Chapter 3: Accounting Elements and Account Titles PDF

Chapter 3: Accounting Elements and Account Titles  Learning Objective Specify the nature of accounting elements Expound the broad classification of accounting elements State the classification of assets Describe the requisites for an item to be classified as a...

Chapter 3: Accounting Elements and Account Titles  Learning Objective Specify the nature of accounting elements Expound the broad classification of accounting elements State the classification of assets Describe the requisites for an item to be classified as a current asset Explain the concept of operating cycle Enumerate the different account titles classified as assets Explain the concept of “contra-account” Point out the characteristics and requirements of liability Analyze the elements affecting owner’s equity; and Discuss the merchandising account titles  Accounting Elements - Are included in the broad classification of accounting values in which similar business transactions and events are grouped The different accounting elements are: 1. Assets 2. Liabilities 3. Capital or equity 4. Revenue 5. Expenses  Assets - Are resources controlled by the business enterprise as a result of past transactions or events, and from which future economic benefits are expected to flow to the entity - Are properties or rights to the property owned by the business with future economic benefits - Requisites of an asset: 1. Considered resources of the business 2. Controlled by the enterprise 3. Result of past transactions or events 4. Expected future benefits that may be derived  Assets 1. Considered resources of the business - Item must be the property of the business or the business must have the legal right to the property 2. Controlled by the Enterprise - The disposition on the use of the property belongs to the business 3. Result of Past Transactions or Events - An item to be classified as an asset should be the result of past transactions, and not of future transactions 4. Expected to Give Future Benefits - An item should provide additional economic benefits to the business in order to be classified as an asset  Assets Assets are classified to: 1. Current Assets 2. Non-current assets  Current Assets An asset is classified as current when it satisfies any of the following criteria: 1. It is expected to be realized in, or is intended for sale or consumption in the entity’s normal operating cycle. 2. It is held primarily for the purpose of being traded. 3. It is expected to be realized within twelve (12) months after the balance sheet date. 4. It is cash or cash equivalent unless it is restricted from being exchanged or used to settle liabilities for at least twelve months after the balance sheet date.  Current Assets 1. A current asset is realizable or consumable within the normal operating cycle. - The first criterion for an asset is that it is realizable. Realizable – the asset is convertible into cash, cash equivalents or credit. - may apply to trade receivables and goods intended for sale or consumed within the normal operating cycle of the business Trade receivables – collectibles that arise from the nature of business operation like sale of goods or services Inventories – goods that are intended for sale to the customers Operating cycle – span of time from the point of acquisition of goods or materials for processing up to the realization in cash or cash equivalents.  Current Assets 1. A current asset is held primarily for the purpose of being traded. - Applicable to short term investments or marketable securities - Purpose of holding the asset is for selling or trade 2. A current asset is expected to be realized within twelve months. - Asset is convertible into cash or collectible within one year from the date of the balance sheet - Applicable to trade receivables that are collectible within 1 year notwithstanding the normal operating cycle of the business - Non trade receivables not realizable within 1 year shall not be considered as current asset  Current Assets 1. A current asset is cash or cash equivalent without restrictions. - Will include all cash and cash equivalents which are not restricted from being used in the operations of the business - Examples of cash that is restricted or intended for a specific purpose and is not considered as current asset: a. Cash set aside to pay long-term financial obligations of the business. b. Cash set aside for the expansion of the business c. Cash specified for contingencies.  Current Assets Accounts Accounts – refers to the device that summarizes business transactions and events - Labeled with a specific name to identify one from the other Account Title – the name designated to the account which describes its nature Current Asset account titles: 1. Cash 6. Interest Receivable 2. Petty Cash Fund 7. Advances to Officers 3. Notes Receivable and Employees 4. Accounts Receivable 8. Supplies 5. Allowance for Bad Debts 9. Prepaid Expenses  Current Assets Accounts 1. Cash – the account title that describes money, either in paper or coins, also includes money substitutes like checks, postal money orders, bank drafts and treasury warrants Types of business cash: a. Cash on hand – cash within the premises of the business b. Cash in bank – cash deposited in the bank 2. Petty Cash Fund – money placed and set aside for “petty” or small expenses - Usually established if the company uses the “imprest fund system”  Current Assets Accounts 3. Notes Receivable – collections from customers or clients arising from sale of goods or services which are supported by promissory notes (PN) executed by the customers. 4. Accounts Receivable – collectibles from customers arising from credit sale of goods and services that are not supported by PN 5. Allowance for Bad Debts – an “asset offset” or “contra- asset” account which provides for possible losses from uncollected accounts receivable - Also called Allowance for Doubtful Accounts 6. Interest Receivable – amount of interest earned on note receivable  Current Assets Accounts 7. Advances to Officers and Employees - Amounts collectible from officers or employees within the company arising from cash advances 8. Supplies or Supplies on Hand - Cost of stationery, paper, pencil, ink and other related supplies purchased, and used, but still on hand at the end of the accounting period - Refers to unused supplies 9. Prepaid Expenses – expenses that are paid in advance but not yet incurred or remain unexpired at the end of the period - The business has paid the expense in advance but has not been able to utilize it at the end of the period  Non-Current Assets Accounts Non-current Assets - Are properties or resources controlled by the business not classified as current assets as a result of past events from which future economic benefits are expected to flow to the entity Common classification and presentation of non- current assets: 1. property, plant and equipment 2. Long-term investment 3. Intangible assets 4. Other non-current assets  Non-Current Assets Accounts A. Property, Plant and Equipment (PPE) - Tangible assets which are held by an enterprise for use in production of goods and services, for rental to others, or for administrative purposes and expected to be used during more than one period. Classification of PPE: 1. Land – site where the administrative building, the store or the plant is located 2. Building – used for the building structures of the business which usually include the administrative building, the warehouse, the processing plant, and the store outlet.  Non-Current Assets Accounts 3. Machinery – machines used in the production process 4. Equipment – includes calculators, typewriters, adding machines, computers, steel filing cabinets and the like - Commonly a term is added before “equipment” to be more specific to the nature of the equipment 5. Furniture and Fixtures – include chairs, tables, counters, display cases and the like 6. Accumulated Depreciation – is an “asset offset” or “contra-asset” account and is deducted from the related property and equipment except land. - Sum of depreciation over the years Depreciation – the expense portion of the asset because of wear and tear  Non-Current Assets Accounts B. Long-term Investments - Investment that is not readily marketable and intended to be held for more than one year - Examples are stocks, investment in bond, subsidiaries, associated equity method and sinking fund C. Intangible Assets - Identifiable non-monetary assets without physical substance that are controlled by an entity as a result of past events from which future economic benefits are expected to flow to the entity D. Other Non-Current Assets - no-current assets that could not be properly included in the preceding classifications  Liabilities - Are present obligations of the enterprise arising from past transactions or events, the settlement of which is expected to result in an outflow from the enterprise of resources embodying economic benefits Requirements to be considered a liability: 1. It is a present obligation – financial obligations that exist as of the date of the FS, thus, does not include those that are expected to be incurred 2. It arises from past transactions – liabilities are results of the transactions entered or made by the enterprise in the past and shall not include expected transactions or transactions that will happen in the future  Liabilities 3. Settlement results in outflow of resources – a liability is an obligation that has to be paid in the form of cash or other resources 4. The transactions provide economic benefits – despite a liability being a financial obligation, the business transaction is assumed to provide additional economic benefits to the enterprise Liabilities are classified into: 1. Current Liabilities 2. Non-current Liabilities  Current Liabilities A liability is considered current if it satisfies any of the ff criteria: 1. It is expected to be settled in the entity’s normal operating cycle 2. It is held primarily for the purpose of being traded. 3. It is due to be settled within twelve months after the balance sheet date. 4. The entity does not have an unconditional right to defer settlement of the liability for at least twelve months after the balance sheet date  Current Liabilities 1. Expected to be settled in the entity’s normal operating cycle - Liabilities of the business that are payable within the normal operating cycle of the business Trade liabilities – obligations incurred that are related to the nature of the business operation 2. Held primarily for the purpose of being traded - Applies to financial obligations in the form of marketable securities that are issued for trading, with which the business has intention of redeeming them within one year  Current Liabilities 3. Due to be settled within twelve months - Applies to non-trade liabilities or liabilities that are not directly related with the nature and operations of the business - Examples are dividends payable, income tax payable, warranty payable, and refundable deposits 4. Entity does not have an unconditional right to defer settlement - Applies to long-term or non-current liability that matures or falls due within one year from the date of the balance sheet  Current Liabilities Accounts 1. Accounts Payable - Obligations or debts of the business arising from services received, merchandise, supplies or property, plant and equipment acquire “on account”. 2. Notes Payable - Similar to accounts payable however N/P are supported by promissory note executed by the business in favor of the creditor or supplier of goods and services 3. Bank Payable or Loan Payable - Financial obligations to banks and other financial institutions  Current Liabilities Accounts 4. Utilities Payable – obligations to utility companies for the use of utilities in the business operation 5. Salaries Payable – unpaid salaries of employees and workers for the services rendered as of the date of FS 6. Interest Payable – unpaid interest to the bank or other financing institutions because of amounts borrowed 7. SSS Premium Payable – amount withheld from the salaries of employees and the employer’s unremitted share contribution to the Social Security System (SSS) 8. Philhealth Premium Payable - amount withheld from the salaries of employees and the employer’s unremitted share contribution to the Philippine Health Insurance Corporation (PHIC)  Current Liabilities Accounts 9. Pag-IBIG Premium Payable - amount withheld from the salaries of employees and the employer’s unremitted share contribution to the Home Development Mutual Fund (Pag- IBIG) 10. Withholding Tax Payable – amount of income tax withheld from the salaries of employees 11. Unearned Income – income collected or received in advance, but is not yet considered as earned - other account title for this is Precollected income Non-Current Liabilities Accounts Non-Current Liabilities - Present obligations of the entity arising from past events which are expected to result in an outflow of resources from the entity that do not meet the criteria of current liabilities Classification of Non-current liabilities: 1. Mortgage Payable 2. Long-term Bank Payable 3. Non-Current Portion of Long-term Debt 4. Finance Lease Liability  Non-Current Liabilities Accounts 1. Mortgage Payable – amount of long-term liability that is supported or backed up by a collateral 2. Long-term Bank Loan – used to present a bank loan with a maturity period or a term of more than one year 3. Non-Current Portion of Long-Term Debt – the portion of a debt or a loan that will not mature within one year from the date of the SFP 4. Finance Lease Liability – liability portion of the asset acquired through finance lease Operating lease – payment of the lessee or the one renting the property simply intended to cover the monthly rental of property Finance lease – the lease payment meant to cover both the monthly rental and partial payment of the property  Equity or Owner’s Equity Equity – the residual interest of the owner in the assets of the business after deducting all its liabilities. - it represents what is left to the business after all the liabilities are fully paid Equity section are usually categorized as: 1. Capital – initial investment of the owner at the start of the business operation or the beginning capital of succeeding years - Decreased by withdrawal and losses incurred and increased by income realized or additional investment made - Ending capital will serve as the beginning capital of the next accounting period  Equity or Owner’s Equity 2. Withdrawal or Drawing - Temporary withdrawal of capital by the owner from the business for his or her personal use 3. Net Income or Net Loss - Not an account title but a line item in the equity section of SFP - Represents the amount of net income realized or net loss incurred during the accounting period Net income – income or revenue is greater that expenses Net loss – income or revenue is less than expense  Income Accounts Income – is increases in economic benefits during the accounting period in the form of inflows or enhancements of assets or decrease of liabilities that result in increase in equity, other than those relating to contributions from equity participants - Encompasses both revenue and gains Revenue – arises in the course of the ordinary activities of an entity and is referred to by different names depending on the nature of the business Gains – other items that meet the definition of income and may or may not arise in the course of the ordinary activities of an entity  Income Accounts Income account titles: 1. Service Income – income realized for all types of income derived from services rendered 2. Professional Income – amount of income earned by professionals from the practice of their professions 3. Rental Income – income earned from buildings, space and other properties rented or leased out by the business 4. Interest Income – amount of income realized arising from lending operations 5. Miscellaneous Income – income earned that could not be classified properly in the preceding income classifications  Income Accounts Income account titles: 6. Gains from Sale of Assets – income realized from sale of asset not intended for sale in the ordinary course of business operations  Expense Accounts Expenses – decreases in economic benefits during the accounting period in the form of outflows or depletions of assets or incurrence of liabilities that result in decreases in equity, other than those relating to distributions to equity participants Expense Accounts: 1. Salaries and Wages – payments of services rendered by workers and employees 2. Rent Expense – amount paid for the use of office space, store space, or factory area. 3. Office Supplies Expense – different materials used by the business in its office or offices  Expense Accounts Expense Accounts: 4. Store Supplies Expense – store-related materials used by the business in its day-to-day of operations 5. Insurance Expense – expired portion of premiums paid for insurance coverage 6. Interest Expense – amount of interest paid or incurred during the accounting period 7. Taxes and Licenses – payments for or incurrence of taxes, licenses, government fees, and other similar fees 8. Utilities Expense – amount incurred or paid for the use of light, water, and gas for the business  Expense Accounts Expense Accounts: 9. Bad Debts Expense or Doubtful Accounts Expense – amount of receivable estimated to be doubtful of collection 10. Depreciation Expense – expired portion of the cost of building, machinery, equipment, store equipment, and other types off PPE except land. 11. SSS Contribution – represents the share of the employer in SSS contribution for the welfare of the employees as required by special law 12. Philhealth Contribution - represents the share of the employer in Philhealth contribution of the employees  Expense Accounts Expense Accounts: 13. Pag-IBIG Contribution - represents the contribution of the employer to Pag-IBIG for the benefit of the employees as mandated by law 14. Miscellaneous Expense – amount paid or incurred where separate account is not necessary because expenses are immaterial, uncommon, and infrequent  Merchandising Accounts Merchandising business uses some account titles that a service entity does not use. The ff account titles are used by merchandising business: 1. Sales 2. Sales Returns and Allowances 3. Sales Discounts 4. Purchases 5. Freight-In 6. Purchase Returns and Allowances 7. Purchase Discounts 8. Merchandise Inventory 9. Cost of Goods Sold 10. Freight-Out  Merchandising Accounts 1. Sales – a revenue account used when product are sold to customers, either on cash basis or on credit. 2. Sales Return and Allowances – amount of goods or merchandise returned by customers, presented as deduction from sales in the FS 3. Sales Discounts – amounts granted as discount to the customers, presented as deduction from sales in the FS 4. Purchases – amount of goods or merchandise bought from suppliers; can be either on cash basis or on account. 5. Freight-In – amount paid for the fare of the merchandise bought by the business from various suppliers. Basically it refers to the fare of the product from the supplier to the business premise. It is added to the account, “Purchases”  Merchandising Accounts 6. Purchase Returns and Allowances – the amounts of merchandise returned by the business to suppliers; account is deducted from the sum of purchases and freight-in in the FS presentation 7. Purchase Discounts – discounts granted by the supplier because of prompt payment on credit purchases; also deducted from purchases 8. Merchandise Inventory – amount of goods still unsold at the end of the accounting period 9. Cost of Sales or Cost of Goods Sold – cost of product sold during the accounting period; a line item in the income statement 10. Freight-Out – the fare of good sold to customers End of Chapter 3