Lesson 1: Basic Concepts of Accounting PDF

Brief History of Accounting Luca Pacioli , a Franciscan monk , introduced the practice of accounting profession On November 1494 in Venice, Luca Pacioli published a book which contained the primary principles of Mathematics and incidentally a set of accounting procedures. The book was ti...

Brief History of Accounting Luca Pacioli , a Franciscan monk , introduced the practice of accounting profession On November 1494 in Venice, Luca Pacioli published a book which contained the primary principles of Mathematics and incidentally a set of accounting procedures. The book was titled “ Summa de Arithmetica, Geometria, Proportioni et Proportionalita” ( Everything about Arithmetic, Geometry, Proportions and Proportionality). Philippine Standards Council (ASC) The Accounting Standards Council was created by PICPA on Nov. 18,1981 A standard setting body which is tasked to establish and improve the GAAP The approved statements and relative interpretations of the ASC are known as Statement of Financial Accounting Standards or SFAS, effective only upon approval by the PRC and shall not be retroactive. ASC is composed of eight members with a term of 2 years. PICPA- 4 members SEC -1 BSP -1 PRC /BOA - 1 FINEX -1 8 ASC is replaced with the Phil. Financial Reporting Standards Council (PFRSC) under the Phil. Accountancy Act of 2004. PFRSC is created by PRC upon recommendation of the Board of Accountancy. The accounting statements are now known as the Phil. Accounting Standards(PAS) Composition of PFRSC Chairman - 1 BOA - 1 SEC - 1 BSP - 1 BIR - 1 COA - 1 Major org. of preparers - 1 and users of F.S. Accredited national org. of CPAs: Public Practice - 2 Commerce & Ind. - 2 Academe - 2 Government - 2 15 International Accounting Standards Council ( IASC) was founded in 1973 as a standard setting body to achieve uniformity in the use of accounting principles around the world. The approved statements of IASC are known as International Accounting Standards ( IAS) IASC was replaced with International Accounting Standards Board ( IASB). Its reporting standards are called International Financial Reporting Standards ( IFRS). IASB has no legal authority to impose the standards it promulgates, but many countries support them.  Definition of Accounting Accounting Standard Council (ASC) defined accounting as : “ It is a service activity. Its function is to provide quantitative information, primarily financial in nature ,about economic entities that is intended to be useful in making economic decision. American Accounting Association (AAA) defined it as : “ It is the process of identifying, measuring and communicating economic information to permit informed judgments and decisions by users of the information.”  Definition of Accounting by the American Institute of Certified Public Accountants ( AICPA): “ It is an art of recording , classfiying,summarizing in a significant manner and in terms of money, transactions, and events which are, in part at least , of a financial character, and interpreting the results thereof.”  Accounting Cycle Accounting cycle refers to the various steps of the accounting process which are being passed -through in a repetitive manner from the start up to the end of every accounting period regardless of some variations in the accounting procedures 9 1 8 2 7 3 6 4 5  Phases of Accounting 1- Recording A phase of Accounting which involves the routine and mechanical process of writing down the business transactions and events in the books of accounts in a chronological manner called Journalizing. a.Identify whether it is a business transaction b. Analyze the dual effect of business transaction. c. Measure the business transaction by assigning monetary values. 2- Classifying The second phase of accounting which involves the sorting or grouping of similar and interrelated transactions and events into their respective kind and classes. This actually the process of transferring the entries from the journal to the ledger called Posting. 3- Summarizing This is the phase of accounting which involves the completion of the financial statements and the accounting requirements as well. This starts from the preparation of trial balance,adjusting entries, closing entries, post –closing trial balance and reversing entries. 4- Interpreting This phase of accounting involves analytical and interpretative work. Financial statements are analyzed interpreted and communicated to those interested parties to help management make sound decision.  Generally Accepted Accounting Principles ( GAAP) What is GAAP? Generally Accepted Accounting Principles (GAAP) are uniform set of accounting rules , procedures, practices and standards that are followed in preparing the financial statements  Requirements for an accounting principle to be generally accepted: a. It must be established by standard –setting body and must gained universal acceptance among practitioners. b. It must have substantial authoritative support from accounting bodies such as SEC,FINEX,BSP, BOA, COA and other respectable members of the financial community both locally and internationally. 1. Cost Principle This principle requires that assets should be recorded at original or acquisition cost. 2. Objectivity Principle This principle requires that accounting records should be based on reliable and verifiable data as evidence of transactions. 3. Materiality Principle This principle dictates practicability to rule over theory in determining the valuation of an item. 4. Matching Principle This is the combined concept of Revenue Recognition and Expense Recognition Principle. Revenue should be recognized when earned and corresponding expense should be recognized when incurred during the same period as revenue is earned. 5. Consistency Principle This principle requires that accounting methods and procedures should be applied on a uniform basis from period to period to achieve comparability 6. Adequate Disclosure Principle This principle requires that financial statements should be free from any material misstatement; that if there is any, proper disclosure should be made.  Basic Accounting Assumptions 1. Accounting Entity This assumes that from the accounting point of view, the business is considered as “ an entity that is separate and distinct from the owner or management. 2. Going Concern or Continuity Concept The business is assumed to have a continuous life of existence. Thus it will continue to operate for an indefinite period of time. 3. Time – Period Assumption or Periodicity Concept Due to the duration of its existence, the life of the business is divided into periods wherein at the end of each period financial statements are prepared. These periods are being referred to as accounting periods. Three annual accounting periods: a. Calendar Year- the accounting period will begin on Jan.1 and will end on Dec.31.  b. Fiscal Year – the accounting period will begin on first day of any month of the year except Jan. and will end on the twelfth month of the year. c. Natural Business year- is a twelve month period that ends on any month when the business is at the lowest or experiencing slack season. 4. Unit of Measure Assumption Peso as a unit of measure is assumed to have a “stable value” which means that the purchasing power of the peso is constant. 5. Accrual Basis Assumption Under the accrual basis, income is recognized when earned regardless of when received and expense is recognized when incurred regardless of when paid.  GROUP ACTIVITY Activity 1 GAAP.docx  Basic Financial Statements Four basic Financial Statements: 1. Balance Sheet- a financial statement which shows the financial position of an enterprise as of a particular date. The Balance Sheet measures and evaluates the following: a. Liquidity – the stability of an enterprise to meet currently maturing obligations b. Solvency- is the ability of the enterprise to meet long term obligations. c. Financial Structure- indicates the source of financing d. Capacity for Adaptation- is the financial flexibility of the enterprise to use the available cash for unexpected requirements and investment opportunities.  SAMPLE BALANCE SHEET FINANCIAL STATEMENTS.xlsx 2. INCOME STATEMENT A financial statement which shows the performance of the enterprise for a given period of time. The income performance used to be known as the “results of operation of the enterprise consisting of revenues, expenses and operating results which would either be profit or loss. FINANCIAL STATEMENTS.xlsx  3. STATEMENT OF CHANGES IN OWNER’S EQUITY A financial statement that summarizes the changes in equity for a given period of time. FINANCIAL STATEMENTS.xlsx  Elements of Financial Statements 1. Assets These are resources controlled by the enterprise as a result of past transactions or events and from which future economic benefits are expected to flow the enterprise. Essential Characteristics of an Asset: a. The asset is controlled by the enterprise b. The asset is a result of a past transaction or event  c. The asset provides future economic benefit d. The cost of the asset can be reliably measured. Types of Assets: a. Current Assets Refers to all assets that are expected to be realized ,sold or consumed within the enterprise ‘s normal operating cycle. Operating Cycle- is the interval of time from the date of acquisition of merchandise, sell the inventory and the ultimate collection of cash from the sale.When the normal operating cycle of the business is not clearly identifiable, it is assumed to be twelve months.  b. Non- Current Assets All other assets not classified as current should be classified as non-current assets. 2. Liabilites Liabilities are present obligations of an 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.  Essential Characteristics of a Liability: a. Liability is the present obligation of a particular enterprise. b. The liability arises from past transactions or events. c. The settlement of the liability requires an outflow of resources embodying economic benefits.  Types of Liability: a. Current Liabilities These are financial obligations of the enterprise which are expected to be settled in the normal course of the operating cycle or due to be settled within one year from the balance sheet date. b. Non-Current Liabilities These are financial long-term obligations of the enterprise which are due and payable for more than one year. 3. Owner’s Equity This is the residual interest in the assets of the enterprise after deducting all its liabilities. It is increased when there is profit or additional contributions by the owner and decreased when there is loss or withdrawal by the owner. 4. Income or Revenue The gross inflow or economic benefits during the period arising in the course of ordinary activities of an enterprise when those inflows result in increase of equity, other than those relating to contributions from owners. 5. Expenses The gross outflow of economic benefits during the period arising in the course of the ordinary activities of an enterprise when those outflow result in decrease in equity.  STEPS OF THE ACCOUNTING PROCESS 1. Journalizing - the first step in the accounting process -recording of transactions and events in the Journal (General Journal and Special Journals) after identifying the business documents supporting the transactions.  STEPS OF THE ACCOUNTING PROCESS 2. Posting -second step in the accounting process -the process of transferring entries from the Journal to the Ledger. The Ledger is the book of final entry and is also called as group of accounts.  STEPS OF THE ACCOUNTING PROCESS 3. Trial Balance -The third step in the accounting process -Trial Balance is a statement listing the debit and credit balances of accounts in the general ledger. Trial balance of Balance is a trial balance that reflects the accounts which remain open at the end of the accounting period.Trial Balance of Totals reflects totals of both debit and credit amount of accounts  STEPS OF THE ACCOUNTING PROCESS 4. Adjusting Entries -5th step in the accounting process - the primary purpose of an adjusting entries is to update the balances of some accounts and to split a mixed account into its real and nominal components. Errors and omissions are also corrected by adjusting entries. - adjusting entries are recorded in the General Journal. -adjustments are grouped into: Accruals, Deferrals ( Pre-collection and Prepayment), provision for uncollectible accounts, provision for depreciation and amortization, and inventory valuation.  STEPS OF THE ACCOUNTING PROCESS 5. Worksheet -5th step in the accounting process -a worksheet is a working paper that facilitates the preparation of financial statements which is actually “optional”. STEPS OF THE ACCOUNTING PROCESS 6. Financial Statements -6th step in the accounting process - There are five(5) basic financial statements: Statement of Financial Position or Balance Sheet Statement of Comprehensive Income or Income Statement Statement of Changes in Owner’s Equity Statement of Cash Flows Notes to Financial Statements STEPS OF THE ACCOUNTING PROCESS 7. Closing Entries -7th step in the accounting process - This is done at the end of the accounting period. -only nominal accounts are closed STEPS OF THE ACCOUNTING PROCESS 8. Post-Closing Trial Balance -8th step in the accounting process - a trial balance showing all real or balance sheet accounts  STEPS OF THE ACCOUNTING PROCESS 9. Reversing Entries -9th step in the accounting process - reversing entries are adjusting journal entries that are prepared at the beginning of the next accounting period - it occurs at the beginning of the second up to the rest of the accounting periods Adjusting entries to be reversed: Accrued Expense Adjustment Accrued Income Adjustment Prepaid Expense Adjustment( if the original entry in recording prepayment uses the Expense Method) Deferred Income Adjustment ( if the original entry in recording deferral uses the Income Method)  Qualities of Financial Statements 1. Understandability Financial statements should be prepared and presented in a way that it can be understood by users. 2. Reliability Financial information should carry the “degree of confidence “ when used by interested parties. To be reliable, it must be free from material error, it must be fairly presented and must be free from bias. Characteristics of a reliable Financial Statements: a. Faithful Presentation- the financial statements should be adequate. b. Neutrality- financial reports should be fairly presented and must be free from bias. c. Conservatism- under this doctrine, when alternatives exist, the alternative which has the least effect on owner’s equity should be chosen. d. Completeness- financial statements is said to be complete if it contains full disclosure of significant information. Financial statements should also contain notes and supplementary schedules and other information. e. Substance over Form-financial statements emphasizes the economic substance of events even though the legal form may differ.  3. Relevance Financial statements are prepared intended to help users make informed economic judgments. Characteristics that describes the relevance of financial statements: a. Materiality- this is dependent on judgment and common sense to focused on: - size of the item in relation to the total of the group to which it belongs. - Size of the company in terms of total sales or capital - Nature of the item b. Predictive Value- the financial information enables the users to forecast and make predictions about the outcome of the future events. c. Feedback Value- the financial information enables users to confirm past predictions or correct earlier predictions. d. Timeliness- the financial information must be available at the time of need or else it will defeat the purpose. 4. Comparability This means that the financial statements prepared are worth comparing for with other companies of the same line of business by pointing out similarities and differences. 5. Consistency Once a method or practice is selected from alternatives, it should be followed from period to period.  Users of Financial Statements 1. Investors 2. Employees 3. Lenders 4. Suppliers and other Trade Creditors 5. Customers 6. Government and their agencies 7. Public  Forms of Business Organizations 1. Sole Proprietorship -The simplest forms of business organization 2. Partnership - The capital of the business is owned or provided by two or more persons called “Partners”.  Forms of Business Organizations 3. Corporation - This is the biggest and the most complicated form of the business organization. - organized by at least five but not more than fifteen persons called “ incorporators”.  Forms of Business Organizations 4. Cooperatives - It operates similar to corporations ,however, while number of voting shares in corporation in based on shareholdings, in a cooperative, it is on a “one-man, one vote” basis.  Classification of Business 1. Service Concern 2. Merchandising 3. Manufacturing 4. Agriculture 5. Hybrid Companies