence will be confirmed on by the occurrence or nonoccurrence of
one or more uncertain future events not wholly within the control of the entity”.

Accounting for Contingent liabilities and Contingent Asset

Contingent liabilities Contingent Asset
Virtually certain
Probable
Possible
Remote

SAMPLE PROBLEM:
On December 31, 2011, an explosion occurred at Cord Company plant causing extensive property damage to area buildings. Although no claims
had yet been asserted against Cord Company by March 10, 2012, Cord’s Management and counsel concluded that it is reasonably possible. Cord
will be responsible for damages, and that P2,500,000 would be reasonable estimate of its liability. Cord’s P10,000,000 comprehensive public
liability policy has a P500,000 deductible clause. In December 31, 2011 financial statements, which were issued on March 25, 2012, how should
this item be reported?
a. No footnote disclosure or accrual is necessary
b. As a footnote disclosure indicating the possible loss of P500,000
c. As an accrued liability of P500,000
d. As a footnote disclosure indicating the possible loss of P2,500,000

On December 31, 2011, Home Company was a defendant in a pending lawsuit. The suit arose from the alleged defect of a product that Home sold
in 2010. In the opinion of Home’s attorney, it is probable that Home will have to pay P500,000 and it is reasonably possible that Home will have
to pay P600,000 as a result of this lawsuit. In its 2011 financial statements, Home should report
a. An accrued liability of P500,000 only.
b. An accrued liability of P500,000 and would disclose a contingent liability of an additional P100,000
c. An accrued liability of P600,000 only.
d. No information about this lawsuit.

In November 2011, attorneys for current and former employees of Mecum Inc. filed a P3,000,000 class action lawsuit, alleging that exposure to a
radiation has caused significant medical problems. Attorneys for Mecum are uncertain as to the outcome of the case. However , similar lawsuits
against other firms in the same industry have resulted in significant payments by the employer but there was no reliable estimate as to amount. In
Mecum’s December 31, 2012 financial statements, which were issued on April 30, 2013, how should this item be reported?
a. No footnote disclosure or accrual is necessary
b. As a footnote disclosure indicating the possible loss of P3,000,000
c. As an accrued liability of P3,000,000
d. If the amount of payment can be estimated, a liability should be recognized, if the amount of expected payment cannot be estimated,
only a note disclosure would be required.

Statement of Comprehensive Income

STATEMENT OF COMPREHENSIVE INCOME

PRESENTATION OF COMPRENSIVE INCOME
PAS 1, provides that an entity has two options of presenting comprehensive income, namely:

TWO SINGLE
STATEMENT STATEMENT
APPROACH APPROACH

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Comprehensive income is the change in equity during a period resulting from transactions and other events, other than changes resulting from
transactions with owners in their capacity as owners.

Accordingly, comprehensive income includes the following

 Components of profit or loss – this is the “bottom line” in the traditional income statement
 Components of other comprehensive income – comprises items of income and expense including reclassification adjustments that are
not recognized in profit or loss as required or permitted by PFRS.

The components of “other comprehensive income” include the following: C O R2 T

1. Unrealized gain or loss on investment in equity instrument measured at fair value through other comprehensive income
2. Gain or loss from translating the financial statements of a foreign operation
3. Revaluation surplus during the year
4. Unrealized gain or loss from derivative contracts designated as cash flow hedge
5. Remeasurement of defined benefit plan, such as actuarial gain or loss

INCOME STATEMENT
An income statement is a formal statements showing the financial performance of an entity for a period of time, is also known as the results of
operations.

The financial performance of an entity is determined using the two approaches:

 Capital maintenance approach
 Transaction approach

CAPITAL MAINTENANCE APPROACH

The “capital maintenance approach” means that net income occurs only after the capital used from the beginning of the period is maintained.

Two concepts of capital maintenance

 Financial capital
 Physical capital

Financial Capital, under this concept, net income occurs “when the nominal amount of net assets at the end of the year exceeds the nominal
amount of the net assets at the beginning of the period, after excluding distribution to and contributions by owners during the period”

Net asset – beg. bal

Withdrawal Additional Investment

Net Loss Net Income

Net asset – end. bal

Physical Capital
Physical capital is the quantitative measure of the physical productive capacity to produce goods and services. Accordingly, physical capacity is
equal to the net assets of the entity expressed in terms of current cost.
The physical concept of capital should be adopted if the main concern of users is the operating capability of the entity, meaning, the resource or
fund needed to achieve that operating capability or capacity

Sample
The following assets, liabilities and other financial data pertain to the current year:
January 1 December 31
Total assets 1,500,000 2,500,000
Total liabilities 1,000,000 1,200,000
Additional investment 400,000
Withdrawals 300,000

Assume the net assets of P500,000 on January 1 had a current cost of P800,000 by reason of inflationary condition. The net income under
 Net asset approach
 Physical capital

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TRANSACTION APPROACH

Is the conventional or traditional preparation of income statement in conformity with PFRS.

This approach of computing net income or loss requires the determination of how much income was earned during the year and how much
expenses were incurred in earning the revenue, this procedure is also called the matching approach.

FORMS OF INCOME STATEMENT

 Functional presentation – is the traditional and common form of income statement. It is also known as the cost of sales method.
 Natural presentation – under this form, expenses are aggregated according to their nature and not allocated among the various
functions within the entity.

Sample
Bart Company provided the following information for the current year:
Disbursements for purchases 5,800,000
Increase in trade accounts payable 500,000
Decrease in merchandise inventory 200,000

What is the cost of goods sold for the current year?

a. 6,500,000 b.6,100,000 c. 5,500,000 d. 5,100,000

Samples
Bicolano Company provided the following information for the current year.
Inventory, January 1 2,000,000
Purchases 7,500,000
Purchase returns and allowances 500,000
Sales returns and allowances 750,000
Inventory on December 31 2,800,000
Gross profit rate on sales 20%

What is the amount of gross sales for the current year?

a. 7,750,000 b. 8,500,000 c.7,000,000 d. 9,125,000

Kay Company provided the following information for the current year:

Increase in raw materials inventory 150,000

Decrease in goods in process inventory 200,000
Decrease in finished goods inventory 350,000
Raw materials purchased 4,300,000
Direct labor payroll 2,000,000
Factory overhead 3,000,000
Freight out 450,000
Freight in 250,000

What is the cost of goods sold for the current year?

a. 9,150,000 b. 9,250,000 c.9,950,000 d. 9,550,000

Tactful company showed cost of goods sold of P4,320,000 in its statement of comprehensive income after the first year of operations. The total
manufacturing cost comprised 50% materials used, 30% direct labor incurred, and 20% manufacturing overhead. Good in process at year end
were 10% of the total manufacturing cost. Finished goods at year end amounted to 20% of the cost of good manufactured. What is the amount of
the direct labor cost incurred?
a. 5,400,000 b.3,000,000 c.2,400,000 d.1,800,000

Tactful company reported that the operating expenses other than interest expense for the current year amount to 40% of cost of sales but only
20% of sales. Interest expense is 5% of sales. The amount of purchases is 120% of cost of sales. Ending inventory is twice as much as the
beginning inventory. The income tax of 30% for the current year is P560,000. What is the amount of sales for the current year?
a. 2,080,000 b. 1,485,000 c. 2,285,000 d.3,200,000

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NOTES TO FINANCIAL STATEMENTS

Notes to financial statement provide narrative description or disaggregation of items presented in the financial statements and information about
items that do not qualify for recognition
In other words, notes to financial statements are used to report information that does not fit into the body of the financial statements in order to
enhance the understandability of the statements.

PURPOSE OF NOTES TO FINANCIAL STATEMENTS

The purpose of notes to financial statements is to “is to provide the necessary disclosure required by the PFRS”
PAS 1, provides that the notes to financial statements shall:
a. Present information about the basis of preparation of the financial statements and the specific accounting policies used
b. Disclose the information required by PFRS that is not presented in the financial statements
c. Provide additional information which is not presented in the financial statements but is relevant to an understanding of the financial
statements

ORDER OF PRESENTING THE NOTES: C A S O

a. Statement of compliance with PFRS
PAS 1, provides an entity whose financial financial statements comply with PFRS shall make an explicit and unreserved
statement of such compliance in the notes

b. Summary of significant accounting policies used

Accounting policies “the specific principles, methods, practices, rules, bases and conventions adopted by an entity in
preparing and presenting FS”

Significant Accounting Policies

The summary of significant policies shall disclose the following:
1. The measurement basis used in preparing the FS
2. The accounting policies used that are relevant to an understanding of the FS

c. Supporting information or computation for line items presented in the FS

d. Other disclosures, such as contingent liabilities, unrecognized contractual commitments and nonfinancial disclosures

PAS 1, provides that an entity shall disclose the following:

1. The domicile and legal form of the entity, its country of information and the address of the registered office or
principal place of business
2. A description of the nature of the entity’s operation and its principal activities
3. The name of the parent and the ultimate parent of the group

PAS 1, provides that an entity shall disclose of the following

1. The amount of dividends proposed or declared before the FS were authorized for issue but not recognized as
distribution during the period and the related amount per share
2. The amount of any cumulative preference dividends not recognized

Post-closing entries – closing of nominal balances/bringing the nominal balances to zero

Real accounts – Balance sheet accounts (e.g. assets, liabilities and equity accounts)

Nominal accounts – profit or loss accounts (e.g. revenues and expenses)

Closing entries
A. Closing of income accounts
B. Closing of expense accounts
C. Closing of Income Summary accounts (note that the Income Summary is a suspense account/temporary account)
D. Closing of withdrawal account

A. Closing of income accounts Entry: Income Summary xx

Entry: Revenues xx Capital xx
Income Summary xx
D. Closing of withdrawal account
B. Closing of expense accounts Entry: Capital xx
Entry: Income Summary xx Withdrawal/Drawings xx
Expenses xx

C. Closing of Income Summary account

SESSION IX PREPARE A POST CLOSING TRIAL BALANCE

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Post-closing trial balance – the balances should be the opening balances or carried forward balances in the next accounting period which is
normally January 1
Sample: Post closing entries and Post closing trial balance

The following is the adjusted trial balance of the Adrian Co mpany

Adrian Company
Adjusted Trial Balance
December 31, 2014

Cash 140,000
Accounts Receivable 230,000
Prepaid Rent 90,000
Office Supplies 150,000
Office Equipment 780,000
Accumulated Depreciation 320,000
Accounts Payable 120000
Salaries Payable 70,000
Adrian, Capital 750,000
Adrian, Drawing 170,000
Counselling Service Revenues 830,000
Miscellaneous Income 110,000
Salaries Expense 320,000
Office Supplies Expense 210,000
Depreciation Expense 60,000
Rent Expense 50,000

Total 2,200,000 2,200,000

REQUIRED:

a. Prepare closing entries

b. Prepare post-closing trial balance

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SESSION X REVERSING ENTRIES

Reversing entries

-this are prepared in the ‘first day of the next accounting period’ e.g. if calendar year – this is January 1

-purpose is to simplify the recording of regular transactions in the next accounting period

-optional and not required

-journal entry that is exact opposite of related adjusting entry made at the end of the accounting period

Reversing entries

A. Prepaid expenses (expense method)

B. Deferral (income method)

C. Accrued income and expenses

Sample: Reversing entries

Presented below are a number of adjusting entries:

2014
A December 31 Printing Supplies 25,000
Printing Supplies Expense 25,000
B December 31 Unearned Subscription Revenues 50,000
Subscription Revenues 50,000
C December 31 Insurance Expense 18,000
Prepaid Insurance 18,000
D December 31 Salaries Expense 20,000
Salaries Payable 20,000
E December 31 Interest Receivable 8,000
Interest Income 8,000

REQURED: Identify the adjusting entries that will require reversing entries and prepare the reversing entries

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SESSION XI ACCOUNTING FOR RECEIVABLES

Trade and other receivables

Receivables
-are financial assets that represent a contractual right to receive cash or another financial asset from another entity

Valuation
-Net Realizable value

Presentation:
- current assets in the Statement of Financial Position. The trade and non-trade receivables that are currently collectible shall be presented as one
line item called “Trade and other receivables”

Classification as to nature of receivables

a. Trade receivables – claims arising from sale or services in the ordinary course of business
-Trade receivables
-Accounts receivables
-Notes receivables

b. Non trade receivables – claims arising from sale or services other than the ordinary course of business
-Advances or receivables from shareholders, directors, officers or employees
-Advances to suppliers
-Creditor’s accounts that have debit balances
-Accrued income
-Claims receivable
-Special deposits on contract bids

Classification as Current or non-current assets

Trade receivable – if expected to be realized within one year or normal operating cycle, whichever is LONGER are classified as current assets.

Non trade receivables – if expected to be realized within one year, the length of operating cycle not withstanding are classified as current assets.

Measurement
Initial measurement – Fair value* plus transaction costs that are directly attributable to the acquisition
Subsequent measurement – net realizable value

*Fair value – the value by which willing seller and buyer would agree upon at upon at arm’s length transaction

Short term receivables

a. Interest bearing – fair value is equal to face value
b. Non-interest bearing – fair value is equal to face value (Note! that this is not discounted because the impact of discounting is
immaterial)

Long term receivables

c. Interest bearing – fair value is equal to face value
d. Non-interest bearing – fair value is equal to present value of all future cash inflows discounted using the prevailing market rate of
interest of similar receivables

Methods of Recording Credit Sales

a. Gross method – record the receivables and sales at GROSS AMOUNT of the invoice.
b. Net method – record the receivables and sales at NET AMOUNT of the invoice. In other words, GROSS AMOUNT LESS SALES
DISCOUNT = NET AMOUNT

Sample
Gutom Company engaged in the following transactions during the month of July
1-Jul Sold merchandise to A Company for P50,000, 2/10, n/30
2 Sold merchandise to B Company for P200,000, 2/10, n/30
12 Received payment from B Company for the July 2 sale
30 Received payment from A Company for the July 1 sale

REQUIRED: Entries using GROSS AND NET method

Accounting for Freight

FOB – Free on Board
FOB Destination – freight to be paid by the seller; seller owns the goods in transit until it reaches the destination
FOB Shipping Point – freight to be paid by the buyer; buyer owns the goods in transit upon shipment

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Freight collect – freight paid by the buyer

Freight prepaid - freight paid by the seller

Sample
Happy Company sold merchandise on account for P500,000. The terms are 3/10, n/30. The related freight charge amounted to P10,000. The
account was collected within the discount period.

REQUIRED:
Prepare entries under the following terms:
a. FOB destination, freight collect
b. FOB destination, freight prepaid
c. FOB shipping point, freight collect
d. FOB shipping point, freight prepaid

Accounting for bad debts

a. Allowance method
b. Direct write off

Allowance Mehod Direct write off

Doubtful accounts xx
Allowance for doubtful accounts xx No Entry
To record doubtful accounts expense To record doubtful accounts expense

Allowance for doubtful accounts xx Bad debts xx

Accounts Receivables xx Accounts Receivables xx
To record the write off of worthless receivables To record the write off of worthless receivables

Accounts Receivables xx Bad debts xx

Allowance for doubtful accounts xx Accounts Receivables xx

Cash xx Cash xx
Accounts Receivables xx Accounts Receivables xx
To record recoveries of subsequently written off accounts To record recoveries of subsequently written off accounts

Trade receivables Allowance for doubtful accounts

Beginning
Credit sales
Collection of previously
written off accounts
x x
x xx Collections* Write off xx x Beginning
x x
x xx Sales returns and allowance x Doubtful accounts expense
xx Sales Discounts Collection of previously
x x
x xx Write off x written off accounts

x x
Ending x x Ending

*assuming collections includes the recovery of previously written off account. But if the recovery of previously written off account is excluded
from collections, then there should not be a debit on the accounts receivable

SESSION XII CASH AND BANK RECONCILIATION

Cash – currency, bills and coins, cash in bank and cash fund

Presentation

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- First line item under current assets in the statement of financial position

Undelivered checks/unreleased checks

-check drawn and recorded but not yet given to the payee before end of the reporting period
-should reclassify as part of cash and cash equivalents because the entity can still cancel the check

Post-dated checks
-check drawn, recorded and already given to the payee but bears a date subsequent to the end of the reporting period
-should reclassify as part of cash and cash equivalents because no payment yet since the check cannot be presented to the bank for encashment.

Stale checks
- checks issued the payee but was not yet encashed for a long period of time e.g. six months
- if material – the payment is reclassified and if immaterial – the cash is treated as miscellaneous income

Accounting for Petty Cash Fund

Imprest fund system Fluctuating fund system

Creation of petty cash fund Petty Cash Fund xx Petty Cash Fund xx
Cash in bank xx Cash in bank xx

Payment of petty cash expenses No entry Expenses xx

Petty Cash Fund xx

Replenishment of petty cash Expenses xx Petty Cash Fund xx

Cash in bank xx Cash in bank xx

Increase of fund Petty Cash Fund xx Petty Cash Fund xx

Cash in bank xx Cash in bank xx

Decrease of fund Cash in bank xx Cash in bank xx

Petty Cash Fund xx Petty Cash Fund xx

Sample: Accounting for Petty Cash

Bomba Company established a petty cash fund and below are the transactions pertaining to the petty cash.
a. Established a petty cash fund of P10,000 on January 1

b. Petty cash expenses amounted to P5,000 which consist of P2,000 travel expenses and P3,000 postage for period January 2-31.

c. The fund was replenished on January 31

d. On February 1, the fund was increased to P15,000

REQUIRED:
a. Record relevant entries using Imprest Fund system
b. Record relevant entries using Fluctuating Fund system

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Bank Reconciliation

-reconciliation of the balance per books and per bank

Adjusted balance method

Books Bank
Balance per books xx xx Balance per bank statement
Credit Memos xx xx Deposit in Transit
Debit Memos (xx) (xx) Outstanding checks
Errors xx(xx) xx(xx) Errors
Adjusted balance xx xx Adjusted Balance

Reconciling items
Book
I Credit memos
a. Notes received by bank
b. Proceeds of bank loan
II Debit memos
a. NSF checks
b. technically defective checks
c. bank charges
d. reduction of loan e.g. auto debit
III Errors

Bank
I Deposit in Transit
-Collections already recorded but not yet appeared in the bank
II Outstanding checks
-Checks already issued to the payee but not yet encashed
III Errors

Sample
The following data are gathered from the records of Adept Company for the month of December of the
current year.
Balance per book P5,000,000
Balance per bank 4,450,000
Deposit in Transit 3,000,000
Outstanding checks 850,000
Bank service charge 50,000
Customer's check returned by bank as "NSF" 500,000
Customer's note collected by bank:
Face P2,000,000; Interest, P200,000; collection fee, P50,000 2,150,000

REQUIRED:
a. Prepare a bank reconciliation on December 31
b. Prepare adjustments to correct the cash balance per book

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SESSION XIII ACCOUNTING FOR MERCHANDISING CONCERN

Service Business – DELIVER SERVICE for a fee (e.g. janitorial services, schools, utilities, restaurants)

Merchandising Business – BUY and SELL of products (e.g. retail supermarkets, auto dealers)

Manufacturing Business – BUY raw materials MANUFACTURE and SELL (e.g. P&G, Coke, Pepsi)

Profit or Loss Statements for Service and Merchandising type of business

SERVICE BUSINESS MERCHANDISING BUSINESS

Revenues from Services xx Net Sales xx

Less: Expenses xx Cost of Goods xx
Net Income xx Gross Profit xx
Operating Expenses xx
Net Income xx

Manufacturing

Raw Materials, beg xx

Raw materials purchases xx

Raw materials available for use xx

Raw materials, end xx

Raw materials used xx

Direct Labor xx

Factory Overhead xx

Manufacturing Cost xx

Work in Process, beg xx

Total Goods placed in process xx

Work in Process, end xx

Cost of Goods Manufactured xx

Finished Goods, beg xx

Cost of Goods Available for sale xx

Finished Goods, end xx

Cost of Goods Sold xx

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Accounting for Inventory (PAS 2)

Inventories
-Held for sale in the ordinary course of business
-In the process of production
-Materials/supplies used in the production

Cost of inventories
a. Cost of purchase
b. Cost of conversion (labor and overhead)
c. Other cost incurred in bringing the inventories to their present location and condition

Cost of Purchase – purchase price, freight in, handling cost, import duties and non-refundable taxes

Cost of conversion – direct labor and overhead (indirect labor & indirect materials)

Other cost – such as normal losses, spoilages and breakages

Items not included in the inventory

a. Abnormal losses – this should be expensed as incurred as this result from inefficiency in productions
b. Storage cost – unless this is necessary in the production process
c. Administrative overheads – if not necessary in bringing the goods to their present condition and location
d. Selling costs – this should be expenses as incurred as this will not result to any benefit in the future

Classes of Inventories

a. Finished Goods – ready for sale

b. Goods in Process – partially complete
c. Raw Materials - materials used in the production
d. Factory supplies – similar to raw materials but have indirect relationship with the end product i.e. not visible to the end product

Accounting for Inventories

Periodic – requires physical counting of goods at the end of the accounting period. This is generally used when the inventory items turn over
rapidly and have small value peso investment (e.g. hardware and autoparts)

Perpetual – requires the maintenance of stock cards or records of in and out of inventory. Generally used where the inventory items
treated individually represent a relatively large peso investment (e.g. cars and jewelry)

PERIODIC SYSTEM PERPETUAL SYSTEM

1. Purchase of merchandise on account 1. Purchase of merchandise on account
Purchases xx Merchandise Inventory xx
Accounts payable Xx Accounts payable xx

2. Payment of freight on the purchase 2. Payment of freight on the purchase

Freight In xx Merchandise Inventory xx
Cash/Accounts Payable xx Cash/Accounts Payable xx

3. Return the merchandise purchased to supplier 3. Return the merchandise purchased to supplier
Accounts payable xx Accounts payable xx
Purchase return xx Merchandise Inventory xx

4. Sale of merchandise on account 4. Sale of merchandise on account

Accounts receivable xx Accounts receivable xx

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Sales xx Sales xx

Cost of Goods Sold xx

Merchandise Inventory xx

5. Return of merchandise sold from customer 5. Return of merchandise sold from customer
Sales return xx Sales return xx
Accounts receivable xx Accounts receivable xx

Merchandise Inventory xx
Cost of Goods Sold xx

6. Adjustment to ending inventory No adjustment for ending inventory

Merchandise Inventory, end xx
Income Summary xx

Sample
Pogito Company is a wholesaler of car seatcovers. On January 1, 2014, the company’s inventory consisted of 90 car seat covers priced at P1,000
each. During the year, the following transactions occurred.
1. Purchased 800 car seat covers on account at P1,000 each
2. Returned 50 defective car seatcovers to supplier and received credit
3. Paid 600 of the car seatcovers purchased
4. Sold 790 car seatcovers at P2,000
5. Received 20 seatcovers returned by a customer and gave credit. The goods were in excellent condition
6. Received cash for 680 seatcovers sold
7. Physical count at year end revealed 60 units on hand

REQUIRED:
a. Prepare entries using perpetual and periodic system
b. Determine the Cost of Sales under each system

Trade Discounts and cash discounts

Trade Discounts – deductions from the list/catalog price. This is not recorded in the books. The purpose is for bulk sale
Cash discount – deductions from the invoice price. This is recorded in the books. The purpose is for prompt payment

Sample
Assume the list price of the merchandise purchased is p500,000 less 20% and 10%, with credit terms of 5/10, n/30

Methods of recording purchases

1. Gross method – purchases and payable are recorded at gross
2. Net Method - purchases and payable are recorded at net

Sample
The following transactions pertain to the purchases of Myriad Company for the current year, its first year of operations.
1. Purchase of merchandise at an invoice price of P4,750,000 excluding freight. Terms are 2/10, n/30
2. Freight paid, P250,000. The freight is allocated to each purchase
3. Cash payment on purchases, P3,717,000, of which P1,617,000 was paid within the discount period.
4. It is expected that all discounts on unpaid accounts payable will be lost
5. On December 31, one fifth of the merchandise remains on hand

REQUIRED: journal entries using gross and net method

ACCOUNTING FOR FREIGHT

FOB – free on board

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FOB Shipping point – buyer bear the cost of freight upon shipment. Buyer owns the goods upon
shipment

FOB SHIPPING POINT

Upon shipment, the title to the goods is

transferred to the buyer

Seller Buyer

FOB DESTINATION

Upon reaching the destination (buyer's warehouse),

the title to the goods transfer to the buyer

Seller Buyer
FOB Destination – seller shoulders the cost of freight up to the destination (buyer’s warehouse). Seller owns the goods until the goods reached
the destination

Freight collect – freight paid by the buyer

Freight prepaid – freight paid by the seller

Sample

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On Mar 10, 2014 Ramirez Company purchase P18,000 worth of merchandise from Valencia Company; terms 1/10, n/30, F.O.B shipping point.
On Mar 12, Ramirez paid P360 freight on the shipment. On Mar 15, Ramirez returned P2,000 of merchandise for credit. Final payment was made
to Valencia on Mar 19. Ramirez Company uses the periodic inventory system.

REQUIRED:

a. Prepare the journal entries for Ramirez Company

b. Prepare the journal entries assuming the terms are FOB Destination

COST FORMULAS

1. First In First Out (FIFO)

2. Weighted Average

FIFO
Ending Inventory = ending inventory x purchase price of earlier purchases

Weighted Average
Ending inventory = ending inventory x weighted average unit cost*

*Weighted average unit cost = Cost of Goods Available for Sale (COGAS) amounts / COGAS (units)

Sample:
The records of Extreme Company showed the following:
Units Unit Cost Total Cost
1-Jan Beginning 10,000 40 400,000
31 Sale 5,000
1-Apr Purchase 15,000 50 750,000
31-Jul Sale 18,000
31-Oct Purchase 25,000 60 1,500,000
31-Dec Sale 12,000

REQUIRED: Compute the Ending Inventory and Cost of Goods Sold (FIFO and Weighted Average)

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SESSION XIV INVENTORY ESTIMATION

Inventory Estimation
- approximating the value of inventory
-useful in computing the value of inventory for interim reporting, in case of loss on fire or inventory theft

Gross profit method (GP Method)

a. GP based on sales
b. GP based on cost

FORMULA:
x
Cost of Goods Available for Sale (COGAS) x
x
Cost of Goods Sold(CGS)* x
x
Ending Inventory x

x
Beginning Inventory x
x
Purchases x
x x
Freight in x x
x
Total x
x
Less: Purchase returns and allowances x
x
Cost of Goods Available for Sale (COGAS) x

*CGS - GP on sales (Net Sales x Cost ratio)

CGS - GP on cost (Net Sales / Sales ratio)

Sample 1
PamCompany has a recent gross profit history of 40% of net sales. The following data are available from
Pam accounting records.
Inventory, beg 650,000
Purchases 3,200,000
Net Sales 4,500,000
Purchase Returns 75,000
Freight in 50,000

Using the gross profit method, the estimated cost of the inventory on March 31, 2014 should be.

Sample 2
The following information is provided by Era Company for the current year.

Inventory, beg 500,000

Purchases 2,000,000
Freight in 100,000
Purchase returns and allowance 120,000
Purchase discount 80,000
Sales 2,200,000
Sales returns 100,000
Sales allowances 50,000
Sales discount 50,000
Gross profit on cost 25%

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Using the gross profit method, the estimated cost of the inventory on December 31 is

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