Business Organizations PDF

Business A person or organization engaged in the regular conduct of commercial, industrial or professional activities, whether for profit or not, in order to fulfill a purpose, goal, mission or cause. The regular conduct or pursuit of a commercial activity or an economic activity,...

Business A person or organization engaged in the regular conduct of commercial, industrial or professional activities, whether for profit or not, in order to fulfill a purpose, goal, mission or cause. The regular conduct or pursuit of a commercial activity or an economic activity, including transactions incidental thereto, by any person regardless of whether or not the person is engaged therein is a non-stock, non-profit private organization or government entity. (Sec 105, NIRC) Business Person or organization Regular conduct Commercial, industrial or professional activities Lawful transactions Whether for profit or not To fulfill a purpose, goal, mission or cause Forms of Business Organization These are the basic forms of business ownership: 1. Sole Proprietorship a business owned by only one person usually adopted by small business entities easy to set-up and requires low capital owner faces unlimited liability not easy to transfer ownership 2. Partnership a business owned by two or more persons the partners contribute resources into the entity the partners divide the profits among themselves. generally, all partners have unlimited liability. In limited partnerships, creditors cannot go after the personal assets of the limited partners. 3. Corporation a business organization that has a separate legal personality from its owners usually adopted by large business organizations can generate large amounts of capital from investments not easy to set-up and organize ownership is usually represented by shares of stock. owners (stockholders) enjoy limited liability but have limited involvement in the company's operations. easy to transfer ownership Basic Types of Business There are major types of businesses: 1. Service Business a business that provides intangible products (products with no physical form) for a fee offers professional skills, expertise, advice, and other similar products. examples are: repair shops, beauty care, health and recreation, transportation, communication, consulting, professional, medical and other service companies. 2. Merchandising Business a business that buys products and sells the same at a higher price for a profit. known as "buy and sell" businesses. sells a product without changing its form. Examples are: grocery stores, convenience stores, distributors, and other resellers. 3. Manufacturing Business a business that buys materials and converts them into a new product. combines raw materials, labor, and overhead costs in its production process, and sells the manufactured goods to customers. 4. Mixed/Hybrid Business companies that can be classified in more than one type of business. example: A restaurant, combines ingredients in making a fine meal (manufacturing), sells a cold bottle of wine (merchandising), and fills customer orders (service). Not considered engaged in business: Government agencies and instrumentalities Pure compensation employment (local or abroad, private or government) Directorship in a corporation Gratuitous transfer of properties by succession or donation Isolated or casual transactions by persons not engaged in trade or business Considered engaged in business: Freelancers, agents and consultants Broadcast media talents and artists Legal Requirements in Organizing a Business 1. Register Business Name and Entity Depending on the form of the business, it must register with the following government agencies: 1. Sole Proprietorship - Department of Trade and Industry (Business Name Registration) 2. Partnership or Corporation - Securities and Exchange Commission (Registration System) 3. Cooperative - Cooperative Development Authority (Registration System) 2. Secure Business Permits and Licenses Depending on the nature of its activities, the business must secure its permits and licenses in the city or municipality where it conducts its business. Generally the following will be obtained: 1. Business Permit or Professional Tax Receipt - from the City or Municipal Government Unit 2. Fire Safety Inspection Certificate - from the Bureau of Fire Protection 3. Barangay Clearance and Community Tax Certificate - from the barangay where the business is operating 4. Employer Registration - SSS, HDMF, PHIC, DOLE (if applicable) 3. Comply with BIR Requirements: The business entity must also comply with the following requirements of the Bureau of Internal Revenue: 1. Business registration 2. Issuance of receipts and invoices 3. Keeping of tax and accounting records 4. Withholding of taxes on certain payments 5. Filing and payment of taxes However profitable or noble the purpose of the business may be, the failure of the business entity to comply with any of these requirements might lead to penalties, fines, surcharges or, at worst, closure of the business. After the registration and securing all the necessary certificates and permits, the company needs to maintain its accounting records. Definition of Accounting Accounting is 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 a financial character, and interpreting the results thereof (American Institute of Certified Public Accountants). 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 (Accounting Standards Council). Accounting is the process of identifying, measuring and communicating economic information to permit informed judgment and decision by users of the information (American Accounting Association). Accounting is an information system that measures, processes and communicates financial information about an identifiable economic entity. Accounting a service activity, a process to provide financial information about economic entities for the use of interested users Purpose of Accounting to provide financial information about the business that will be useful in making economic decisions of the users of the information Financial Statements 1. Statement of Financial Position (Balance Sheet) 2. Statement of Financial Performance (Income Statement) 3. Statement of Changes in Owner's Equity 4. Statement of Cash Flows 5. Notes to the Financial Statements Users of Accounting Information Internal Users (within the business organization) Owners Managers Employees Officers  Internal Auditors External Users (outside the business organization) Customers Suppliers Creditors Investors External Auditors Government Agencies Industrial Organizations Public Branches of Accounting 1. Financial Accounting 2. Management Accounting 3. Tax Accounting 4. Auditing Bookkeeping Bookkeeping is the recording of financial transactions and is part of the process of accounting in business (Financial Accounting 2003, Weygandt; Kieso; Kimmel). It is largely concerned with the implementation of the accounting procedures manual and maintenance of the accounting records. Bookkeeping is the procedural implementation of Accounting. Bookkeeper is the person who keeps and maintains the books of accounts of the business organization. The bookkeeper is responsible for recording the transactions of the business. Functions of a Bookkeeper General Accounting Verify deposit of cash collections Verify petty cash disbursements Prepare bank reconciliation Record transactions in the journals Post to the subsidiary and general ledgers Reconcile general and subsidiary ledgers Prepare a draft of the Trial Balance  Assist the Accountant in the closing of the accounts and finalization of the financial statements. Maintain proper filing and retrieval of accounting records Accounts Receivable Record sales invoices Record cash receipts from customers Record sales returns, account adjustments and credit memos from suppliers Issue Statement of Accounts to customers Reconcile accounts receivable ledger balance with unpaid customer invoices. Maintain Accounts Receivable Subsidiary Ledger Prepare Accounts Receivable reports Accounts Payable Record purchase invoices Record payments to suppliers Record purchase returns, account adjustments and debit memos from suppliers Receive Statement of Accounts from suppliers Reconcile accounts payable ledger balance with unpaid customer invoices. Maintain Accounts Payable Subsidiary Ledger Prepare Accounts Payable reports Inventory Accounting Record receipts of inventory from suppliers. Record release of inventory to customers Record inventory returns and adjustments Prepare purchase requests and Inventory issuance slips Reconcile physical count of inventory to ledger balances Maintain inventory subsidiary ledgers Prepare Inventory reports The Bookkeeper may also be assigned to handle other functions, such as: Property control and monitoring Payroll preparation Remittance of statutory deductions and reports Tax bookkeeping Treasury and banking Audit assistance Managerial and administrative functions. The scope and variety of functions depends on the nature, type, size, organization structure of the business and other factors. Due to the importance of his or her functions, the Bookkeeper must possess the knowledge, abilities and temperaments required to properly fulfill his or her duties and functions. One of the knowledge requirements would be the basic knowledge in Accounting. The Accounting Cycle Recording 1. Identification of Accountable Transactions. Business transactions or events are analyzed and identified whether they are accountable or not. 2. Journalizing. The accountable transactions are recorded in the book of original entry known as the journal. The transactions are recorded chronologically using the appropriate accounts and amounts. 3. Posting. The transactions from the journal are classified in the book of final entry known as the ledger. The ledger classifies the transactions effecting the increases and decreases for each account. Summarizing 4. Trial Balance. The summary of accounts balances from the ledger is prepared in the list of accounts known as the trial balance. This is the proof that the ledger debit balances and credit balances are equal and is in balance. 5. Adjusting Entries. Adjusting journal entries are made at the end of the accounting period to assign revenues to the period in which they are earned and expenses to the period in which they are incurred. Reporting 6. Financial Statements. The following financial statements are prepared: statement of financial position, statement of financial performance, statement of changes in equity, statement of cash flows and the notes to the financial statements. These financial statements provide useful information to interested parties for their decision-making. 7. Closing Entries. The temporary nominal accounts are eliminated from the accounts by recording and posting the closing entries. This will prepare the accounting records for the next accounting period. 8. Post-Closing Trial Balance. After the closing entries are posted, the post-closing trial balance is prepared to check that the debit and credit balances of the remaining accounts are correct. Optional 9. Recording of Reversing Entries. At the beginning of the next accounting period, selected adjusting journal entries made at the previous accounting period are reversed to “normalize” the recording of the related actual transactions. MODULE 2 - RECORDING TRANSACTIONS The Chart of Accounts The specific account titles and codes to use in recording transactions are maintained in a Chart of Accounts. It is a list of the account codes and titles that are used in recording entries in the Journal. It shall be maintained and updated for necessary changes, like additions of new accounts, change of titles and codes and removal of accounts that will no longer be used. The accounts are normally listed in the order in which they appear in the financial statements. An account code identifies the account which will serve as its cross-reference in the journal and ledger. A sample is as follows: Identifying Accountable Transactions Business transactions or events are analyzed whether they are accountable or not. Only transactions which are identified to be accountable transactions are recorded in the accounting records. A transaction or event is accountable when it meets the following criteria: 1. It involves the business entity. 2. It can be measured in terms of money. 3. It occurred on a specific date or for a specific period. 4. It affects the assets, liabilities or equity of the business. 5. It is supported by a document. Examples of accountable transactions: Mr. Luca Pacioli established Pacioli General Services and had the following transactions for the month of January: Jan 2 Investment of P100,000 capital funds by Mr. Pacioli into the business Jan 7 Receipt of a Charge Invoice from a supplier for the purchase of a desktop computer amounting to P30,000. Jan 9 Purchase of supplies amounting to P8,000 in cash. Jan 15 Issuance of a Service Invoice for an amount of P40,000 to a customer for services rendered on account. Jan 17 Receipt of P28,000 cash from customers in payment of their account. Jan 22 Payment in cash and receipt of an official receipt from supplier for payment of accounts, P22,000. Jan 31 Cash payment of P12,000 for the salary of an employee. Jan 31 Mr. Pacioli withdrew P10,000 cash from the business. Examples of non-accountable transactions: The owner of the business spent P80,000 for his wedding. The owner spent transportation and representation expenses amounting to P5,000. A secretary was hired for P15,000 monthly salary. The company received from a customer a sales order amounting to P100,000 worth of goods. The company issued to a supplier a purchase order amounting to P200,000 worth of inventory. The company entered into a contract to provide services for the next 5 years, at an amount of P500,000 per year.  The company has been using the electricity for the first month of its operations but has not yet received the electric bill. The company has been recognized by the local government unit as the best service provider in the locality. It is foreseen to grow into a P10 million company in the next few years. Business Documents The business documents forms serve as evidence to support the accountable transactions or events. These documents provide the data concerning the parties involved, the exchange made, the date and the money value of the exchange made. Some of the common business documents include the following: 1. Sales Invoice – document issued to customer for specific materials or supplies furnished or services rendered. It is called Purchase Invoice from the point of view of the customer. 2. Delivery Receipt – document signifying delivery of goods and receipt of inventory. 3. Official Receipt – document issued to acknowledge receipt of cash. 4. Deposit Slip – document used to deposit cash and cheques to a bank. 5. Purchase Invoice – a bill from a vendor for specific materials or supplies furnished or services rendered. It is called Sales Invoice from the point of view of the supplier. 6. Disbursement Voucher – a written, approved record of payment of cash. 7. Withdrawal Slip – document used to withdraw cash from a bank. 8. Cheque Issuance Record – a record of cheques issued by the company. 9. Promissory Notes – a written promise to pay a certain sum of money to the payee. It may sometimes bear an interest over a period of time. 10. Bank Statement – a document listing the bank transactions of the depositor. 11. Billing Statement or Statement of Account – document listing the unpaid invoices of a customer. Oftentimes, it lists chronologically the invoices, payments and adjustments to the account of the company. 12. Business Letters – correspondences to other companies, organizations or government entities which may serve as a basis in recording an accountable transaction or event. Posting to the General Ledger After the entries are recorded in the journal, the entries are posted into the ledger. A ledger is a collection of all of the accounts of the company. It is the book of final entry. Each account has an assigned account number and the individual accounts are properly arranged. Each journal entry is posted into the related ledger account, indicating the date, description debits and credits, and the posting reference. The posting reference serves as the cross-reference between the journal entry and the ledger account posting. Trial Balance The trial balance is a listing of all the balances of the different accounts as of a given date. The total of all accounts with debit balances must equal to the total of all accounts with credit balances. Purpose of Trial Balance: To check the accuracy of posting in the ledger by testing the equality of the debits and credits. It aids in locating errors in posting. It serves as the basis in the preparation of the financial statements. Errors in The Accounting Process When the total debits and total credits are not equal, this automatically signify that there is an error in the recording or posting of entries. Some of the errors that could occur are the following: Journal entry with unequal debit and credit. Posting to the incorrect debit or credit of an account. Incorrectly footing the account balance, or trial balance. Forwarding the wrong amount from the ledger to the trial balance. Listing the account balance to the wrong side of the trial balance. The following errors will not be detected by the preparation of a trial balance, but on a careful review of the records: Failing to record a transaction or event. Multiple recording and posting of a transaction or event. Entries or posting to the wrong account. Reversed entries and posting. Recording and posting of amounts with transposition and trans-placement errors. Types of Trial Balance 1. Unadjusted Trial Balance 2. Adjusted Trial Balance 3. Post-Closing Trial Balance ADJUSTING ENTRIES Purpose of Adjusting Entries The purpose of adjusting entries is to match costs against revenues. The expenses incurred during the period, whether paid or not, are matched against the revenue earned for the same period, whether collected or not, for the correct determination of the profit for the period. Adjusting entries are recorded at the end of an accounting period. Most common transactions requiring adjusting entries: 1. Depreciation of property, plant and equipment 2. Allowance for uncollectible accounts 3. Accrued and prepaid expenses 4. Accrued and unearned revenues 5. Other adjustments, like ○ Unused or unsold Inventory at the end of the period Accounts → Depreciation Depreciation is the decrease in value of a property due to usage, passage of time, action of natural elements, or decay. As it is difficult to measure the actual decrease in value of the property, the accounting of depreciation is done through a systematic basis. The cost of a deprecible asset is systematically allocated over its estimated useful life. The estimated scrap value at the end of the life of the asset is not included in the amount expensed over the periods of depreciation. The simplest method of depreciation is the straight-line method. Under this method, the depreciation expense is calculated by allocating the depreciable amount equally over the estimated useful life in years of the property. The formula for the computation of depreciation using the straight line method is as follows: Depreciation Expense = Depreciable value Estimated Useful Life The depreciable value of the asset is the difference between its cost and estimated residual value at the end of its useful life. The cost of the asset is the amount paid to purchase the asset, including the incidental costs in bringing the asset to the location and condition intended for its use. The residual value, sometime called scrap or salvage value, is the amount estimated to be recovered at the end of the useful life of the property. The estimated useful life is the estimated length of time, normally in years, when the property is expected to be used. Exercises: Using the Straight-Line Method of Depreciation Exercise 1. A machine was purchased by the company for P120,000. It is expected to be sold as scrap for P20,000 after its estimated useful life of 10 years. Present the journal entry to record the annual depreciation. Exercise 2. A computer equipment was purchased for P65,000. The equipment will be sold for P5,000 after its useful life of 5 years. Present the depreciation table for 5 years. Exercise 3. Compute the depreciation of the following properties and present the journal entry to record the depreciation for one month: Asset Cost Salvage Value Useful Life (yrs) Building P6,400,000 P100,000 20 Machinery 1,500,000 60,000 10 Equipment 480,000 0 4 Uncollectible Accounts Methods of accounting for bad debts: 1. Direct write-off 2. Allowance method 1. Percent of sales 2. Percent of receivables 3. Aging of accounts Direct Write-Off When an account is proven to be uncollectible and worthless, it is written-off. The write-off is recorded by crediting the receivables and debiting an expense account, such as bad debts expenses, uncollectible accounts expense, etc. The proforma entry to record the write-off is as follows: Bad Debts Expense xxx Accounts Receivable xxx Allowance Method The allowance method of recognizing uncollectible accounts expenses is recommended for the better matching of costs against revenues. This method requires recording of the bad debts expense if the accounts are doubtful of collection. The proforma entry to record the recognition of bad debts is as follows: Bad Debts Expense xxx Allowance for Bad Debts xxx The “Allowance for Bad Debts” account is a deduction from the accounts receivable account. Illustration: Jun 30, 2020 Sold on account to a customer merchandise for P20,000. Sep 30, 2020The customer paid P12,000. Nov 30, 2020 The account balance is considered doubtful of collection. Jan 31, 2021 The account balance is proved to be uncollectible. Journal entries: Direct Write-off Method: 2020 Jun 30 Accounts P20,000 Receivable Sales P20,000 Sep 30 Cash 12,000 Accounts 12,000 Receivable (No entry on Nov 30) 2021 Jan 31 Bad Debts Expense 8,000 Accounts 8,000 Receivable Allowance Method: 2020 Jun 30 Accounts P20,000 Receivable Sales P20,000 Sep 30 Cash 12,000 Accounts 12,000 Receivable Nov 30 Bad Debts Expense 8,000 Allowance for 8,000 Bad Debts  2021 Jan 31 Allowance for Bad 8,000 Debts Accounts 8,000 Receivable Exercises: Exercise 4. During its first year of operations, the company had sales of P6,000,000. Collection from customers amounted to P4,000,000. Required: Prepare the adjusting journal entries to provide for doubtful accounts under the each of the following independent assumptions: 1. The company believes one percent of sales may prove uncollectible. 2. The company policy is to maintain an allowance for doubtful accounts equal to 10% of the outstanding accounts receivable Exercise 5: At the beginning of the year, Outwork Everyone Company has an Accounts Receivable of P3 million and an Allowance for Uncollectible Accounts of P120,000. During January, it sold goods to customers amounting to P300,000 and collected P200,000. A receivable accounting amounting to P50,000 has proven to be uncollectible and was written off. During February, it sold goods to customers amounting to P900,000 and collected P300,000. A receivable previously written off amounting to P5,000 has been collected. The company estimates that 2% of Accounts Receivable is uncollectible. Required: Prepare the adjusting entries for January and February. Accrued and Prepaid Expenses Accrued Expenses Accrued expenses are expenses already incurred but not yet paid. These expenses create an obligation to pay in the future. The proforma entry to record an accrued expense is as follows: Expense xxx Accounts Payable xxx or Accrued expense payable Common examples of accrued expenses are salaries, utilities and interest expenses. Employee services that have been rendered to the company but not yet paid are accrued salaries expenses. Electricity, water and telephone services that have been consumed but not yet paid are also accrued expenses. Illustration: The company borrowed P300,000 from a bank. It issued a 90-day 10% promissory note on November 30, 2020. Journal entries related to the promissory note are as follows: 2020 Nov 30 Cash P300,000 P300,000 Notes Payable Dec 31 Interest Expense 2,500 2,500 Interest Payable Jan 31 Interest Expense 2,500 2,500 Interest Payable Feb 28 Interest Expense 2,500  2,500 Interest Payable Notes Payable 300,000 Interest Payable 7,500 307,500 Cash Prepaid Expenses Prepaid expenses are expenses already paid but not yet incurred. During the accounting period, the portion that is already consumed is recorded as expense. There are two methods in accounting prepaid expenses: the asset method and the expense method. Illustration: On October 31, 2020, a company paid P120,000 as rent payment for 3 months. The entries related to the rent payment are as follows: Asset Method: 2020 Oct 31 Prepaid Rent P120,000 P120,000 Cash To record the payment of rent for 3 months. Nov 30 Rent Expense 40,000  40,000 Prepaid Rent To record the expiration of the rent for 1 month. Dec 31 Rent Expense 40,000 40,000 Prepaid Rent To record the expiration of the rent for 1 month. 2021 Jan 31 Rent Expense 40,000 40,000 Prepaid Rent To record the expiration of the rent for 1 month. Expense Method: 2020 Oct 31 Rent Expense P120,000 P120,000 Cash To record the payment of rent for 3 months. Dec 31 Prepaid Rent 40,000 40,000 Rent Expense To record the unexpired portion of rent. 2021 Jan 31 Rent Expense 40,000 40,000 Prepaid Rent To record the expiration of the rent for 1 month. Exercises: Exercise 6: Believe You Can Corporation has the following information during the month of December: Total purchases for office supplies during the year amounted to P240,000. A year-end physical count revealed that only 20,000 worth of supplies were on hand. Fees for security services provided to the company, amounting to P45,000 per month, are scheduled to be paid on the 5th day of the following month.  On December 31, the company received the following utility bills which were paid on the following month: Liwanag Electric Company, P40,000; DoonDito Telecom, P20,000 Clear Water District P5,000 Prepare the necessary adjusting journal entries. Exercise 7: Driven by the owner’s drive and focus, Icandoit Corporation started its operations on July 1 of this year. As a protection, the company purchased an insurance plan for P60,000 per year. The company paid the insurance premiums for 1 year at the start of its operations. Prepare the journal entries relevant to the insurance. Use the asset method. Exercise 8: Driven by the owner’s motivation, Relentless Company started its operations on April 1 of this year. He rented an office space for the company at P10,000 per month. The company paid its 12 months’ rent in advance at the start of its operations. Prepare the journal entries relevant to the rent payment. Use the expense method. Accrued and Unearned Revenues Accrued Revenues Accrued revenues are revenues already earned but not yet collected. These require recognition of both the revenue and the receivable for the amount earned. The proforma entry to record an accrued revenue is as follows: Accounts Receivable xxx Sales or xxx Service Income or Accrued Revenue Some examples are services already rendered to the client but have not yet been collected. Illustration: The company was hired to provide consultancy services for two months from December 16, 2020 to February 15, 2021. The service contract amount is P200,000 and will be paid at the end of the contract. The journal entries relevant to the contract are as follows: 2020 Dec 31 Accounts P50,000 Receivable Service P50,000 Revenue 2021 Jan 31 Accounts 100,000 Receivable  Service 100,000 Revenue Feb 15 Accounts 50,000 Receivable Service 50,000 Revenue 15 Cash 200,000 Accounts 200,000 Receivable Unearned Revenues Unearned revenues are revenues already collected but not yet earned. During the accounting period, the portion that is already earned is recorded as income. There are two methods in accounting deferred revenues: the liability method and the revenue method. Illustration: The company was hired to provide consultancy services for two months from December 16, 2020 to February 15, 2021. The service contract amount is P200,000 and is paid on December 16, 2020. Liability Method 2020 Dec 16 Cash P200,000  Unearned P200,000 Service Revenue 31 Unearned Service 50,000 Revenue Service 50,000 Revenue 2021 Jan 31 Unearned Service 100,000 Revenue Service 100,000 Revenue Feb 15 Unearned Service 50,000 Revenue Service 50,000 Revenue Revenue Method 2020 Dec 16 Cash P200,000 Service P200,000 Revenue  31 Service Revenue 150,000 Unearned 150,000 Service Revenue Exercises Exercise 9: Mr. Pasion owns Passionate Corporation providing grooming and beauty services to its clients. One of his clients, International Bilibid Prison, pays a fixed monthly fee of P30,000. The fee is paid 5 days after the end of the month. Another client who was provided with beauty services in December, has an unrecorded unpaid balance of P10,000. Prepare the necessary journal entries to recognize the accrued revenues for the month of December. Exercise 10: Starlink Networks provide internet and communication services to its clients. On October 1, one of its clients paid P60,000 as a subscription for 6 months. The bookkeeper has recorded the collection into the Unearned Subscription Revenue account. Prepare the necessary adjusting entries. Exercise 11: Get Tough Company is providing training and coaching services to aspiring young professionals. It collects services fees in advance as a policy to secure collections from clients. The monthly service fee is P10,000 per client, and each client pays 3 months of service fees in advance. The accountant books all the collections into the Service Revenue account. During its first months of operations, it had the following number of clients: October 30 November 40 December 50 Prepare the necessary adjusting entry on December 31. (Assume all of the collections were made at the start of the month.) Adjusted Trial Balance After recording the adjusting journal entries, the Adjusted Trial Balance is prepared. It will serve as the basis for the preparation of the financial statements. Exercise: Exercise 12: PACIOLI GENERAL SERVICES Unadjusted Trial Balance As of January 31, 2021 Code Account Title Debit Credit 101 Cash P76,000 111 Accounts 12,000 Receivable 121 Supplies 8,000 151 Equipment 30,000 201 Accounts Payable P8,000 301 Pacioli, Capital 100,000 311 Pacioli, Drawing 10,000  401 Service Revenue 40,000 601 Salaries 12,000 TOTAL P148,000 P148,000 Additional information: 1. The computer is estimated to have a useful life of 5 years and no scrap value. 2. Unused supplies amounts to P7,000. 3. Unbilled service fees amount to P10,000. 4. The electricity bill received on February 1 amounts to P2,500. Prepare the Adjusted Trial Balance. Purpose and Users of Financial Statements The financial statements are the financial reports of the business entity in order to provide information that is useful for the decision-making of its users. The users of the financial statements include the following: Owners, investors and prospective investors Lenders and suppliers and prospective creditors Employees, customers Government agencies The general public As different groups of users will use the financial statements, it should be useful and understandable to someone who has a reasonable understanding of accounting and business and who is willing to study and analyze the information presented. The financial statements must be relevant, reliable and comparable. Most of all, it must follow the applicable Philippine Financial Reporting Standards. The financial statements are prepared at least once a year and can be presented as frequent as monthly or quarterly. A complete set of Financial Statements comprises the following: 1. Income Statement or Statement of Financial Performance 2. Statement of Changes in Equity 3. Balance Sheet or Statement of Financial Position 4. Statement of Cash Flows 5. Notes to the Financial Statements Back to '4. Financial Statements 4. Financial Statements Income Statement The Income Statement, also called Statement of Financial Performance, presents the financial results of a business for a given period of time. The statement presents the amount of revenue generated and expenses incurred by the business during a reporting period, as well as the resulting net income or net loss. Revenues are increases in economic benefits during the accounting period in the form of inflows or enhancements of assets or decreases of liabilities (or a combination of both) from the delivery or production of goods, rendering of services, or other activities that constitute the entity’s ongoing major or central operations. Examples of revenues are as follows: Sales Professional fees earned Service revenues Interest revenue Dividend revenue Rent income Subscription revenue Expenses are decreases in economic benefits during the accounting period in the form of outflows or using up of assets or incurrences of liabilities (or a combination of both) from the delivery or production of goods, rendering of services, or other activities that constitute the entity’s ongoing major or central operations. Examples of expenses are as follows: Cost of sales Depreciation expense Salaries and wages Utility costs Insurance expense Permits, taxes and licenses Repair and maintenance Representation expenses Losses Exercise 1: Prepare the Income Statement based on the following information: PACIOLI GENERAL SERVICES Adjusted Trial Balance As of January 31, 2021 Code Account Title Debit Credit 101 Cash P76,000 111 Accounts 22,000 Receivable 121 Supplies 7,000 151 Equipment 30,000 152 Accumulated P500 Depreciation - Equipment 201 Accounts Payable 10,500 301 Pacioli, Capital 100,000 311 Pacioli, Drawing 10,000 401 Service Revenue 50,000 601 Salaries 12,000 602 Depreciation 500 603 Supplies Expense 1,000 604 Utility Expense 2,500 TOTAL P161,000 P161,000 Statement of Changes in Equity The statement of changes in equity presents a reconciliation of the beginning and ending balances in a company’s equity during a reporting period. The statement starts with the beginning equity balance, and then adds or subtracts such items as profits, capital investments or reductions, and dividend payments to arrive at the ending balance. Changes in equity over an accounting period include the following elements: Net income or loss during the accounting period Increase or decrease in capital Capital withdrawals or dividend payments to shareholders Exercise 2: Prepare the Statement of Changes in Equity of Pacioli General Services (Exercise 1). Balance Sheet A Balance Sheet, also referred to as Statement of Financial Position, presents a company’s financial position as of a given date. It shows the assets, liabilities and equity of the business entity. An asset is a resource controlled by the entity as a result of past events and from which future economic benefits are expected to flow to the entity (IASB Framework). Examples of assets include the following: Cash – includes coins, currencies, checks, bank deposits and other cash items ready for use in the operations of the business. Accounts Receivable – amounts collectible from customers for goods provided and services rendered on credit. Merchandise Inventory – unsold goods for sale to customers. Prepaid Expenses – expenses paid but not yet used. Investments – assets for the accretion of wealth through capital returns or capital appreciation or for other benefits to the business. Property, Plant and Equipment – tangible assets used in the production or supply of goods and services, or for business administration purposes. Intangible Assets – includes identifiable, non-monetary properties without physical substance, like licenses, copyrights, patents, trademarks and others. 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 (IASB Framework). Examples of liabilities include the following Accounts Payable – obligations due to suppliers of goods and services purchased on credit. Notes Payable - obligations due to suppliers of goods and services evidenced by a promissory note. Loans Payable - obligations due to lenders as a result of borrowing of funds. Lease Payable – obligations due to lessors for property and equipment used for business operations. Utilities Payable - obligations due to utility companies for services rendered. Accrued liabilities - obligations due to others for expenses already incurred but not yet paid. Unearned Revenues - obligations due to customers for goods and services paid but not yet delivered. Equity is the residual interest in the assets of the entity after deducting all the liabilities (IASB Framework). It represents the capital investments, net of the capital withdrawals of the owner in the entity, and the net income or loss in the operation of the business. Equity accounts include the following: Capital account –the equity investment of the owner (in a single proprietorship) or for each partner (in a partnership), and the cumulative effect of the withdrawals of capital and business net profits and losses. Drawing – the equity withdrawals of the owner or for each partner. Common Stock, Preferred Stock – the equity of the owners of a corporation Retained Earnings – the cumulative balance of the net income or losses of the corporation, investments of the owners, less the distribution to the owners. Exercise 3: Prepare the Balance Sheet of Pacioli General Services (Exercise 1). Statement of Cash Flows The Statement of Cash Flows shows the cash receipts and cash payments from the business activities of the enterprise during the period. The business activities are classified into operating, investing and financing activities. Activities of Business Organizations Operating activities are the principal activities of the enterprise. They are the transactions and events that enter into the determination of profit or loss. Operating Activities include the following: Cash receipts from sales of goods and rendering of services. Cash receipts from interests, royalties, commissions, fess and other sources. Cash payments to suppliers of goods and services. Cash payments to employees for salaries and other employee expenses. Cash payments for operating expenses such as advertising, supplies, utilities, taxes, and others. Investing activities include the acquisition and disposal of non-current assets of the business. Examples of investing activities are Cash payments in purchasing land, constructing a building, buying furniture and equipment, acquiring intangible and other long-term assets. Cash receipts in selling property and equipment, intangible and other long-term assets. Cash payments in investing in equity and debt instruments of other companies. Cash receipts from selling investments in equity and debt instruments of other companies. Financing activities include equity transaction of the business and the owners, as well as borrowing of funds from financial institutions. Examples are Investment and withdrawal of capital of the owners Cash proceeds from bank loans and repayment of the loans. Closing Entries Types of Accounts 1. Permanent or Real Accounts 1. Asset accounts 2. Liability accounts 3. Equity accounts 2. 3. Temporary or Nominal Accounts 1. Revenue accounts 2. Expense accounts 3. Gains and Losses accounts 4. Equity drawing accounts 5. Income and Expense summary account 4. 5. Mixed Accounts At the end of the accounting period, the temporary or nominal accounts are closed. The following entries are recorded and posted: 1. Revenue accounts are closed (debited) against the Income and Expense Summary account. 2. Cost of goods sold accounts are closed (credited) against the Income and Expense Summary account. 3. Expense accounts are closed (credited) against the Income and Expense Summary account. 4. The resulting balance of the Income and Expense Summary account is closed to the Equity account. 5. Any drawing account is closed against the Equity account. Exercise 1. Based on the following Adjusted Trial Balance of Pacioli General Services, prepare the closing entries. PACIOLI GENERAL SERVICES Adjusted Trial Balance As of January 31, 2021 Code Account Title Debit Credit 101 Cash P76,000 111 Accounts 22,000 Receivable 121 Supplies 7,000 151 Equipment 30,000 152 Accumulated P500 Depreciation - Equipment 201 Accounts Payable 10,500 301 Pacioli, Capital 100,000 311 Pacioli, Drawing 10,000 401 Service Revenue 50,000  601 Salaries 12,000 602 Depreciation 500 603 Supplies Expense 1,000 604 Utility Expense 2,500 TOTAL P161,000 P161,000 Post-Closing Trial Balance A Post-Closing Trial Balance is prepared after the recording and posting of the closing entries. The remaining Permanent/Real accounts of assets, liabilities and equity are presented with their balances. This provides the starting balances for the next accounting period 6. Service Business Next: Exercise → Introduction A service business provides services to clients for a fee. Typically, the business provides intangible products such as repairing beauty care health and recreation transportation communication consulting professional  medical, and other services. The accounting for a service business is simpler, in contrast to a merchandising business, because the business do not involve accounting for inventories. In rendering services, the business earns revenues, which it eventually collects. The focus of the bookkeeping is on recording the revenues and collections. Major activities involved in a service business 1. Rendering of services 2. Collection of payments 3. Incurrence and payment of expenses Sample Journal entries: Cash/Accounts Receivable xxx  Service Revenue xxx Cash xxx Accounts xxx Receivable Expenses xxx Cash/Accounts xxx Payable Accounts Payable xxx  Cash xxx 7. Merchandising Business Next: Payment Terms and Discounts → Transactions of Merchandising Businesses The focus of this chapter is bookkeeping for the transactions of merchandising businesses. The business purchases products from its suppliers which it sells to its customers for a profit. Businesses in this type includes the following: Sari-sari stores, groceries and market stalls Hardware Appliance store Gadgets and electronics store Fashion and dress shop Sports equipment store Online product sellers In contrast to a service business, a merchandising business is more complex due to the presence of inventory. The inventory items needed to be purchased, transported, kept and then sold to the customers. In purchasing merchandise inventory, the company pays for the purchase price of the goods. There could be an agreement for credit terms between the buyer and seller. The buyer might be offered discounts within a certain period to encourage early or prompt payments. This is also true in selling the merchandise inventory. The company might also offer credit terms and discounts to its customers. In buying and selling the merchandise inventory, there might be some returns of goods that needed to be accounted for. Also, in buying and selling, the inventory items need to be transported and thus, freight costs are incurred. These freights costs may be charged to the buyer or to the seller depending on their agreement. Purchasing and keeping merchandise inventory requires some internal control procedures in order to maintain the right quantity or level of goods on hand. One of the basic internal control is the recording and monitoring of the cost and quantity of merchandise inventory. Purchases should be properly recorded on a timely basis in the books of accounts. Also regular physical counting is done to match the recorded quantity and amount of inventory with the actual quantity and amount of inventory. This need for the proper recording and control of the movement of inventory that two systems of inventory were being commonly used: the periodic inventory system and the perpetual inventory system. We will study these inventory systems on this chapter. The study of this chapter is very important in your professional growth and development as an accountant. The topic is not complicated nor intricate, but requires a careful focus and attention so that you can comfortably include this in your competencies for your exams, in your work, in your public practice or in your own business. Items related to Purchases and Sales of Merchandise Inventory: Returns and Allowances Payment Terms Discounts Freight or Shipping Costs Value-Added Tax Inventory System In the next pages, we will study the bookkeeping for these items. Payment Terms Examples of payment terms: Cash COD n/30 n/EOM 2/10, n/30 3/5, 2/10, n/30 3/EOM, n/45 4/10 EOM, n/60 Discounts Types of discounts: 1. Trade Discount 2. Payment Discount Accounting Methods for Discounts: 1. Discount Taken Method 2. Discount Not Taken Method 3. Discount Offered Method Freight Charges In purchasing and selling, merchandise inventory needs to be shipped from the seller to the buyer. The costs of shipping the goods may be charged to the buyer or the seller depending on their agreement. There are two most common freight charge agreement: 1. Free on board, Shipping point (FOB-SP), and 2. Free on board, Destination (FOB-D) To easily understand these terms, just take note that this is the transfer of ownership to the goods: In FOB shipping point, the ownership of the goods is being transferred from the seller to the buyer from the seller's shipping point. Therefore, the buyer shoulders the freight charges. In FOB destination, the ownership of the goods is being transferred from the seller to the buyer upon the arrival of the goods to the destination (buyer). And therefore, the seller shoulders the freight charges. FOB Shipping Point: Owner of the merchandise: Buyer Freight should be paid by: Buyer FOB Destination: Owner of the merchandise: Seller Freight should be paid by: Seller Account to be used for freight charges: Buyer: Freight in Seller: Freight out Periodic and Perpetual Inventory Methods There are two methods of accounting for the inventory of merchandising businesses, namely periodic inventory method and perpetual inventory method. Periodic Inventory Method The Periodic Inventory Method is generally used when the individual inventory items have small peso values. Under this method, the business maintains temporary accounts like purchases, purchase returns, and sales returns. At the end of the accounting period, these temporary accounts are used to determine the amount of inventory available for sale. The value of the ending balance of inventory is determining by conducting a physical count multiplied by the corresponding unit costs. Physical inventory count at the period end is mandatory under the periodic inventory system. Without such count, cost of sales (or cost of goods sold) cannot be determined therefore, businesses have to conduct this activity at least once a year or at every end of an accounting period. Perpetual Inventory Method This inventory method is generally used when the individual inventory items have relatively large values. This method requires the use and maintenance of stock cards. Under this method, the inventory account is continually updated for each inventory transaction. For every journal entry of sales, a corollary journal entry for the cost of inventory sold is also recorded. Purchases and returns are recorded in directly in the Merchandise Inventory account. Physical count of inventory is conducted to confirm the balances in the stock cards. PERIODIC INVENTORY SYSTEM Typical Journal Entries PURCHASES 1. To record purchase goods from a supplier: Purchases xxxx Cash/Accounts Payable xxxxx 2. To record purchase freight costs: Freight-in xxxx Cash xxxx 3. To record purchase discount: Accounts Payable xxxx Purchase Discounts xxxx 4. To record purchase return: Accounts Payable xxxx Purchase Returns and Allowances xxxx SALES 1. To record sales to customer: Cash/Accounts Receivables xxxx Sales xxxx 2. To record freight costs: Freight Out xxxx Cash xxxx 3. To record sales discount:  Sales Discount xxxx Accounts Receivable xxxx 4. To record sales return: Sales Returns and Allowances xxxx Cash/Accounts Receivable xxxx PERPETUAL INVENTORY SYSTEM Typical Journal Entries PURCHASES 1. To record purchase goods from a supplier: Merchandise Inventory xxxx Cash/Accounts Payable xxxxx 2. To record purchase freight costs: Merchandise Inventory xxxx Cash xxxx 3. To record purchase discount: Accounts Payable xxxx Merchandise Inventory xxxx 4. To record purchase return: Accounts Payable xxxx Merchandise Inventory xxxx SALES 1. To record sales to customer: Cash/Accounts Receivables xxxx Sales xxxx Cost of Goods Sold xxxx Merchandise Inventory xxxx 2. To record freight costs: Freight Out xxxx Cash xxxx 3. To record sales discount: Sales Discount xxxx Accounts Receivable xxxx 4. To record sales return: Sales Returns and Allowances xxxx Cash/Accounts Receivable xxxx Merchandise Inventory xxxx  Cost of Goods Sold xxxx Exercise. Periodic Inventory System (Salonga) Salonga Marketing is established by Mr. J. Salonga. He opted to use the periodic inventory system. The business had the following transactions for the month of February: 3 Mr. Salonga invested P80,000 cash into the business. 4 Bought computer equipment for P20,000 cash. 5 Bought merchandise on account from Mathew Trading Co. P30,800, terms 2/10, n/30. 6 Bought office supplies on cash basis for P3,000. 7 Sold merchandise on account P58,500, FOB Destination, terms 2/10, n/30. 10 Received credit from Mathew Trading Co. for merchandise returned P400. 11 Paid Mathew Trading Co. 12 Collected from Feb 7 customers. 13 Bought merchandise on cash basis for P38,900. 15 Salaries paid P7,000. 17 Borrowed money from Banko, signed a promissory note for P12,000. 18 Received refund from a supplier on cash purchase of March 13, P500. 19 Paid freight on February 13 purchase, P800. 20 Sold merchandise for P51,600. 24 Mr. Salonga withdrew cash from the business, P12,000. 25 Gave refunds to cash customers for defective merchandise, P1,500. 28 Paid the following: Utilities P1,138; Rent P3,000; Salaries, P7,000. 28 Based on a physical count conducted, the value of inventory remaining is P17,200. Instructions: 1. Prepare the necessary journal entries. 2. Post to the ledger. 3. Prepare the trial balance. 4. Prepare the financial statements. 5. Record and post the closing entries. 7. Merchandising Business Periodic and Perpetual Inventory Methods There are two methods of accounting for the inventory of merchandising businesses, namely periodic inventory method and perpetual inventory method. Periodic Inventory Method The Periodic Inventory Method is generally used when the individual inventory items have small peso values. Under this method, the business maintains temporary accounts like purchases, purchase returns, and sales returns. At the end of the accounting period, these temporary accounts are used to determine the amount of inventory available for sale. The value of the ending balance of inventory is determining by conducting a physical count multiplied by the corresponding unit costs. Physical inventory count at the period end is mandatory under the periodic inventory system. Without such count, cost of sales (or cost of goods sold) cannot be determined therefore, businesses have to conduct this activity at least once a year or at every end of an accounting period. Perpetual Inventory Method This inventory method is generally used when the individual inventory items have relatively large values. This method requires the use and maintenance of stock cards. Under this method, the inventory account is continually updated for each inventory transaction. For every journal entry of sales, a corollary journal entry for the cost of inventory sold is also recorded. Purchases and returns are recorded in directly in the Merchandise Inventory account. Physical count of inventory is conducted to confirm the balances in the stock cards. PERIODIC INVENTORY SYSTEM Typical Journal Entries PURCHASES 1. To record purchase goods from a supplier: Purchases xxxx Cash/Accounts xxxxx Payable 2. To record purchase freight costs: Freight-in xxxx Cash xxxx 3. To record purchase discount: Accounts Payable xxxx Purchase Discounts xxxx 4. To record purchase return: Accounts Payable xxxx Purchase Returns xxxx and Allowances SALES 1. To record sales to customer: Cash/Accounts xxxx Receivables Sales xxxx 2. To record freight costs: Freight Out xxxx Cash xxxx  3. To record sales discount: Sales Discount xxxx Accounts xxxx Receivable 4. To record sales return: Sales Returns and xxxx Allowances xxxx Cash/Accounts Receivable PERPETUAL INVENTORY SYSTEM Typical Journal Entries PURCHASES 1. To record purchase goods from a supplier: Merchandise Inventory xxxx  Cash/Accounts xxxxx Payable 2. To record purchase freight costs: Merchandise Inventory xxxx Cash xxxx 3. To record purchase discount: Accounts Payable xxxx Merchandise xxxx Inventory 4. To record purchase return: Accounts Payable xxxx Merchandise xxxx Inventory SALES 1. To record sales to customer: Cash/Accounts xxxx Receivables Sales xxxx Cost of Goods Sold xxxx  Merchandise xxxx Inventory 2. To record freight costs: Freight Out xxxx Cash xxxx 3. To record sales discount: Sales Discount xxxx Accounts xxxx Receivable 4. To record sales return: Sales Returns and xxxx Allowances xxxx Cash/Accounts Receivable Merchandise Inventory xxxx Cost of xxxx Goods Sold