ACCO 20203 Accounting Instructional Material PDF

ACCOUNTING 1 INSTRUCTIONAL MATERIAL FOR ACCO 20203 ACCOUNTING Compiled by: MELINDA S. BALBARINO LEONARDO COQUILLA MARIA TERESA M. CORRALES...

ACCOUNTING 1 INSTRUCTIONAL MATERIAL FOR ACCO 20203 ACCOUNTING Compiled by: MELINDA S. BALBARINO LEONARDO COQUILLA MARIA TERESA M. CORRALES MARIETTA M. DOQUENIA JULIETA G. FONTE FRANCIA PEÑAFLOR EDITHA A. PERALTA ANDREA ROSE E. RIMORIN CATHERINE D. SOTTO 2020 2 ACCOUNTING GENERAL INFORMATION ABOUT THE COURSE Course Code and Title : ACCO 20203 – ACCOUNTING Course Credit : 3 Units Pre-Requisite : None Course Description : This course provides an introduction to accounting, within the context of business and business decisions. Students obtain basic understanding of the principles and concepts of accounting as well as their applicability and relevance in the national context and learn how to use various types of accounting information found in financial statements and annual reports. Emphasis is placed on understanding the reasons underlying basic accounting concepts and providing students with an adequate background on the recording, classification, and summarization functions of accounting to enable them to appreciate the varied uses of accounting data of a sole-proprietorship for service type of business. Course Outcomes : Upon completion of the course, the students will be able to: a. Have detailed knowledge and understanding of the accounting process of a Single Proprietorship for service business b. Produce the required entries and financial records of a Single Proprietorship c. Competence and honesty in the performance of accountancy service d. Demonstrate the qualities of a future accountant e. Skilled in the use of a calculator, computer and other business equipment  ACCOUNTING 3 GENERAL INSTRUCTIONS FOR STUDENTS This instructional material is composed of five (5) modules that will introduce you to the world of accounting and its reporting. Faculty members who prepared this instructional material purposively chose only five (5) topics which are the most relevant topics when learning about accounting. FOR STUDENTS WITH INTERNET CONNECTIVITY, you are tasked to answer the activities or performance tasks in accordance with the instruction of your instructor. FOR STUDENTS WHO DO NOT HAVE INTERNET CONNECTIVITY AND RECEIVED THIS INSTRUCTIONAL MATERIAL VIA COURIER SERVICES, you are tasked to accomplish the activities or performance tasks at your own space. If the sheets provided are not enough, use another sheet of paper for your answers. You may have your answers handwritten OR computerized and printed. House Rules The following guides and house rules will help you further to be on track and to say at the end of the module, ―Yes! I conquered Accounting!‖. 1. Schedule and manage your time to read and understand every part of the of the module. Peruse it over until you decipher the undertakings. 2. Study how you can manage to do the activities of the course in consideration of your modules from other courses. Be very conscious with the study schedule. Post it on a conspicuous place so that you can always see. Do not ask you your course facilitator about questions that are already answered in the guide. 3. Do not procrastinate. Remember, it is not others who will be short- changed if you will do your work on time. 4. Before you start doing your tasks, read and understand the assessment tools provided. Do not settle with the low standards, target the highest standards in doing your assigned tasks. I know that you can! :) 5. You are free to browse and read the different materials even prior to doing the tasks in each until the module. However, you need to ensure that you will not miss any part of the module and you will submit course activities in the prescribed due date. 4 ACCOUNTING Table of Contents Topic Pages Module 1 – Introduction to Accounting..................................................................... 5 – 29 Module 2 – The Accounting Equation And Analyzing Business Transactions........... 30 – 41 Module 3 – Recording and Posting the Business Transactions........... 42 – 66 Module 4 – Adjusting Entries..................................... 67 – 84 Module 5 – Completion of the Accounting Process................................................. 85 – 107 Long Examination 108 -111  ACCOUNTING 5 Module I INTRODUCTION TO ACCOUNTING Overview: Accounting is one of the key functions for almost any business. It may be handled by a bookkeeper or an accountant at a small firm, or by sizable finance departments with dozens of employees at larger companies. A bookkeeper can handle basic accounting needs, but a Certified Public Accountant (CPA) should be utilized for larger or more advanced accounting tasks. The reports generated by various streams of accounting, such as cost accounting and managerial accounting, are invaluable in helping management make informed business decisions. Regardless of the size of a business, accounting is a necessary function for decision making, cost planning, and measurement of economic performance measurement. It is therefore important to know and understand the definition of accounting and its branches, its history, principles and standards. Learning Objectives: 1. The learner should be able to know the history of accounting, its origin and the people who first use the system and how the system evolved into its present condition. 2. The Learners should be able to define Accounting and understand every word used in its definition and relate these words with the ultimate purpose or purposes of accounting information system and to identify the primary uses of the financial information. 3. The learner should understand the basic principles in accounting to be able to understand how the system works and how the information should be recorded and presented in the financial reports. 4. The learner should be able to understand the different types of business and the different forms of business organization and should be able to identify each and distinguish it from the others. 5. The learner should be able to understand the basic accounting equation and all the elements in it as well as the account titles that would be used in recording the transactions. History of Accounting The first name that might come to mind when referencing early accounting history is Fra Luca Bartolomeo de Pacioli , an Italian mathematician, Franciscan friar, collaborator with Leonardo da Vinci, who described double-entry bookkeeping in his ―Summa de Arithmetica, Geometria, Proportioni et Proportionalita‖ in 1494. While that may sound like a long time ago, accounting may have roots that trace back even earlier. Accounting has been around for centuries. It’s a critical part of the business, record-keeping, and life in general. The earliest accounting records were found over 7,000 years ago among the ruins of Ancient Mesopotamia. At the time, people relied on accounting to keep a record of crop and herd growth. They used accounting techniques that are still used today to determine if there was a surplus or shortage after crops were harvested each season. The first record of accounting 6 ACCOUNTING that occurred thousands of years ago in Mesopotamia has evolved into the intricate element of business and life that it is today. Accounting History During the Roman Empire During the reign of the Roman Empire, accounting continued to evolve much further. ―The Deeds of the Divine Augustus‖ is an account of Emperor Augustus’ financial dealings. It listed such quantities as distributions to the people, grants of land, building of temples, money to military veterans, religious offerings, and money spent on theatrical shows and gladiator events. This discovery hints at the scope of accounting information available to the emperor, which he then probably used for planning and decision-making purposes. Roman historians also recorded public revenues, the amount of money in the state treasury, taxes, slaves, freedmen, and more. Fra. Luca Pacioli’s Contribution to the Accounting Profession In 1494, Pacioli wrote Summa de Arithmetica, Geometria, Proportioni et Proportionalita, which included a twenty-seven-page treatise on bookkeeping titled, Particularis de Computis et Scripturis (Details of Calculation and Recording) on the subjects of record keeping and double- entry accounting. Pacioli’s book became the reference text and teaching tool on the subjects of bookkeeping and accounting for the next several hundred years. This was the first time that symbols for plus and minus appeared in a printed book. This book was the first known published work on the topic of double-entry bookkeeping. Accounting During the Middle Ages During the Middle Ages, bartering was the primary form of money-changing, but when Europe changed to a monetary economy is the 13th Century, merchants began relying on bookkeeping to keep a record of multiple transactions. This is when double-entry bookkeeping got its start, which is when a debit and credit value is entered for each transaction by the accountant. Merchants at the time used accounting as a new recording system. It provided them with constant information about their businesses that they could use in decision-making to grow their business as they saw fit. This laid the foundation of how we use and understand accounting today. Accounting Systems in Today’s Generation Nowadays, there are accounting standards, auditing regulations, and ethical standards for accountants to follow. Along with this standard is the advancement in technology and accounting has gone through many changes throughout the ages. Through all the changes, accounting technology has always played a part in making the accountant’s job just a little easier. As people’s knowledge of technology increased so has the accountant’s ability to analyze statistical values. Technology advancements have enhanced the accountant’s ability to interpret data efficiently and effectively. He/she now has the ability to interpret the language of business with such ease that the accountant has become a business’ most trusted business advisor. Accountants were pushed towards acquiring new skills due to the advancements that information technology has made on the accounting industry. Accountants now have to have a high level of computer and technical skills. These skills have become part of the knowledge, and abilities of the accounting professionals. In its report the American Institute of Certified Public Accounts (AICPA) cites that, ―The knowledge, skills and abilities necessary for the entry-level accountant now include the application and integration of information technology into the  ACCOUNTING 7 accounting process, as well as financial and managerial accounting principles‖ (Dillon, Kruck, 2004). From this research, not only does an accountant need to have a broad range of accounting knowledge and a strong ability to apply accounting principles, government regulations and interpret tax laws; they must also have strong skills in information technology, to be able to merge accounting with information systems. These accountants will be in greater demand by the profession (Dillon, et al, 2004). Definition of Accounting What Is Accounting? Accounting is the process of recording financial transactions pertaining to a business. The accounting process includes analyzing, recording, summarizing, financial transactions or events over an accounting period, and reporting these transactions in the form of financial statements (Income Statement, Balance Sheet, Capital Statement and Statement of Cash Flows) to government’s regulatory, and tax collecting agencies. In simple explanation, Accounting is how the business records, organizes, and understands its financial information. Accounting can be thought of as a big machine where raw financial information are put into, such as records of all business transactions, taxes, estimates and allowance, etc., that then spits out an easy to understand reports or statements about the financial state of the business. These financial statements tell its reader whether the business is making a profit or not, where the cash came from and where it was put, what the current amount of the assets and liabilities of the business and how much remained as capital of the business owner or owners. Technical definitions of accounting have been published by different accounting bodies. The American Institute of Certified Public Accountants (AICPA) defines accounting as: "the art of recording, classifying, and summarizing in a significant manner and in terms of money, transactions and events which are, in part at least of financial character, and interpreting the results thereof." The American Accounting Association on the other hand defines accounting as ―the process of identifying, measuring and communicating economic information to permit informed judgment and decision by users of the information‖. According to the Accounting Standards Council, ―accounting 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 decisions, in making reasoned choices among alternative courses of action.‖ Branches of Accounting As a result of economic, industrial, and technological developments, different specialized fields in accounting have emerged. The most commonly known branches or types of accounting include: financial accounting, cost accounting, auditing, managerial accounting, AIS ,taxation, forensic, and fiduciary accounting. 1. Financial Accounting- Financial accounting involves recording and categorizing transactions for business. This data is generally historical, meaning it’s from the past. It also involves generating financial statements based on these transactions. All financial 8 ACCOUNTING statements, such a balance sheet and income statement, must be prepared according to the generally accepting accounting principles (GAAP). Financial accounting is performed to conform to external regulations and requirements. 2. Cost Accounting - Cost accounting is considered a type of managerial accounting. Cost accounting is most commonly used in the manufacturing industry, an industry that has a lot of resources and costs to manage. It is a type of accounting used internally to assess a company’s operations. Cost accounting concerns itself with recording and analyzing manufacturing costs. It looks at a company’s fixed (unchanging and constant costs, like rent) and variable costs (changing costs, like shipping charges) and how they affect a business and how these costs can be better managed, according to Accounting Tools. 3. Auditing - There are two types of auditing: external and internal auditing. In external auditing, an independent third party reviews a company’s financial statements to make sure they are presented correctly and comply with GAAP and IFRS. Internal auditing involves evaluating how a business divides up accounting duties, who is authorized to do what accounting task and what procedures and policies are in place. Internal auditing helps a business to zero in fraud, mismanagement and waste or identify and control any potential weaknesses in its policies or procedures. 4. Managerial Accounting -Also known as management accounting, this type of accounting provides data about a company’s operations to managers. The focus of managerial accounting is to provide data that managers need to make decisions about a business’s operations, not comply strictly with GAAP. Managerial accounting includes budgeting and forecasting, cost analysis, financial analysis, reviewing past business decisions and more. Cost accounting is a type of managerial accounting. 5. 5. Accounting Information Systems - Known as AIS for short, accounting information systems concerns itself with everything to do with accounting systems and processes and their construction, installation, application and observation. This can include accounting software management and the management of bookkeeping and accounting employees. 6. 6. Tax Accounting- Tax accounting involves planning for tax diminution, payment scheme and the preparation of tax returns. This branch of accounting helps businesses to comply with regulations of the Philippine Taxing Authorities, more particularly the Local Government Units for the Mayor’s Permits, BIR for the Internal Taxes and Bureau of Customs for taxes on importation and exportation. Tax accounting also helps businesses figure out their income tax and other taxes and how to legally reduce their amount of tax owing. Tax accounting also analyzes tax-related business decisions and any other issues related to taxes. 7. Forensic Accounting -This specialized accounting service is trending in accounting and is becoming increasingly popular. Forensic accounting focuses on legal affairs such as inquiry into fraud, legal cases and dispute and claims resolution. Forensic accountants need to reconstruct financial data when the records are incomplete. This could be to decode fraudulent data or convert a cash accounting system to accrual accounting. Forensic accountants are usually consultants who work on a project basis. 8. 8. Fiduciary Accounting - This branch of accounting centers around the management of property for another person or business. The fiduciary accountant manages any account  ACCOUNTING 9 and activities related to the administration and guardianship of property. Fiduciary accounting covers estate accounting, trust accounting and receivership (the appointing of a custodian of a business’s assets during events such as bankruptcy). Purposes and Uses of Accounting Information The purpose of accounting is to accumulate and report on financial information about the performance, financial position, and cash flows of a business. Accounting provides people interested in the business or company with various pieces of information regarding business operations, this information is then used to reach decisions about how to manage the business, or invest in it, or lend money to it. Uses of Accounting Information 1. A common use of accounting information is measuring the performance of various business operations. While financial statements are the classic accounting information tool used to assess business operations, business owners may conduct a more thorough analysis of this information when reviewing business operations. Financial ratios use the accounting information reported on financial statements and break it down into leading indicators. These indicators can be compared to other companies in the business environment or an industry standard. This helps business owners understand how well their companies operate compared to other established businesses. 2. Business owners often use accounting information to create budgets for their companies. Historical financial accounting information provides business owners with a detailed analysis of how their companies have spent money on certain business functions. Business owners often take this accounting information and develop future budgets to ensure they have a financial road map for their businesses. These budgets can also be adjusted based on current accounting information to ensure a business owner does not restrict spending on critical economic resources. 3. Accounting information is commonly used to make business decisions. For financial management, an income statement and accounting of expenses provides an important overview of the business. Decisions may include expanding current operations, using different economic resources, purchasing new equipment or facilities, estimating future sales or reviewing new business opportunities. 4. Accounting information usually provides business owners information about the cost of various resources or business operations. These costs can be compared to the potential income of new opportunities during the financial analysis process. This process helps business owners understand how current business operations will be affected when expanding or growing their businesses. Opportunities with low income potential and high costs are often rejected by business owners. 5. External business stakeholders often use accounting information to make investment decisions. Banks, lenders, venture capitalists or private investors often review a company's accounting information to review its financial health and operational 10 ACCOUNTING profitability. This provides information about whether or not a small business is a wise investment decision. Many small businesses need external financing to start up or grow. The inability to provide outside lenders or investors with accounting information can severely limit financing opportunities for a small business. ACCOUNTING PRINCIPLES The phrase "generally accepted accounting principles" (or "GAAP") consists of three important sets of rules: (1) the basic accounting principles and guidelines, (2) the detailed rules and standards issued by FASB and its predecessor the Accounting Principles Board (APB), and (3) the generally accepted industry practices. If a company distributes its financial statements to the public, it is required to follow generally accepted accounting principles in the preparation of those statements. Further, if a company's stock is publicly traded, Philippine law requires the company's financial statements be audited by independent public accountants. Both the company's management and the independent accountants must certify that the financial statements and the related notes to the financial statements have been prepared in accordance with GAAP. Since GAAP is founded on the basic accounting principles and guidelines, we can better understand GAAP if we understand those accounting principles. The following is a list of the ten main accounting principles and guidelines with a highly condensed explanation of each. 1. Economic Entity Assumption The accountant keeps all of the business transactions of a sole proprietorship separate from the business owner's personal transactions. For legal purposes, a sole proprietorship and its owner are considered to be one entity, but for accounting purposes they are considered to be two separate entities. 2. Monetary Unit Assumption In the Philippines economic activity is measured in Philippine pesos, and only transactions that can be expressed in Philippine pesos are recorded. Because of this basic accounting principle, it is assumed that the peso's purchasing power has not changed over time. As a result, accountants ignore the effect of inflation on recorded amounts. For example, pesos from a 1960 transaction are combined (or shown) with pesos from a 2019 transaction. 3. Time Period Assumption This accounting principle assumes that it is possible to report the complex and ongoing activities of a business in relatively short, distinct time intervals such as the five months ended May 31, 2019, or the 5 weeks ended May 1, 2019. The shorter the time interval, the more likely the need for the accountant to estimate amounts relevant to that period. For example, the property tax bill is received on December 15 of each year. On the income statement for the year ended December 31, 2018, the amount is known; but for the income statement for the three months ended March 31, 2019, the amount was not known and an estimate had to be used.  ACCOUNTING 11 It is imperative that the time interval (or period of time) be shown in the heading of each income statement, statement of owner’s/stockholders' equity, and statement of cash flows. Labeling one of these financial statements with "December 31" is not good enough–the reader needs to know if the statement covers the one week ended December 31, 2019 the month ended December 31, 2019 the three months ended December 31, 2019 or the year ended December 31, 2019 4. Cost Principle From an accountant's point of view, the term "cost" refers to the amount spent (cash or the cash equivalent) when an item was originally obtained, whether that purchase happened last year or thirty years ago. For this reason, the amounts shown on financial statements are referred to as historical cost amounts. Because of this accounting principle asset amounts are not adjusted upward for inflation. In fact, as a general rule, asset amounts are not adjusted to reflect any type of increase in value. Hence, an asset amount does not reflect the amount of money a company would receive if it were to sell the asset at today's market value. (An exception is certain investments in stocks and bonds that are actively traded on a stock exchange.) If you want to know the current value of a company's long-term assets, you will not get this information from a company's financial statements–you need to look elsewhere, perhaps to a third-party appraiser. 5. Full Disclosure Principle If certain information is important to an investor or lender using the financial statements, that information should be disclosed within the statement or in the notes to the statement. It is because of this basic accounting principle that numerous pages of "footnotes" are often attached to financial statements. For example, the company is named in a lawsuit that demands a significant amount of money. When the financial statements are prepared it is not clear whether the company will be able to defend itself or whether it might lose the case. As a result of these conditions and because of the full disclosure principle the lawsuit will be described in the notes to the financial statements. In compliance with this full disclosure principle, a business usually lists its significant accounting policies as the first note to its financial statements. 6. Going Concern Principle This accounting principle assumes that a business will continue to exist long enough to carry out its objectives and commitments and will not liquidate in the foreseeable future. If the business' financial situation is such that the accountant believes that it will not be able to continue on, the accountant is required to disclose this assessment. The going concern principle allows the business to defer some of its prepaid expenses until future accounting periods. 12 ACCOUNTING 7. Matching Principle This accounting principle requires companies to use the accrual basis of accounting. The matching principle requires that expenses be matched with revenues. For example, sales commissions expense should be reported in the period when the sales were made (and not reported in the period when the commissions were paid). Wages to employees are reported as an expense in the week when the employees worked and not in the week when the employees are paid. If a company agrees to give its employees 1% of its 2019 revenues as a bonus on January 15, 2020, the company should report the bonus as an expense in 2019 and the amount unpaid at December 31, 2019 as a liability. The expense is recorded as the sales or revenue are recorded. 8. Revenue Recognition Principle Under the accrual basis of accounting (as opposed to the cash basis of accounting), revenues are recognized as soon as a product has been sold or a service has been performed, regardless of when the money is actually received. Under this basic accounting principle, a company could earn and report P1,000,000 of revenue in its first month of operation but receive P0 in actual cash in that month. For example, if ABC Company completes its service at an agreed price of P50,000, ABC should recognize P50,000 of revenue as soon as its work is done—it does not matter whether the client pays the P50,000 immediately or in 30 days. Do not confuse revenue with a cash receipt. 9. Materiality Because of this basic accounting principle or guideline, an accountant might be allowed to violate another accounting principle if an amount is insignificant. Professional judgement is needed to decide whether an amount is insignificant or immaterial. An example of an obviously immaterial item is the purchase of a 7,500 printer by a highly profitable multi-million-peso company. Because the printer will be used for five years, the matching principle directs the accountant to expense the cost over the five-year period. The materiality guideline allows this company to violate the matching principle and to expense the entire cost of 7,500 in the year it is purchased. The justification is that no one would consider it misleading if 7,500 is expensed in the first year instead of 1,500 being expensed in each of the five years that it is used. Because of materiality, financial statements usually show amounts rounded to the nearest hundred, to the nearest thousand, or to the nearest million pesos depending on the size of the company. 10. Conservatism If a situation arises where there are two acceptable alternatives for reporting an item, conservatism directs the accountant to choose the alternative that will result in less net income and/or less asset amount. Conservatism helps the accountant to "break a tie." It does not direct accountants to be conservative. Accountants are expected to be unbiased and objective.  ACCOUNTING 13 The basic accounting principle of conservatism leads accountants to anticipate or disclose losses, but it does not allow a similar action for gains. For example, potential losses from lawsuits will be reported on the financial statements or in the notes, but potential gains will not be reported. Also, an accountant may write inventory down to an amount that is lower than the original cost, but will not write inventory up to an amount higher than the original cost. Accounting Standards in the World and in the Philippines Financial statements have incredible importance for both internal and external stakeholders. They basically are a report card for the company; hence, it is important that they are regulated and do not report misleading information. Accounting standards are exceedingly useful because they attempt to standardize and regulate accounting definitions, assumptions, and methods. Because of generally accepted accounting standards we are able to assume that there is consistency from year to year in the methods used to prepare a company's financial statements. And although variations may exist, we can make reasonably confident conclusions when comparing one company to another, or comparing one company's financial statistics to the statistics for its industry. Over the years the accounting standards have become more complex because financial transactions have become more complex. The International Financial Reporting Standards (IFRS) Foundation is a not-for-profit international organization responsible for developing a single set of high-quality, global accounting standards, known as IFRS Standards. IFRS Standards are set by the IFRS Foundation’s standard-setting body, the IASB. The Monitoring Board is a group of capital market authorities and provides formal link between the Trustees and public authorities in order to enhance the public accountability of the IFRS Foundation. The International Accounting Standards Board (IASB) is the independent standard- setting body of IFRS Foundation responsible for the development and publication of 14 ACCOUNTING IFRS and for approving Interpretations of IFRS as developed by the IFRS Interpretations Committee. The Trustees of the IFRS Foundation are responsible for the governance and oversight of the IASB, including the due process for the development of the accounting standards. The IFRS Advisory Council provides advice and counsel to the Trustees and the Board, whilst the Board also consults extensively with a range of other standing advisory bodies and consultative groups. The Accounting Standards Advisory Forum (ASAF) provides an advisory forum in which members can constructively contribute towards the achievement of the IASB’s goal of developing globally accepted high-quality accounting standards. The IFRS Interpretations Committee is the interpretative body of the International Accounting Standards Board, which reviews implementation issues. The first accounting standards used in the Philippines were the Generally Accepted Accounting Principles of the US. However, with the convergence of reporting standards, the Philippine Financial Reporting Standards (PFRS)/Philippine Accounting Standards (PAS) the new set of accounting standards issued by the Accounting Standards Council (ASC) are adopted to govern the preparation of financial statements. These standards are patterned after the revised International Financial Reporting Standards (IFRS) and International Accounting Standards (IAS) issued by the International Accounting Standards Board (IASB). The IFRS is a set of accounting standards that are recognized by at least 120 countries (including the Philippines) and provides a guide on how particular types of transactions and other events should be reported in financial statements. The rationale for using the IFRS is to ensure consistency in recording, recognizing and measuring financial transactions, which, if followed properly, will ensure stability and transparency throughout the financial reporting process of the company. These standards are not enforceable and compliance is voluntary. The International Accounting Standards (IAS) were an older set of standards stating how particular types of transactions and other events should be reflected in financial statements. The PFRS, the Philippine version of the IFRS with some minor modifications, and the Philippine Accounting Standards are issued by the PFRS Council (formerly the Accounting Standards Council [ASC]), under the oversight of the Board of Accountancy (BOA). The Bangko Sentral ng Pilipinas (BSP) pronounced its adoption of the PFRS/PAS effective the annual financial statements beginning 1 January 2005 in its Memorandum to All Banks and Other BSP Supervised Financial Institutions (BSFIs) dated 11 January 2005. Forms of Business Organization A business entity is a group of people organized for some profitable or charitable purpose. The source of capital of the business determines the form of business organization. Business entities include organizations such as corporations, partnerships, charities, trusts, and other forms of organization. Business entities, just like individual persons, are subject to taxation and must file a tax return. In Philippines the most common forms of businesses are sole proprietorships, partnerships and corporation.  ACCOUNTING 15 1. Sole Proprietorship - Sole Proprietorship is a business entity owned by an individual who has full control/authority of its business and owns all the assets, personally owes answers to all liabilities or suffers all losses but enjoys all the profits to the exclusion of others. A sole proprietorship must apply for a business name and be registered with the Department of Trade and Industry (DTI) - National Capital Region (NCR). In the provinces, application may be filed with the DTI regional/provincial offices. 2. Partnership - Under the Civil Code of the Philippines, a partnership is treated as juridical person, having a separate legal personality from that of its members. Partnerships may either be general partnerships, where the partners have unlimited liability for the debts and obligation of the partnership, or limited partnerships, where one or more general partners have unlimited liability and the limited partners have liability only up to the amount of their capital contributions. It consists of two or more partners. A partnership with more than Peso 3,000 capital must register with the Securities and Exchange Commission (SEC). 3. Corporation - Corporation is composed of juridical persons established under the Corporation Code and regulated by the SEC with a personality separate and distinct from that of its stockholders. The liability of the shareholders of a corporation is limited to the amount of their share capital. It consists of at least five to 15 incorporators, each of whom must hold at least one share and must be registered with the SEC. Minimum paid up capital is Peso 5,000. A corporation can either be stock or non-stock company regardless of nationality. Such company, if 60% Filipino - 40% foreign-owned is considered a Filipino corporation; if more than 40% foreign-owned, it is considered a domestic foreign-owned corporation. a. Stock Corporation- Stock Corporation is a corporation with capital stock divided into shares and authorized to distribute to the holders of such share’s dividends or allotments of the surplus profits on the basis of the shares held. b. One Person Corporation- A One-Person Corporation (OPC) is a corporation with a single stockholder, who can only be a natural person (who must be of legal age), trust or estate. As an incorporator, the ―trust‖ does not refer to a trust entity but rather pertains to the subject being managed by a trustee. c. Non-Stock Corporation- Non-Stock Corporation is a corporation organized principally for public purposes such as charitable, educational, cultural, or similar purposes and does not issue shares of stock to its members. Types of Business Activity A business entity is an organization that uses economic resources to provide goods or services to customers in exchange for money or other goods and services. There are three major types of businesses: 1. 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. 16 ACCOUNTING 2. 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. 3. 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. A manufacturing business combines raw materials, labor, and overhead costs in its production process. The manufactured goods will then be sold to customers. Reports or Financial Statements Generated from the Accounting System Financial statements are written reports prepared by business’ management to present its financial affairs in a given period (monthly, quarterly, six monthly or yearly). These statements include Balance Sheet, Income Statement, Cash Flows and Statement of Owner/s’ Equity (for sole proprietorship and partnership) or Shareholders’ Equity (in case of corporation). Balance Sheet. A balance sheet is a financial statement that reports a company's assets, liabilities and shareholders' equity at a specific point in time, and provides a basis for computing rates of return and evaluating its capital structure. It is a financial statement that provides a snapshot of what a company owns and owes, as well as the amount invested by owner/s’ or shareholders. The equation that you need to remember when you prepare a balance sheet is this – Assets = Liabilities + Shareholders Equity. Assets. The International Financial Reporting Standards (IFRS) framework defines an asset as follows: ―An asset is a resource controlled by the enterprise as a result of past events and from which future economic benefits are expected to flow to the enterprise.‖ Properties of an Asset There are three key properties of an asset:  Ownership: Assets represent ownership that can be eventually turned into cash and cash equivalents  Economic Value: Assets have economic value and can be exchanged or sold  Resource: Assets are resources that can be used to generate future economic benefits  ACCOUNTING 17 Classification of Assets Importance of Asset Classification Classifying assets is important to a business. For example, understanding which assets are current assets and which are fixed assets is important in understanding the net working capital of a company. In the scenario of a company in a high-risk industry, understanding which assets are tangible and intangible helps to assess its solvency and risk. Determining which assets are operating assets and which assets are non-operating assets is important to understanding the contribution of revenue from each asset, as well as in determining what percentage of a company’s revenues comes from its core business activities. Assets are generally classified in three ways: 1. Convertibility: Classifying assets based on how easy it is to convert them into cash. 2. Physical Existence: Classifying assets based on their physical existence (in other words, tangible vs. intangible assets). 3. Usage: Classifying assets based on their business operation usage/purpose. 1. Classification of asset as to Convertibility - If assets are classified based on their convertibility into cash, assets are classified as either current assets or fixed assets. An alternative expression of this concept is short-term vs. long-term assets. a. Current Assets - Current assets are assets that can be easily converted into cash and cash equivalents (typically within a year). Current assets are also termed liquid assets and examples of such are: o Cash o Cash equivalents o Short-term deposits 18 ACCOUNTING o Stock o Marketable securities o Office supplies b. Non-Current Assets or Fixed Assets - Non-current assets are assets that cannot be easily and readily converted into cash and cash equivalents. Non-current assets are also termed fixed assets, long-term assets, or hard assets. Examples of non-current or fixed assets include: o Land o Building o Machinery o Equipment o Patents o Trademarks 2. Classification of asset as to Physical Existence - If assets are classified based on their physical existence, assets are classified as either tangible assets or intangible assets. a. Tangible Assets - Tangible assets are assets that have a physical existence (we can touch, feel, and see them). Examples of tangible assets include: o Land o Building o Machinery o Equipment o Cash o Office supplies o Stock o Marketable securities b. Intangible Assets - Intangible assets are assets that do not have a physical existence. Examples of intangible assets include: o Goodwill o Patents o Brand o Copyrights o Trademarks o Trade secrets o Permits o Corporate intellectual property 3. Classification of assets as to Usage - If assets are classified based on their usage or purpose, assets are classified as either operating assets or non-operating assets. a. Operating Assets - Operating assets are assets that are required in the daily operation of a business. In other words, operating assets are used to generate revenue from a company’s core business activities. Examples of operating assets include:  ACCOUNTING 19 o Cash o Stock o Building o Machinery o Equipment o Patents o Copyrights o Goodwill b. Non-Operating Assets - Non-operating assets are assets that are not required for daily business operations but can still generate revenue. Examples of non-operating assets include: o Short-term investments o Marketable securities o Vacant land o Interest income from a fixed or time deposit Liabilities -Defined by the International Financial Reporting Standards (IFRS) Framework: “A liability is a present obligation of the enterprise arising from past events, the settlement of which is expected to result in an outflow from the enterprise of resources embodying economic benefits.” Classification of Liabilities These are the three main classifications of liabilities: 1. Current liabilities (short-term liabilities) are liabilities that are due and payable within one year. 2. Non-current liabilities (long-term liabilities) are liabilities that are due after a year or more. 3. Contingent liabilities are liabilities that may or may not arise, depending on a certain event. 1. Current Liabilities also known as short-term liabilities, are debts or obligations that need to be paid within a year. Current liabilities should be closely watched by management to make sure that the company possesses enough liquidity from current assets to guarantee that the debts or obligations can be met. Examples of current liabilities: Accounts payable Interest payable Income taxes payable Bills payable Bank account overdrafts Accrued expenses Short-term loans Current liabilities are used as a key component in several short-term liquidity measures. Below are examples of metrics that management teams and investors look at when performing financial analysis of a company. Examples of key ratios that use current liabilities are:  The current ratio: Current assets divided by current liabilities  The quick ratio: Current assets, minus inventory, divided by current liabilities 20 ACCOUNTING  The cash ratio: Cash and cash equivalents divided by current liabilities 2. Non-current liabilities, also known as long-term liabilities, are debts or obligations that are due in over a year’s time. Long-term liabilities are an important part of a company’s long-term financing. Companies take on long-term debt to acquire immediate capital to fund the purchase of capital assets or invest in new capital projects. Long-term liabilities are crucial in determining a company’s long-term solvency. If companies are unable to repay their long-term liabilities as they become due, then the company will face a solvency crisis. List of non-current liabilities: Bonds payable Long-term notes payable Deferred tax liabilities Mortgage payable Capital leases 3. Contingent Liabilities are liabilities that may occur, depending on the outcome of a future event. Therefore, contingent liabilities are potential liabilities. For example, when a company is facing a lawsuit of P100,000, the company will incur a liability if the lawsuit proves successful. However, if the lawsuit is not successful, then no liability would arise. In accounting standards, a contingent liability is only recorded if the liability is probable (defined as more than 50% likely to happen) and the amount of the resulting liability can be reasonably estimated. Examples of contingent liabilities: Lawsuits Product warranties Capital also known as net assets or equity; capital refers to what is left to the owners after all liabilities are settled. Simply stated, capital is equal to total assets minus total liabilities. Capital is affected by the following: 1. Initial and additional contributions of owner/s (investments), 2. Withdrawals made by owner/s (dividends for corporations), 3. Income, and 4. Expenses. Owner contributions and income increase capital. Withdrawals and expenses decrease it. The terms used to refer to a company's capital portion varies according to the form of ownership. In a sole proprietorship business, the capital is called Owner's Equity or Owner's Capital; in partnerships, it is called Partners' Equity or Partners' Capital; and in corporations, Stockholders' Equity. In addition to the three elements mentioned above, Assets, Liabilities and Capital, there are two items that are also considered as key elements in accounting equation. They are income and expenses; these items are ultimately included as part of capital.  ACCOUNTING 21 Income refers to an increase in economic benefit during the accounting period in the form of an increase in asset or a decrease in liability that results in increase in equity, other than contribution from owners. Income encompasses revenues and gains. Revenues refer to the amounts earned from the company’s ordinary course of business such as professional fees or service revenue for service companies and sales for merchandising and manufacturing concerns. Gains come from other activities, such as gain on sale of equipment, gain on sale of short-term investments, and other gains. Income is measured every period and is ultimately included in the capital account. Examples of income accounts are: Service Revenue, Professional Fees, Rent Income, Commission Income, Interest Income, Royalty Income, and Sales. Expenses are decreases in economic benefit during the accounting period in the form of a decrease in asset or an increase in liability that result in decrease in equity, other than distribution to owners. Expenses include ordinary expenses such as Cost of Sales, Advertising Expense, Rent Expense, Salaries Expense, Income Tax, Repairs Expense, etc.; and losses such as Loss from Fire, Typhoon Loss, and Loss from Theft. Like income, expenses are also measured every period and then closed as part of capital. Net income refers to all income minus all expenses. Income Statement The income statement is the next financial statement everyone should look at. It looks quite different than the balance sheet. In the income statement, it’s about the revenue and the expenses. It starts with the gross sales or revenue. Then we deduct any sales return or sales discount from the gross sales to get the net sales. From net sales, we deduct the costs of goods sold, and we get the gross profit. From gross profit, we deduct the operating expenses like the expenses required for daily administrative and selling expenses. By deducting the operating expenses, we get the operating income. From the operating income we add, if there is any, interest and other non-operating income received during the period and deduct the interest charges paid and other non-operating losses sustained during the period, by this we get the EBT, meaning Earnings Before Taxes. From EBT, we deduct the income taxes for the period, and we get the Net Income or Net Profit, meaning profit after tax. Cash Flow Statement Cash Flow Statement is the third most important statement every investor should look at. There are three separate segments of a cash flow statement. These are cash flow from the operating activities, cash flow from investing activities, and cash flow from finance activities. 1. Cash Flow from Operations is the cash generated from the core operations of the business. 2. Cash Flow from Investing Activities relates to the cash inflows and outflows related to investment in the company like buying of property, plant, and equipment or other investments. 3. Cash Flow from Financing Activities relates to the cash inflows or outflows related to debt or equity of the company. It includes raising of equity or capital, debt, loan repayments, buyback of shares, and similar financing activities. 22 ACCOUNTING Statement of Owner/Partners’ Equity (for sole proprietorship and partnership) or Statement of Changes in Shareholders’ Equity (for corporation) Statement of Owner/Partners’ Equity or Statement of Changes in Shareholders’ Equity is a financial statement that provides a summary of changes in the owner/partners’ or shareholders’ equity in a given period. Illustration of Income Statement for the Different Forms of Business Organization: Sole Proprietorship’s Income Statement Terimacor Bicycle Rental Services Statement of Owner's Equity For the year ended December 31, 2019 Teresa Corrales, capital Jan. 1, 2019 90,000 Add: additional capital by Teresa Co net income from Jan.1-Dec. 31 Total Less: withdrawals or drawings from 92,000 Teresa Corrales, capital Dec. 31, 2019 182,000 Partnership’s Income Statement Terimacor Bicycle Rental Services Ltd. Statement of Partner's Equity For the year ended December 31, 2019 Teresa Anita Total Balances Jan. 1, 2019 90,000 160,000 250,000 Add: additional capital by partners 82,000 10,000 92,000 net income from Jan.1-Dec. 31 28,000 28,000 56,000 Total 200,000 198,000 398,000 Less: withdrawals or drawings from 18,000 24,000 42,000 Capital balances Dec. 31, 2019 182,000 174,000 356,000 Elements of Statement of Changes in Owner/Partners’ Equity/Capital Capital or investment- A capital or investment is a sum of cash acquired by a business to pursue its objectives, such as continuing or growing operations. It also can refer to permanent fixed assets such as property, plant, & equipment which ownership has been transferred to the business. Net income - For a business, net income equals is the amount remaining after subtracting all costs and expenses from revenue. If the costs and expenses exceed revenue, it is called net loss and this is subtracted from the capital or investment. Drawings or withdrawals- represent an amount of cash or non-cash items removed by the owner or partners from the business for personal use or expenditure.  ACCOUNTING 23 Corporation’s Income Statement Terimacor Bicycle Rental Services Co. Statement of Stockholders' Equity For the year ended December 31, 2019 Additional Common paid-in Retained Stock capital earnings Balance Jan. 1, 2019 80,000 160,000 130,000 Issuance of Stock 20,000 65,000 Net income 69,000 Cash dvidends -21,000 Stock dividend- 8% 8,000 26,000 -34,000 Purchase of treasury stock Sale of treasury stock 13,000 Balance Dec. 31, 2019 108,000 264,000 144,000 Elements of Statement of Changes in Stockholders’ Equity Common Stock is the first and most important component of shareholders’ equity. Common stockholders are the owners of the company, however there are corporations which issue preference shares which holders are also owners of the company but with limited rights. Additional Paid in Capital means when the company receives a premium on the shares. Premium results when the shares of stock are issued above par value. Retained earnings or losses are accumulated from the previous period. In simple terms, retained earnings are the amount the company keeps after paying the dividend from net income. Treasury shares are the sum total of all the common shares that have been purchased back by the company. Dividend is the distribution of some of a company's earnings to a class of its shareholders, as determined by the company's board of directors.