Review of the Previous Lesson

ACCOUNTING EQUATION & THE DOUBLE-ENTRY SYSTEM Week 2 ACCOUNTING EQUATION & THE DOUBLE-ENTRY SYSTEM ACCOUNTING INFORMATION SYSTEM Subject:

Learning Objectives Differentiate the elements of financial statements Explain the meaning of the account Discuss the accounting equation Explain the nature of debits and credits – the double-entry system Discuss accounting events and transactions Identify and differentiate typical account titles used – Balance Sheet & Income Statement Explain the accounting procedures for business transactions

ELEMENTS OF FINANCIAL STATEMENTS The elements of financial statements  refer to the quantitative information shown in the statement. Assets Liabilities Owner’s Equity or Capital Balance Sheet (Financial Position) - Real Account The elements directly related to the measurement of financial positions are assets, liabilities and equity. The elements directly related to the measurement of financial performance are income and expenses. 4. Income or Revenue 5. Expenses Income Statement (Financial Performance) - Nominal Accounts

ACCOUNT T-ACCOUNT A detailed record of the increases, decreases & balance of each element that appears in an entity’s financial statements. The simplest form of the account. It has 3 parts: account title, debit side & credit side. Account Title ACCOUNT TITLES – are identifications or brief description of items that fall to same kind, class or nature in recording business transactions, the elements of financial statements which are better known as “accounting elements” or “accounting values” are to be assigned with their individual names called “account titles”. In other words, it is a part of our study in accounting where we are to give or assign names to various accounts. Left side or Debit side Right side or Credit Side

ASSET ACCOUNTS - Debit Current Assets Non-Current Assets Cash Petty Cash Fund Cash Equivalents Notes Receivable Accounts Receivable Allowance for Bad Debts Accrued Interest Income Advances to Employees Inventories Prepaid Expenses Unused Supplies Property, Plant & Equipment Land Building Equipment Furniture & Fixtures Accumulated Depreciation Intangible Assets

LIABILITIES ACCOUNTS - Credit Current Liabilities Non-Current Liabilities Accounts Payable Notes Payable (short-term) Accrued Expenses or Accrued Liabilities Unearned Revenues or Unearned Income SSS Premium Payable Philhealth Premium Payable Pag-ibig Premium Payable Withholding Tax Payable Pre-collected or Unearned Income Mortgage Payable Bonds Payable Notes Payable (Long-term) Accounts Payable

OWNER’S EQUITY ACCOUNTS The original and additional investments of the owner of the business entity. Increased by net income Decreased by net loss Capital (Credit) When the owner of a business entity withdraws cash or other assets Withdrawals (Debit)

INCOME OR REVENUE ACCOUNTS - Credit Sales Income or revenue derived from the sale of merchandise. Service Income or Service Revenue Income or revenue derived from rendering services. Professional Income Accounting or Auditing Fees Income Legal Fees Income Dental Fees Income Medical Fees Income Rental Income Interest Income Miscellaneous Income

EXPENSES ACCOUNTS - Debit Cost of Sales or Cost of Goods Sold Salaries or Wages Expense Bad Debts or Uncollectible Accounts Expense Utilities Expense Depreciation Expense Taxes & Licenses SSS Contribution Philhealth Contribution Pag-ibig Contribution Insurance Expense Supplies Expense Miscellaneous Expense CHART OF ACCOUNTS – list of account titles or account name.

ACCOUNT T-ACCOUNT A detailed record of the increases, decreases & balance of each element that appears in an entity’s financial statements. The simplest form of the account. It has 3 parts: account title, debit side & credit side. In every transaction, there is a value received, we call Debit and value parted with, we call a Credit. Account Title Left side or Debit side (Dr.) Value received Right side or Credit Side (Cr.) Value parted with ACCOUNT TITLES – are identifications or brief description of items that fall to same kind, class or nature in recording business transactions, the elements of financial statements which are better known as “accounting elements” or “accounting values” are to be assigned with their individual names called “account titles”. In other words, it is a part of our study in accounting where we are to give or assign names to various accounts. Debit balance Credit balance

Account titles  are identifications or brief descriptions of items that fall to same kind, class or nature. In other words, are assigned names to various accounts. Account Title CREDIT ENTRY: An amount entered on the right-hand side of the account. DEBIT ENTRY: An amount entered on the left-hand side of the account. Left side or Debit side (Dr.) Value received Right side or Credit Side (Cr.) Value parted with = account balance Debit total Credit total ACCOUNT BALANCE  the difference between the debit total & credit total of an account. DEBIT BALANCE  if the debit total exceeds credit total. CREDIT BALANCE  if the credit total exceeds debit total. IN BALANCE or CLOSED ACCOUNT  if the debit total equals credit total. ACCOUNT TITLES – are identifications or brief description of items that fall to same kind, class or nature in recording business transactions, the elements of financial statements which are better known as “accounting elements” or “accounting values” are to be assigned with their individual names called “account titles”. In other words, it is a part of our study in accounting where we are to give or assign names to various accounts.

Example of Chart of Accounts CHART OF ACCOUNTS – list of account titles or account name. Account titles  are identifications or brief descriptions of items that fall to same kind, class or nature. In other words, are assigned names to various accounts.

THE NATURE OF DEBITS AND CREDITS – The double-entry system A double-entry system means that the dual effects of a business transaction is recorded. A debit side entry must have a corresponding credit side entry. Dual effects debit = credit value received = value parted with Each transaction affects at least two accounts. The total debits for a transaction must always equal the total credits. Business transactions total debits = total credits assets = liabilities & owner's equity

THE RULES OF DEBIT & CREDIT Rule 1 – Asset: debit to increase credit to decrease Rule 2 - Liabilities: credit to increase debit to decrease Rule 3 – Owner’s Equity: credit to increase Rule 4 – Drawing: debit to increase Rule 5 – Income: credit to increase Rule 6 – Expenses: debit to increase

NORMAL BALANCE OF THE ELEMENTS OF FINANCIAL STATEMENTS DEBIT BALANCE CREDIT BALANCE Liabilities Assets Owner’s Equity Income or Revenue Expenses

BASIC ACCOUNTING EQUATION Assets = Liabilities + Capital Credit Debit Credit normal balance Credit Debit Credit increase Credit Debit Debit decrease Income – Expenses = Net Income Credit normal balance Credit Debit Credit increase Credit Debit Credit Debit decrease Debit

EXPANDED ACCOUNTING EQUATION Assets = Liabilities + Capital (- Drawing + Income – Expenses) Credit Credit Debit normal balance Debit Debit Credit increase Credit Debit Debit Credit Credit Debit Credit Debit Credit decrease Credit Debit Debit

NOTE: Steps 1 to 10 is the ACCOUNTING CYCLE. PHASES OF ACCOUNTING Recording Classifying Summarizing Interpreting 5. Adjusting journal entries Profitability – How much is the increase in capital as a result of business operation? 1. Identifying transactions and events – source documents 3. Posting to the ledger – general ledger 6. Preparing the worksheet 4. Trial balance preparation 7. Preparing financial statements 2. Journalizing transactions – the journal Liquidity – Are there available funds to finance the business operation? RECORDING Business transactions are the economic activities of a business. Recording these historical events is a significant function of accounting. Before the effects of transactions can be recorded, they must be measured. In order that accounting information will be useful, it must be expressed in terms of a common financial denominator---money. Money serves as both a medium of exchange and a measure of value. CLASSIFYING – by simply measuring and recording transactions, the resulting information will be of limited use. To be useful in making decisions, the recorded data must be classified and summarized. Classification reduces the effects of numerous transactions into useful groups or categories. SUMMARIZING – summarization of financial data is achieved through the preparation of financial statements or financial reports. These usually summarize the effects of all business transactions that occurred during some period. INTERPRETING – after going through the preceding phases, it is imperative that the result of the summarization phase be interpreted of analyzed to evaluate the liquidity, profitability and solvency of the business organization. 8. Closing entries NOTE: Steps 1 to 10 is the ACCOUNTING CYCLE. 9. Post-closing trial balance Solvency – Can the business pay its long-term obligations to others? 10. Reversing entries

Steps 1 of the ACCOUNTING CYCLE. PHASE 1 - RECORDING Steps 1 of the ACCOUNTING CYCLE. 1. Identifying transactions and events – source documents a) Identification of business transaction  what transactions are considered as accountable and what are not. RULE: Only transactions & events which are of financial character to the business are being recognized. SOURCE DOCUMENTS or SUPPORTING BUSINESS DOCUMENTS the basis of identifying transactions. b) Analysis of business transactions  Business transactions are analyzed from the view point of the business. “Always consider yourself as the business” when making the analysis. By analyzing, we have to ask: What is the value received and value parted with in this particular transactions? c) Measuring of business transaction  the peso is our financial denominator.

Example of Source Documents (under Servicing Activities) Customers’ & suppliers’ sales invoices Official receipts Cash or Check Vouchers Service Order Slip

Steps 2 of the ACCOUNTING CYCLE. PHASE 1 - RECORDING RECORDING  is the 1st phase of accounting. This involves the writing down of business transaction in a systematic manner and in order of their occurrence in the book of original entry called Journal. Steps 2 of the ACCOUNTING CYCLE. 2. Journalizing transactions – the journal JOURNALIZING  is the process of recording the effects of economic transaction in the journal.  the act of recording business transactions in the journal. JOURNAL ENTRY  the accounting record written in the journal which consists of debit account and credit account with their respective values.

ANALYSIS OF BUSINESS TRANSACTION Transaction: Bought a car for cash, P650,000.00. Questions guide: Identifying: Who bought the car? The business. Analyzing: What is the value received? Car. What is the value parted with? Cash. Measuring: What is the amount involved? P650,000.00. Journalizing: Debit, value received – car P650,000.00 Credit, value parted with – cash 650,000.00

To illustrate the analyzing process of accounting, consider the transactions of Valrox, a servicing business. Chart of Accounts Utility expense Bank charge expense Service Income Salaries expense Owner’s drawing Cash on hand Cash in bank Accounts Receivable Office equipment Notes Payable Valrox, Capital SSS Premium Payable Withholding tax payable Supplies expense

The formal reports prepared by accountants Financial Statements Objective: To provide financial information useful to the users. The information that accumulated and processed in financial accounting The formal reports prepared by accountants The final products of the accounting process. Shows the financial position of a business entity as of a particular date. 1. Statement of Financial Position Shows the performance of the business entity for a given period. 2. Income Statement 3. Statement of Changes in Equity Shows the movement or changes in owner’s capital or equity in a certain period. 4. Cash Flow Statement Shows and explains the changes of cash during an accounting period. 5. Notes to the Financial Statement Part of the financial statements in a parenthesis form, to achieve proper understanding of the financial reports.

Relationships Among the Financial Statements

Example of Income Statement Example of the Statement of Owner’s Equity

Example of Statement of Financial Position Report Form – in vertical order Account Form – in horizontal order

Example of Statement of Cash Flows

Example of Notes to Financial Statement

ELEMENTS OF FINANCIAL STATEMENTS The elements of financial statements  refer to the quantitative information shown in the statement. Assets Liabilities Owner’s Equity or Capital Balance Sheet (Financial Position) - Real Account 4. Income or Revenue 5. Expenses Income Statement (Financial Performance) - Nominal Accounts The elements directly related to the measurement of financial positions are assets, liabilities and equity. The elements directly related to the measurement of financial performance are income and expenses. Real accounts are not closed at the end of the accounting period. Nominal accounts are temporary accounts that are closed or put to zero balance at the end of the accounting period.

ELEMENTS OF FINANCIAL STATEMENTS Assets – are resources controlled by the entity as a result of past transactions or events and from which future economic benefits are expected to flow to the entity. Asset accounts have a normal debit balance. Is a leased lot or rented machines considered an asset of the entity? Is a machine that can not be repaired and owned by the entity considered an asset? Is buying a machine in the future transactions considered an asset? Is a machine bought by the entity for the personal use of the owner considered an asset?

ELEMENTS OF FINANCIAL STATEMENTS 2. Liabilities – are present obligations of the entity arising from past transactions or events the settlement of which is expected to result in an outflow from the entity of resources embodying economic benefits. Liability accounts have normal credit balance. a. Is the debt of the owner considered a liability of the entity? b. Is a bank loan in the future transaction, thus a future obligation considered a liability?

ELEMENTS OF FINANCIAL STATEMENTS 3. Equity – is the residual interest in the assets of the entity after deducting all of its liabilities (asset – liabilities = equity). Equity accounts have normal credit balance. 4. Income or Revenue – represents the earnings of the business from sales of goods or service rendered. Revenue accounts have a normal credit balance. 5. Expenses – are costs incurred in conducting the business activities. Expense accounts have normal debit balances.

ELEMENTS OF FINANCIAL STATEMENTS RECOGNITION OF ELEMENTS MEASUREMENT OF ELEMENTS Recognition  means the process of reporting the elements of financial statements of an entity. Measurement  is the process of determining the monetary amounts at which the elements of financial statements are recognized. The 4 measurement bases: When is an item recognized as an element of financial statements? Historical cost Current cost Realizable value Present value Probability of future benefit  When the item has any future economic benefit that will flow to or from the entity. Reliability of measurement  When the item has a cost or value that can be measured with reliability.

MEASUREMENT OF ELEMENTS The 4 measurement bases: Historical cost  is the amount paid when an asset was acquired. Current cost  is the amount to be paid if the asset (already acquired) was acquired today. Realizable value or settlement value  is the amount to be received if the asset is to be sold. Present value  the amount that a future sum of money is worth today given a specified rate of return. Present value is the value on a given date of a future payment or series of future payments, discounted to reflect the time value of money and other factors such as investment risk. This sounds a bit confusing, but it really isn't. An investment that earns 10% per year and can be redeemed for $1,000 in five years would have a present value of $620. In other words, $620 today is worth $1,000 in five years. the amount that a future sum of money is worth today given a specified rate of return. 10% 5 years from now P1,000.00 P620.00

ACCOUNTING CONCEPTS & PRINCIPLES Accounting concepts  are important assumptions or ideas which accountants observe in recording business transactions in the books of accounts. Accounting conventions  are the means of implementing accounting principles. They are the rules, procedures & methods used in accounting practice. They comprise the large body of practices that prescribe definitely how to do the accounting process. Accounting principles  refers to a doctrine which is the basis of accounting conventions. GAAP  Generally Accepted Accounting Principles Guide accountants in the accounting process of an enterprise. Are developed based on experience, research, & careful study. Become generally accepted by agreement among accounting practitioners. OBJECTIVE: to fairly present the financial statements…in conformity with GAAP.

ACCOUNTING CONCEPTS & PRINCIPLES IMPLICIT ASSUMPTIONS ACCOUNTING PRINCIPLES Entity concept Periodicity concept Stable monetary unit concept Objectivity principle Historical cost Revenue recognition principle Expense recognition principle Adequate disclosure Materiality Consistency principle UNDERLYING ASSUMPTIONS Accrual basis Going concern Assignment: Give the description of each concepts & principles (except implicit assumptions).

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