Entrepreneurial Reviewer: Bookkeeping and Financial Statements PDF

**ENTREP REVIEWER** **Bookkeeping** - the process of recording all financial transactions made by business. **Bookkeepers** are responsible for recording, classifying, and organizing every financial transaction that is made through the course of business operations. Bookkeeping diffe...

**ENTREP REVIEWER** **Bookkeeping** - the process of recording all financial transactions made by business. **Bookkeepers** are responsible for recording, classifying, and organizing every financial transaction that is made through the course of business operations. Bookkeeping differs from accounting. The accounting process uses the books kept by the bookkeeper to prepare the end-of-the-year accounting statements and accounts. - **Bookkeeping** is the process of keeping track of every financial transaction made by a business--- from the opening of the firm to the closing of the firm. Depending on the type of accounting system used by the business, each financial transaction is recorded based on supporting documentation. That documentation may be a receipt, an invoice, a purchase order, or some similar type of financial record showing that the transaction took place. **Single-Entry** - Single-entry bookkeeping is probably only going to work for you if your business is very small and simple, with a low volume of activity. It is actually similar to keeping your own personal checkbook. You keep a record of transactions like cash, tax deductible expenses, and taxable income when you use single-entry bookkeeping. - bookkeeping is characterized by the fact that only one entry is made for each transaction, just like in your check register. In one column, entries are recorded as a positive or negative amount. In single-entry bookkeeping, you can actually keep a two-column ledger, one column for revenue and one for expenses. It's still considered single-entry because there is just one line for each transaction. - This type of bookkeeping is not for large, complex companies. It does not track accounts like inventory, accounts payable, and accounts receivable. You can use single-entry bookkeeping to calculate net income, but you can't use it to develop a balance sheet and track the asset and liability accounts. Transactions are a single entry, rather than a debit and credit made to a set of books like in double-entry bookkeeping. **Double-Entry** - Most businesses, even most small businesses, use double-entry bookkeeping for their accounting needs. Two characteristics of double entry bookkeeping are that each account has two columns and that each transaction is located in two accounts. Two entries are made for each transaction -- a debit in one account and a credit in another. - An example of a double-entry transaction would be if the company wants to pay off a creditor. The cash account would be reduced by the amount the company owes the creditor. That would be the debit. Then, the double-entry reduces the amount the business now owes to the creditor account as it has received the amount of the credit the business is extending. That is the credit. - If you want to keep track of asset and liability accounts, you want to use double-entry bookkeeping instead of single-entry. Other advantages that double-entry bookkeeping has over single-entry bookkeeping are that the owner can accurately calculate profit and loss in complex organizations, financial statements can be prepared directly from the books, and errors or fraud are easy to detect. **Income Statement and Bookkeeping: Revenue, Expenses, and Costs** - ***Income statement*** is developed by using revenue from sales and other sources, expenses, and costs. In bookkeeping, you have to record each financial transaction in the accounting journal that falls into one of these three categories. - ***Revenue*** is all the income a business receives in selling its products or services. Costs, also known as the cost of goods sold, are all the money a business spends to buy or manufacture the goods or services it sells to its customers. The purchases account on the chart of accounts tracks goods purchased. - ***Expenses*** are all the money that is spent to run the company that is not specifically related to a product or service sold. An example of an expense account is salaries and wages or selling and administrative expenses A **bookkeeper** is responsible for identifying the accounts in which transactions should be recorded. **NATURE and OBJECTIVES of FINANCIAL STATEMENTS** **Financial Statements** - The **financial information** being provided to users are called financial statements. These financial statements are purpose **FINANCIAL STATEMENTS**. - A **REPORTING GENERAL ENTITY** is an entity for which there are users who rely on the financial statements as their major source of financial information about the entity. **Component of Financial Statements According to PAS 1, Presentation of Financial Statement (revised 2007), paragraph 10, a complete set of financial statements comprises:** 1\. a statement of financial position (balance sheet) as of the end of the period; 2\. a statement of comprehensive income for the period; 3\. a statement of changes in equity for the period: 4\. a statement of cash flows for the period; 5\. notes, comprising a summary of significant accounting policies, and other explanatory information; and 6. a statement of financial position as at the beginning of the earliest comparative period when an entity applies an accounting policy retrospectively or makes a retrospective restate mentor items in its financial statements or when it reclassifies items in its financial statements. **Users of Financial Statements According to PAS 1 (revised 2007), paragraph 9, the users of financial statements include present and potential investors, employees, lenders, suppliers and other trade creditors, customers, the government and its agencies (BIR, SEC, NEDA), and the public. They use financial statements in order to satisfy some of their different needs for information. These needs include the following:** ***1.Investors and Shareholders*** - The providers of risk capital and their advisers are concerned with the risk inherent in, and the return provided by their investment. - They need information to help them determine whether they should buy, hold or sell their investment in the corporation. - Shareholders are enables them to assess the ability of the entity to provide remuneration, retirement benefits and employment opportunities. ***2. Manager*** - Using accounting information, managers and executives fulfill their function of planning (budgeting), directing (execution), and control (monitoring actual vs. budget) by evaluating the operational efficiency and taking remedial actions whenever necessary. ***3. Employees*** - Employees representative and groups there are interested in information about the stability and profitability of their employer. ***4. Lenders*** - Lenders are interested in information that enables them to determine whether their loans, and the interest attached to them, will be paid when due. ***5. Suppliers and other Trade Creditors*** - Suppliers and other trade creditors are interested in information that enables them to determine whether amounts owing to them will be paid when due. ***6. Customers*** - Customers are interested on information about the continuance of an entity, especially if they have a long-term involvement with, or are dependent on the entity for supply of inventory. ***7. Government and their agencies*** - Government and their agencies require information from economic entities in order to regulate the activities of such entities, determine taxation policies, and use such information as basis for national income statistics and similar statistics. ***8. Public*** - Entities affect members of the public in a variety of ways. For example, entities may make a substantial contribution to the local economy in many ways including the number of people that they employ, their patronage of local suppliers, and paying of local and national taxes. **Importance of Understanding Financial Statements to Management** The **chief executive officer (CEO)** or any corporate officer considered as among those belonging to the top management echelon, need not be an accountant, an auditor, or a CPA. He can master fundamental financial management skill and make major policy decision with assurance if: 1\. He knows the meaning of each asset and liability account on his balance sheet and the meaning of each major item appearing on the income statement. 2\. He is thoroughly familiar with the financial ratio analysis of his financial statements so that he can accurately assess his company\`s position and draw meaningful conclusions when comparing the results of his company with those of its competitor and industry. **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. - Financial statements prepared for this purpose meet the common needs of most users. - Financial statements also show the result of the stewardship of management, or the accountability of management for the resources entrusted to it. **To meet this objective, financial statements provide information about an entity's:** **A. assets;** **B. liabilities;** **C. equity;** **D. income and expenses, including gains and losses;** **E. changes in equity; and F. cash flows.** **Presentation of Financial Statements** According to **Philippine Accounting Standard No. 1 (PAS 1):** **"*Financial statements*** shall present fairly the financial position, financial performance and cashflows of an entity. Fair presentation requires the faithful representation of the effects of transactions, other events and conditions in accordance with definitions and recognition criteria for assets, liabilities, income and expense set out in the ***Framework.*** The application of the International Financial Reporting Standard (IFIRS), with additional disclosure, when necessary, is presumed to result in financial statements that achieve a fair presentation.\" - **Responsible for the Preparation of an Entity\'s Financial Statements** - The management of an entity is primarily responsible in the preparation and presentation of its financial statements. The Board of Directors reviews and authorizes the financial statements for issuance to the stockholders of the entity and to the public. - As required by the Securities and Exchange Commission and the Bureau of Internal Revenue, all audited financial statements should include the Statement of Management Responsibility, which state that the management of the company is primarily responsible for the preparation of the financial statements being audited an example, is provided. **Generally Accepted Accounting Principles (GAAP**) - In the Philippines, the development of GAAP was initially formalized through the creation in 1981 of the ***Accounting Standard Council (ASC).*** The accounting standards promulgated by ASC constitute thegaap in the Philippines. - From the start of the accounting profession up to 1995, the Philippines is developing its accounting standard following the standard setting body in the USA, the ***Financial Accounting Standard Board (FASB).*** But beginning 1996, the Philippines has started to develop new accounting standard or GAAP based from the **International *Accounting Standard Board (IASB).*** The pronouncements of IASB are called ***"International Financial Reporting Standard\" (IFRS).*** - Today, the ***Generally Accepted Accounting Principles (GAAP)*** includes those principles regardingthe recognition criteria for assets, liabilities, income and expense set out in the PAS\'s Framework for the preparation and Presentation of Financial Statement. - **Underlying Assumptions of Financial Statements** 1. **Accrual Basis Principle (PAS 1, Framework, revised 2007, paragraph 22** It refers to the recording of revenues of a company as these are earned and expenses as these are incurred, even when no money has changed hands yet. Under this basis, the effects of transactions and other events are recognized, when they occur (and not as cash or its equivalents is received or paid) and they are recorded in the accounting records and reported in the financial statements of the periods to which they relate. 2. **Going Concern Principle (PAS 1, Framework, revised 2007, paragraph 23)** The financial statements are normally prepared on the assumption that an entity is a going concern and will continue in operation for the foreseeable future in the absence of evidence to the contrary. Hence, it is assumed that the entity has neither the intention nor the need to liquidate or curtail materially the scale of its operations; if such intention or need exists, the financial statement may have to be prepared on a different basis and, if so, the basis used is disclosed. 3. **Understandability Principle 1, Framework, revised 2007, paragraph 25)** (PAS users are assumed to have a reasonable knowledge of business and economic activities and accounting and a willingness to study the information with reasonable diligence. 4. **Relevance Principle (PAS 1, Framework, revised 2007, paragraph 26)** To be useful, the information must be relevant to the decision-making needs of users. Information is relevant when it influences the economic decisions of users by helping them evaluate past, present or future events or confirming, or correcting, their past evaluations. The predictive and confirmatory roles of information are interrelated. 5. **Materiality Principle (PAS 1, Framework, revised 2007, paragraph 29)** The relevance of information is affected by its nature and materiality. In the preparation of financial statements, each material class of similar items shall be presented separately. Items of a dissimilar nature or function shall be presented separately unless they are immaterial. An item in the financial statements is material if its omission or misstatement could individually or collectively influence the economic decisions of the users. Materiality depends on the size and nature of the omission or misstatement judged in the surrounding circumstances. The size or nature of the item, or a combination of both, could be the determining factor. 6. **Reliability Principle (PAS 1, Framework, revised 2007, paragraphs 31 to 36)** Information has the quality of reliability when it is free from material error and bias (neutrality)and can be depended upon by users to represent faithfully (faithful representation) that which it either purport to represent or could reasonably be expected to represent. Information may be relevant but so unreliable in nature or representation that its recognition may be potentially misleading to the user. Included in reliability is completeness. To be reliable, the information in the financial statement must be complete within the bounds of materiality and cost. An omission can cause information to be false or misleading and thus unreliable. 7. **Comparability Principle (PAS 1, Framework, revised 2007, paragraph 39)** Users must be able to compare the financial statements of an entity through time in order to identify trends in its financial position and performance. Users must be able to compare the financial statements of different entities in order to evaluate their relative financial position, performance, cash flows, and changes in equity. Included in the essence of comparability is the quality of consistency of the application of accounting policies through time. It means the presentation and classification of items in the financial statements should be retained from one period to another. Except when a Standard or an interpretation permits or requires otherwise, comparative information shall be disclosed in respect of the previous period for all amounts reported in the financial statements. Comparative information shall be included for narrative and descriptive information when it is relevant to an understanding of the current period\'s financial statements. Also, financial statements should be prepared for this year and last year for easy comparison, analysis and preparation of cash flows statement. 8. **Prudence (Conservatism) Principle** The preparers of financial statements have to contend with the uncertainties that inevitably surround many events and circumstances, such as the collectivity of doubtful account receivables, the probable useful life of plant and equipment and the number of warranty claims that may occur. In this regard, the exercise of prudence or conservatism in the preparation of financial statements is required. Prudence or conservatism is the inclusion of a degree of caution in the exercise of the judgments needed in making the estimates required under conditions of uncertainty, such that assets or income are not overstated and liabilities or expenses are not understated. 9. **Cost Principle** The financial statements shall be prepared on the basis of historical cost, except when a standard or Interpretation permits, and do not take into account changing market prices and current cost of non-current assets. Assets are recorded at the amount of cash or cash equivalents paid or the fair value of the consideration given to acquire them at the time of their acquisition. 10. **Matching Principle** Expenses are recognized in the period in which the related revenue was earned. The cost of inventory sold, therefore, is charged from income in the period when the sale (revenue) was made. Costs that are difficult to match with revenues earned during the period, or whose benefit in future periods is uncertain or indeterminable, are immediately recognized as expense such as research and development expenses. 11. **No Offsetting Principle** Assets and liabilities, and income and expenses, shall not be offset unless required or permitted by a Standard or an Interpretation. A receivable and a payable to the same companyshould not be offset and an income from a company and an expense to the same company should not be offset. Measuring assets net of valuation allowance- for example, obsolescence allowance on inventories, allowance for doubtful account for receivables- is not offsetting. 12. **Separate Entity Principle** From the point of view of accounting, the enterprise is assumed to be a separate entity from its owner. The assets and liabilities of the owner should not be mingled with the assets and liabilities of the enterprise. - **Neutrality Principle** - **Faithful Representation Principle** - **Substance Over Form Principle** - **Completeness Principle** - **Constraints on Relevant and Reliable Information** 13. **Timeliness** If there is undue delay in the reporting of information, it may lose its relevance to provide information on a timely basis. It may often be necessary to report before all aspects of a transaction or other event are known, thus impairing reliability. 14. **Benefit and Cost Principle** The balance between benefit and cost is a **[pervasive constraint rather than a qualitative characteristic. The benefits derived from information should exceed the cost of providing it.]** 15. **Measurement in terms of Money Principle** To allow for aggregation and comparability, assets (economic resources) and liabilities(obligations) should be measured in monetary terms. This principle also imposes **[the constraint that only information presented in the financial statements is that which can be expressed in objectively determined monetary terms.]** - **Constraints on Relevant and Reliable Information** All financial statements issued in the Philippines for shareholders and investors should be in terms of Philippine peso; those issued in the United States of America, should be in US dollars; and those issued in Japan, should be in Japanese Yen. Thus, a multi-national corporation whose shares of stocks are traded in various stock markets in the world are required to prepare financial statement in terms of their local currency. - **Compliance with GAAP** An entity whose financial statements comply with generally accepted accounting principles shall make an explicit and unreserved statement of such compliance in the notes to the financial statements. Financial statements shall not be described as complying with GAAP unless they comply with the Philippine Accounting Standard or all the requirements of each applicable Philippine financial reporting Standard (PFRS). - **Income Statement and Statement of Financial Position** **Philippine Accounting Standard (PAS) 1** PAS 1 is effective for annual financial statement periods beginning on or after January 1, 2005. **INCOME STATEMENT** is the financial statement that shows the **[financial performance]** of the entity during a given period of time, usually a year. The financial performance is also called **[the result of operation]** during a given period of time. Income statement measures the profitability of the entity considering its resources. Sometimes it is also called **[Profit and Loss statement.]** [**INCOME**] the conceptual framework defines ***[income as an increase in economic benefit]*** during the accounting period in the form of **[*inflows or enhancements of assets or decrease of liabilities that result in increases of equity*,]** other than those relating to contributions from equity participants. According to PAS 1, paragraphs 74 to 77**[, the term income includes revenues]** **[and gains]**. Revenue arises in the course of the ordinary activities of an entity that include sales of products, professional fees, service income, interest income, divided income, royalty income and rent income. **GAINS** represent other items that meet the definition of income and may, or may not, arise in the course of ordinary activities of the enterprise. **[Gains are incidental income from peripheral transaction of the entity.]** **EXPENSE** is a **[decrease in economic benefit]** during the accounting period in the form of outflow or depletion of assets or incident of liabilities that result in the decrease of equity. **Classification of expenses includes the following:** 1. **Cost of goods sold or cost of sales** Cost of goods sold is the value of goods sold to customers. For manufacturing entity, the formula to compute the cost of goods sold: cost of goods manufactured plus finished goods at the beginning of the period less finished goods at the end of the period equals cost of goods sold. 2. **Selling or distribution expenses** Selling expenses are expenses related to selling and marketing activities of products and services, such as advertising and promotion and delivery of products to customers. Selling expenses for example, include expenses of a store such as store supplies expense, sales lady\'s salary. store rent expense, store utility expense, and depreciation expense of store furniture, equipment, delivery vehicles and all depreciable assets in the store. 3. **Administrative or general expenses** Administrative expenses are expenses in managing the business. These are office rent expense, taxes and licenses (excluding income tax), bad debts expense, office pore supplies. Expenses such as office salaries and wages, office employees fringe benefits, office fees expense, transportation expense, depreciation expense of office building, expense of office building, office furniture and equipment, and amortization of intangibles. 4. **Other expenses** Other expenses are expenses or losses from peripheral or incidental transaction of the entity such as loss on sale of investments. 5. **Financing cost** Financing costs are the expenses incurred for borrowing to finance the operation of the business such as interest expense from a bank loan, interest expense from bonds payable and business such as others. 6. **Income tax** expense is equal to the accounting income subject to tax multiplied by the tax rate. **ENTERPRISE** - ***Is an organization that is engage in commercial activities -- the trade of goods or services, or both, with consumers.*** - Its goal basically, is to earn profit. - **Profit** is the return or compensation to the entrepreneur for taking on the risk of developing an idea into an actual business venture. - It is ***created by an entrepreneur*** and the ***process of its creation is called entrepreneurship.*** **Entrepreneurial idea:** Is a specific innovative way to satisfy want, overcome a problem, or meet a challenge. **Types of enterprises according to concept** 1. **An enterprise can involve a new concept.** - This usually means creating or stumbling on a new idea or concept, and creating or inventing something radically new. The inventor then builds anew business around this product. An example of a keen innovator who had an uncanny knack of creating new products that captured people's imaginations and convinced that they needed these products is the genius Maverick Steve Jobs. **2. An enterprise can be built on an existing concept, but give rise to a new business**. - An example of this is Mang Inasal. It offers chicken in a new light: grilled chicken as fast food. With this new concept, Mang Inasal, which started in the Visayas, took the country by storm because its founder, Edgar "injap" Jsia, correctly perceived a need of people for affordable, quick-serve inihaw or grilled chicken. Thus, this business was founded and flourished, to the extent of offering very real competition to the Jollibee's popular chicken joy. **3.An enterprise can involve an existing concept and an existing business.** - An entrepreneur can have a laundry business dean of clean, for example, had three branches in Metro Manila, mostly in the center and south areas of the metropolis. The son of the owner, while still in college, was permitted by his parents to set up a fourth branch in Quezon city. Although the new store was built on an existing business -- it is still a laundry shop, it required the young entrepreneur to take some personal, family, and financial risks the setting up of branches or franchises can be considered an example of this type of enterprise. Thus, in summary, an entrepreneurial enterprise can involve: **Relevance of entrepreneurship** **A) development of managerial capabilities   ** - Entrepreneurship helps in identifying and developing the managerial capabilities of entrepreneurs.  - Studying a problem, identifying its alternatives, and comparing alternatives in terms of cost and benefit implication, and choosing the best alternative help in sharpening the decision-making skills of an entrepreneur.  - Besides, these managerial capabilities are used by entrepreneurs in creating new technologies and products in place of older technologies and products resulting in higher performance. **B) creation of organizations** - Entrepreneurship results in the creation of organizations when entrepreneurs - Assemble and coordinate physical, human, and financial resources and direct them towards the achievement of objectives through managerial skills. **C) improving the standard of living** - Entrepreneurship helps in making a wide variety of goods and services available to society which results in a higher standard of living for the people. - Possessions of luxury cars, computers, mobile phones, the rapid growth of shopping malls, etc. Point to the rising living standards of people. All these are due to the efforts of entrepreneurs.  **D) means of economic development.** - Entrepreneurship involves the creation and use of innovative ideas, maximization of output from given resources, and development of managerial skills. All these factors are essential to the development of a country.