C1-Accounting-in-General PDF

LEARNING OUTCOMES At the end of the course, the students shall be able to: 1. Clearly understand the principles and concepts of accounting 2. Execute correctly the accounting cycle. 3. Present properly basic financial statements such as Income Statement, Balance Sheet. Statement of Cash...

LEARNING OUTCOMES At the end of the course, the students shall be able to: 1. Clearly understand the principles and concepts of accounting 2. Execute correctly the accounting cycle. 3. Present properly basic financial statements such as Income Statement, Balance Sheet. Statement of Cash Flows and Statement of Changes in Owner’s Equity. 4. Interpret financial data as shown in the Financial Statements. 1 CHAPTER 1: ACCOUNTING IN GENERAL Learning Objectives  Define accounting  Identify Essential elements of the definition of accounting  Define bookkeeping  State the difference between accounting and bookkeeping.  Explain how to derive information using the accounting system.  Understand the accounting cycle.  Identify the users of financial information.  Describe common branches of accounting  Understand forms of business organization  Know the different types of business according to activities 2 What is Accounting? Accounting is the process of identifying, recording, and communicating economic information to permit informed judgments and decisions by users of the information. Its’ key products are the financial statements that indicate financial information about a business entity which is vital to decision makers. Through the financial statements, the user will see the financial performance and position of the business. Essential elements of the definition of accounting Identifying – analyzing business transactions and identifying accountable events to be recorded. Accountable events or economic events are those that affect the assets, liabilities, equity, income and expenses of a business. Recording – includes recording of economic events then classifies the effects on the accounts which is called posting. Account is the basic storage of information in accounting, e.g., cash, accounts receivable, equipment, sales, salary expense, etc. Communicating – summarizing the information processed in the accounting system to produce meaningful reports and are communicated to interested users through financial statements. What is bookkeeping? Bookkeeping is the process of recording financial transactions and keeping financial records. It normally ends with the preparation of the trial balance. Unlike accounting, bookkeeping does not require the interpretation of the significance of the information processed. 3 What is the difference between accounting and bookkeeping? Bookkeeping focuses on business transactions at hat are recurring and so is a subset of the much larger set of tasks that can be encompassed by accounting. It is the beginning stage and acts as a base for accounting whereas accounting begins where bookkeeping ends. Bookkeeping also doesn’t require any special skills as it is mechanical in nature. Accounting on the other side requires special skills due to its analytical and somewhat complex in nature. Some activities under Bookkeeping and Accounting are the following: Bookkeeping  Issuance and recording of sales invoices  Receiving and recording of payments by customers  Making and recording payments to suppliers  Posting journal entries to the ledger  Processing payroll  Processing petty cash transactions  Preparing unadjusted trial balance Accounting  Accruing or deferring expense  Accruing or deferring revenue  Creating the chart of accounts  Setting up the general ledger  Designing the financial statements  Analysis of financial data  Generating a budget and comparing it to actual results Users of Accounting Information 4 Parties Interested in the accounting information are divided into two groups. They are the internal and external users. a. Internal users use management accounting information. They are the managers of the business entity that need accounting information to effectively and efficiently manage the business. b. External users normally use financial accounting information. Some of them are Investors/owners, lenders/creditors, government agencies, employees, general public, customers, suppliers/sellers 1. Investors/Owners – are interested in information because they are concern with the return on their investment. They may also determine whether they should buy, sell or hold shares of stocks. 2. Creditors/lenders – want to know if their clients have the capacity to pay their maturing obligations 3. Government agencies –use financial information for the purpose of imposing tax and regulations. 4. Employees – are interested in financial information because it enables them to assess the ability of the business to provide them job security, better remuneration, job promotion and retirement benefits. 5. General public – are interested in financial information because it will be a source of information about the future of a particular enterprise, for the people looking for job opportunities, etc. 6. Customers - are interested in financial information especially when they have a long-term involvement with, or are dependent on the enterprise. 7. Suppliers/sellers – use accounting information to enable them to determine the capability of enterprise to pay their obligations when due. 5 Figure 1.1 – Flow of Information TRANSACTION DOCUMENT JOURNALIZING POSTING TO THE LEDGERS UNADJUSTED TRIAL BALANCE ADJUSTING ENTRIES ADJUSTED TRIAL BALANCE FINANCIAL STATEMENTS The flow of information as shown above are the following:  Business events or transactions to be recorded are to be identified and analyzed. 6  All business transactions are evidenced or supported by printed forms or documents. These documents provide the information needed in recording the transactions.  Recording of transactions to the journals.  Posting of journal entries to the applicable T-accounts or four column general ledger accounts.  Preparing the Unadjusted trial balance from the general ledger accounts.  Preparing the year-end adjusting entries.  Posting the adjusting entries and preparing the Adjusted Trial Balance.  Preparing Financial Statements using the Adjusted Trial Balance. Four Phases of Accounting: Recording In this phase, all financial transactions are identified and recorded in a systematical and chronological manner in the appropriate books or databases. Classifying This involves sorting and grouping similar items under the designated name, category or account Summarizing This involves summarizing the data after each accounting period, such as a month, quarter or year. The data must be presented in a manner which is easy to understand and use by both external and internal users of the financial statements. Interpreting This is concerned with analyzing of the financial statements. This function interprets the recorded data in a manner which allows end-users to make meaningful judgments regarding the results of operations and financial conditions of a business. 7 Accounting Cycle It is a set of steps or procedures that are repeated in the same order every period. It is used to record transactions and prepare financial statements. Figure 1.2 Transaction Reversing Documentation Entries Post-closing Journalizing Trial Balance Closing Posting to Entries the Ledger Financial Unadjusted Statement Trial Balance Adjusted Adjusting Trial Balance Entries Accounting Cycle:  Transaction  Documentation 8   Journalizing  Posting to the Ledger  Preparing an Unadjusted Trial balance  Adjustment/adjusting entries  Preparing an Adjusted Trial Balance  Financial statements (balance sheet, income statement and cash flow statement)  Closing entries  Preparing a Post-costing trial balance  Reversing entries Common branches of accounting 1. Financial Accounting - is the branch of accounting that focuses on general purpose financial statements that cater to the common needs of a wide range of external users. Financial accounting is governed by the Philippine Financial Reporting Standards (PFRSs). 2. Managerial or Management Accounting - focuses on providing information for use by internal users, the management. This branch deals with the needs of the management rather than strict compliance with generally accepted accounting principles. Managerial accounting involves financial analysis, budgeting and forecasting, cost analysis, evaluation of business decisions, and similar areas. 3. Cost Accounting – is sometimes considered as a subset of management accounting, cost accounting refers to the recording, presentation, and analysis of manufacturing costs. Cost accounting is very useful in manufacturing businesses since they have the most complicated costing process. 9 Cost accountants also analyze actual and standard costs to help managers determine future courses of action regarding the company's operations. 4. Auditing – involves the inspection of an entity’s financial statements or business processes to ascertain their correspondence with an established criteria. 5. Tax Accounting - helps clients follow rules set by tax authorities. It includes tax planning and preparation of tax returns. It also involves determination of income tax and other taxes, tax advisory services such as ways to minimize taxes legally, evaluation of the consequences of tax decisions, and other tax-related matters. 6. Accounting Education – refers to teaching accounting and accounting-related subjects in an organized learning environment. It is a process of facilitating the acquisition of knowledge and skills regarding on or more of the other branches of accounting. 7. Government Accounting – refers to the accounting for the government and its instrumentalities, focusing attention on the custody of public funds, the purpose or purposes to which those funds are committed, and the responsibility and accountability of the individuals entrusted with those funds. Forms of business organization A business is an activity where goods and services are exchanged for money. A person who is engaged in business is called entrepreneur or businessman. In Philippines, businesses are formed in one of the following: 1. Sole or single proprietorship – is the most common form of business organization. It's easy to form and offers complete control to the owner. But 10  the business owner is also personally liable for all financial obligations and debts of the business. A sole proprietorship is registered with the Department of Trade and Industry (DTI). 2. Partnership - is the relationship existing between two or more persons who join to carry on a trade or business. Each person contributes money, property, labor or skill, and expects to share in the profits and losses of the business. The business owners are called partners. Each partner reports his share of the partnership net profit or loss on his personal tax return. A partnership is registered with Securities and Exchange Commission (SEC). 3. Corporation is a juridical entity established under the Corporation Code and registered with the SEC. It must be created by or composed of at least 5 natural persons (up to a maximum of 15), technically called “incorporators.” Juridical persons, like other corporations or partnerships, cannot be incorporators, although they may subsequently purchase shares and become corporate shareholders/stockholders. The liability of the shareholders of a corporation is limited to the amount of their capital contribution. In other words, personal assets of stockholders cannot generally be attached to satisfy the corporation’s liabilities, although the responsible members may be held personally liable in certain cases. A corporation, however, is relatively more difficult to create, organize and manage. There are more reportorial requirements with the SEC. Unless you own sufficient number of shares to control the corporation, you’ll most likely 11  be left with no participation in the management. The impact of these concerns, however, is minimized by the army of lawyers, accountants and consultants that assist the corporation’s management. Different types of business according to activities There are three major types of businesses:  Service Business A service type of business provides intangible products (products with no physical form). Service type firms offer professional skills, expertise, advice, and other similar products. Examples of service businesses are: salons, repair shops, schools, banks, accounting firms, and law firms.  Merchandising Business This type of business buys products at wholesale price and sells the same at retail price. They are known as "buy and sell" businesses. They make profit by selling the products at prices higher than their purchase costs. A merchandising business sells a product without changing its form. Examples are: grocery stores, convenience stores, distributors, and other resellers.  Manufacturing Business Unlike a merchandising business, a manufacturing business buys products with the intention of using them as materials in making a new product. Thus, there is a transformation of the products purchased. 12 A manufacturing business combines raw materials, labor, and factory overhead in its production process. The manufactured goods will then be sold to customers. Hybrid Business Hybrid businesses are companies that may be classified in more than one type of business. A restaurant, for example, combines ingredients in making a fine meal (manufacturing), sells a cold bottle of wine (merchandising), and fills customer orders (service). Nonetheless, these companies may be classified according to their major business interest. In that case, restaurants are more of the service type – they provide dining services. 13  REVIEW QUESTIONS TRUE OR FALSE. Write TRUE if the statement is correct and FALSE if the statement is incorrect on the space provided. ______1. A business is considered as an entity separate and distinct from the personality of the owners. ______2. Accounting is necessary only in recording the transactions but not to communicate ideas or events affecting the business. ______3. The corporation is the simplest form of business organization. ______4. Management Advisory Services involves the giving of business advice to management like forecasting, financial planning, and system installation. ______5. Under the accounting entity concept, the personal expenses of the owner are recorded as expenses of the business regardless of payment. ______6. An internal auditor is an employee of a company. ______7. Cost accounting is primarily concerned with the preparation of a company’s financial statements. ______8. A sale is an economic event or condition that directly changes an entity’s financial condition or directly affects its results of operations. ______9. A stakeholder is a person or entity who has interest in the economic performance of a business. ______10. The unit of measurement used in the financial statements is the currency used in the country where the principal place of business is located. ______11. A company must only be involved in one type of business operation. Violation of such, is contrary to law. ______12. The time period assumption is essential so there can be comparability of the financial reports. ______13. The time period concept assumes that the business is always divided into twelve months. ______14. Success is possible in a business entity if they use money, machines, men and materials efficiently at the less possible cost. 14 ______15. A local “sari-sari” store is an example of a manufacturing type of business. ______16. A sole proprietorship is advantageous profit-wise, since he has the absolute right over the profits of the business. ______17. One disadvantage of a corporation is that when the business suffers heavy losses, the corporation’s creditors may go after the personal assets of its investors. MULTIPLE CHOICE. Encircle the letter of the correct answer. 1. Which of the following statements regarding accounting is incorrect? a. All business transactions and events are recorded in the accounting books. b. Although bookkeeping and accounting are interrelated, they are not the same. c. The purpose of accounting is to provide information that is useful in making economic decisions. d. A transaction or event is recorded in the accounting records only if it has an effect on the assets, liabilities, equity, income or expenses of the business. 2. Which of the following is not one of the necessary processes performed in accounting in order to provide information that is useful to interested users? a. Identifying b. Summarizing c. Recording d. Counting 3. Accounting is described in various ways. Which of the following is not one of those descriptions? a. Accounting is a process and a service activity. b. Accounting is a social science and a practical art. c. Accounting is the “language of business” because it is fundamental to the communication of financial information. 15  d. Accounting is the art of professionally stealing money and other evil purposes. 4. The main purpose of accounting is a. to account for money so it will not be lost. b. to provide information that is useful in making economic decisions. c. to safeguard the assets of a company. d. to provide a clear view of the state of the industry’s economy. 5. In accounting, the term “recording” is also called a. journalizing. b. communicating. c. debiting. d. videoing. 6. This process refers to the reporting of the information processed in the accounting system to interested users. a. Measuring b. Identifying c. Communicating d. Classifying 7. Which of the following statements is correct? a. Financial accounting is the branch of accounting that deals with the specific needs of an entity’s management. b. The internal users of accounting information include management, owners and creditors. c. The external users of accounting information include potential and existing investors and lenders and other creditors. d. Government accounting is the branch of accounting that deals with the analysis of the costs of products and services. 8. Which of the following statements is incorrect? a. Erroneous financial statements can lead to bad financial decisions. b. Internal users of financial information refer to the entity’s management personnel. 16  c. Tax accounting refers to the branch of accounting that deals with tax computations, filing of tax returns, and tax planning. d. Accounting education is the branch of accounting that deals with the teaching of accounting and related subjects in order to produce competent and responsible business professionals. 9. The most common form of business organization is a. corporation. b. sole proprietorship. c. partnership. d. cell phone stand. 10. This branch of accounting focuses on catering to the information needs of external users. a. Management accounting b. Financial accounting c. Auditing d. External accounting 11. These users need accounting information in order to regulate businesses that are within the scope of their legal authority. a. Employees b. Creditors c. Auditors d. Government regulatory bodies or agencies 12. These users need accounting information in evaluating the stability of the business in so far as their job security, future remuneration, and career growth and opportunities are concerned. a. Employees b. Creditors c. Auditors d. Regulatory authorities 17 13. The following are decisions made by external users except a. whether to hold or sell investments in stocks. b. whether or not to extend a loan to the business. c. whether to sell goods on credit to the business. d. whether to obtain additional capital from outside creditors or to generate it internally. 14. Which of the following users of financial information is not considered a creditor of the business? a. A loan provider, such as a bank b. A supplier that sells goods to the entity on credit c. A customer that buys goods from the entity on credit d. A financing company that provides the entity with machineries on a “rent- to-own” basis 15. It is the branch of accounting that involves the careful analysis of economic events and other variables to understand their impact on decisions. a. Accounting education b. Cost accounting c. Accounting research d. Tax accounting 16. It is the process of objectively evaluating evidence and expressing an opinion regarding the correspondence between management’s assertions and established criteria. a. Accounting education b. Auditing c. Accounting research d. Tax accounting 18 17. You own a business. Your business is engaged in buying goods at a wholesale price and reselling them at retail prices on Facebook. Your business is a a. service business. b. manufacturing business. c. merchandising business. d. monkey business. 18. An advantage of a sole proprietorship over the other forms of a business organization is a. you are the only boss and you keep all the profits. b. although it is easier to form, it may be more difficult to raise financing. c. it has unlimited life. d. it has limited liability. 19. Which of the following is not an advantage of a partnership over the other forms of business organization? a. Compared to a sole proprietorship, risks are spread out over more than one owner. b. Compared to a cooperative, the business organization is driven more towards the earning of profit. c. Compared to a corporation, it is easier to form because of fewer legal requirements. d. Compared to a corporation, it has an unlimited life and an unlimited liability. 19 DISCUSSION 1. Explain in your own words the distinctions between accounting and bookkeeping. ___________________________________________________________________ ___________________________________________________________________ ___________________________________________________________________ ___________________________________________________________________ ___________________________________________________________________ ___________________________________________________________________ ___________________________________________________________________ 2. Discuss how each of the forms of business organizations is different from the other. ___________________________________________________________________ ___________________________________________________________________ ___________________________________________________________________ ___________________________________________________________________ ___________________________________________________________________ ___________________________________________________________________ ___________________________________________________________________ ___________________________________________________________________ 3. Enumerate the types of business according to activities. Describe and give two examples of each type of business (do not use any examples given in the chapter). ___________________________________________________________________ ___________________________________________________________________ ___________________________________________________________________ ___________________________________________________________________ ___________________________________________________________________ ___________________________________________________________________ 20 ___________________________________________________________________ ___________________________________________________________________ In Ong’s (2014) presentation, the following were discussed: Fundamental Concepts 1. Entity Concept regards the business enterprise as separate and distinct from its owners and from other business enterprises. Ex. Mr. Santos has a car repair shop and a barber shop. The car repair shop is considered as a separate entity distinct from the barber shop and the owner, Mr. Santos. The expenses of the car repair shop should not be mixed with the expenses of the barber shop and the personal expenses of Mr. Santos. The two businesses are considered to be separate economic units, separate and distinct from their owner. As such, these should be treated as different from each other, although owned and operated by only one person. Hence, the personal expenses of Mr. Santos should not be mixed with the expenses of any business. 2. Periodicity is the concept behind providing financial accounting information about the economic activities of an enterprise for specified time periods. For reporting purposes, one year is usually considered as one accounting period. Ex. Separate financial reports are prepared yearly for the car repair shop and the barber shop of Mr. Santos. Hence, Mr. Santos can measure the income of the two businesses annually. An accounting period may be classified as either of the following: a. Calendar year – a twelve-month period that starts on January 1 and ends on December 31. 21  b. Fiscal year – a twelve-month period that starts on any month of the year other than January and ends twelve months after the start period. (e.g. A business whose fiscal year starts June 1, 2014 ends its fiscal year on May 31, 2015. This is still a twelve- month period although it does not start in January and end in December). A natural business year is any twelve-month period that ends when business activities are at their lowest point. 3. Going concern is a concept which assumes that the business enterprise will continue to operate indefinitely. Ex. In preparing the statements of the car repair shop and the barber shop, the accountant assumes that the business will not close or shut operations within the next years. Basic Principles 1. Objectivity Principle states that all business transactions that will entered in the accounting records must be duly supported by verifiable evidence. Ex. Payments must be supported by official receipts, and bank deposits must be supported by deposit slips. 2. Historical cost means that all properties and services acquired by the business must be recorded at its original acquisition cost. Ex. Land bought in 1990 for one million pesos should be recorded at one million pesos even though its market value in the year 2014 is already two million pesos. 22 3. Accrual Principle states that income should be recognized at the time it is earned such as when goods are delivered or when services have rendered. Likewise, expenses should be recognized at the time they are incurred such as when goods and services are actually used and not at the time when the entity pays for those goods and services. Ex. A hotel cannot consider as income the advance payment of a customer who paid the hotel in advance for one month accommodation until the customer has checked in. This is because the hotel has not yet rendered the services to the customer. As such, the advance payment by the customer should be considered as a liability on the part of the hotel in the form of services rendered. 4. Adequate Disclosure states that all material facts that will significantly affect the financial statements must be indicated. Ex. Land bought at one million pesos in 1998 should be recorded at historical cost in 2014 financial statements. However, the current market value of two million pesos in the year 2014 may be indicated in the financial statements for the year 2014 in the form of a footnote or parenthetical note. 5. Materiality means that financial reporting is only concerned with information significant enough to affect decisions. This refers to the relative importance of an item or event. An item is considered significant if knowledge of it would influence prudent users of the financial statements. Ex. Items of insignificant amount such as paper clips can be charged outright to expenses. 23  6. Consistency means that approaches used in reporting must be uniformly employed from period to period to allow comparison of results between time periods. Any changes must be clearly explained. Ex. If the straight line method of depreciation is being used by the company, then the method should be uniformly used by the company in computing its annual depreciation. Exercise 1 Write the letter of the correct answer on the blank. ____1. All business transactions that will be entered in the accounting records must be fully supported by verifiable evidence. ____2. Revenue is recognized when actually earned. ____3. All properties and services acquired by the business must be recorded at its original cost. ____4. Expense is recognized when actually incurred or used. ____5. All material facts that will significantly affect the financial statements must be indicated. ____6. Approaches used in reporting must be consistently employed from period to period. ____7. Financial reporting is concerned with significant information enough to affect evaluation and decisions. A. Historical Cost B. Objectivity C. Conservatism (Prudence) D. Accrual Principle E. Full Disclosure F. Consistency G. Materiality 24 Exercise 2 Write the letter of the correct answer on the blank. ____1. The business organization is separate and distinct from its owners. ____2. Financial accounting provides information about the activities of an economic enterprise for specified time periods. ____3. Assumes that business has the ability to operate indefinitely. A. Entity B. Periodicity C. Going concern 25