ABRAHAM, Daisy Jane ACCT1A&B Reviewer

Introduction to Accounting

Business – An organization engaged in the trade of

goods, services or both, to consumers.

Profit-oriented – administered to earn profit

to increase the wealth of owners

Non-profit oriented – uses surplus revenues

to achieve its goals (ex. charity)

Forms of Business Entities According to Nature

Service Business

- simplest form among the three

- offers services and generates profit by

charging a fee.

Merchandising Business - buys goods and

sells them in their original form; no change

in product

Manufacturing Business - buys goods called

raw materials, then converts them into

finished products; MOST COMPLEX

because of the conversion of the raw

materials into finished goods

Legal Forms of Business (Business Ownership)

Sole Proprietorship

- one owner; can operate on his own or employ

others as business operations expand; most basic

legal form of business

Advantages

- Easiest to form

- Less complex business transactions

- Minimal regulatory requirements

- Decisions implemented faster

- Proprietor enjoys all profits

Disadvantages

- Limited ability to raise capital

- No second opinion

- Proprietor bears the risks and losses of the

enterprise

- Unlimited personal liability

Partnership - an association of two or more

persons, the partners, who bind themselves to

contribute money, property or industry to a

common fund, with the intention of dividing the

profits among themselves.

- governed by the Civil Code of the Philippines

Advantages

- Easier to organize compared to a corporation

- Burden is shared

- More ideas are exchanged, better decision

making

Disadvantages

- May result to disagreement

- Life of partnership is fragile

- Unlimited personal liability for partnership debts

Corporation - Most complex form of business

organization; Corporation code defines a

corporation as an artificial being created by law.

They can sue and be sued.

Stockholder - a person who invests

and becomes an owner of the

corporation

Advantages

- Has the greatest capacity to raise capital

- Stockholders may transfer their shares

- Limited liability of owners

Disadvantages

- Cost of forming and managing is relatively high

- Subject to greater scrutiny, regulation, control

and supervision by the government

- Has limited powers

- Higher income tax rate

Economic Decisions

- One important assumption in decision making

is the existence of reliable information

- Significant number of this comes from

accounting information

- Making right decisions requires great skill,

timing, sound professional judgment, and the

use of reliable financial information

Financial Information

-Decision making process requires financial and

nonfinancial information as well

-summary of all the transactions of the business

over a period of time

- Transactions of the business are recorded by

bookkeepers or accountants

Accounting Defined

“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” (Committee on

Accounting Terminology of the American Institute of

Certified Public Accountants)

“Accounting is the process of identifying,

measuring and communication economic

information to permit informed judgment and

decision by users of the information.” (American

Accounting Association)

“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)

Basic Purpose of Accounting

- Supply financial information to users to help

them make informed judgments and better

decisions

Accounting – the language of business; used to

communicate financial information to interested parties;

through accounting, different users of financial

information understand what is happening in the

business enterprise.

Accounting And Bookkeeping Distinguished

Bookkeeping - procedural or mechanical aspect

of accounting; involves the set-up, update and

maintenance of accounting records

Accounting – conceptual and goes beyond

bookkeeping; includes interpretation of

information recorded under bookkeeping

The Accountancy Profession

The profession is relatively new; accounting is a

profession because it has the attributes required of a

profession:

1. Mastery of a particular intellectual skill, acquired by

training and education

2. Adherence by its members to a common code of

values and conduct established by its administrating

body, including maintaining an outlook which is

essentially objective

3. Acceptance of a duty to society as a whole (usually

in return for restrictions in use of a title or in the

granting of a qualification)

The Philippine Accountancy Act Of 2004

This profession is governed by law; R.A. NO. 9298–

was signed into law with the following objectives:

- Standardization and regulation of accounting

education

- Examination for registration of certified public

accountants

- Supervision, control, and regulation of the practice

of accountancy in the Philippines

Article II of RA 9298 -Creates the Professional

Regulatory Board of Accountancy

PRBA - Agency tasked to enforce the provisions of

the Philippine Accountancy Act; also granted the

right to issue, suspend, revoke or reinstate CPA

certificated for the practice of the profession

- Composed of a chairman and six members, all of

whom are appointed

The CPA Board Exams

Requisites for any person applying for examination:

- Filipino citizen

- Good moral character

- Holder of the degree of Bachelor of Science in

Accountancy conferred by a school, college, academy

or institute duly recognized and/or accredited by the

CHED or other authorized government offices

- Has not been convicted of any criminal offense

involving moral turpitude

Subjects, but not limited to:

- Management Services

- Business Law and Taxation

- Theory of Accounts

- Auditing Theory

– Auditing Problems

- Practical Accounting Problems I

- Practical Accounting Problems II

75% - general average, with no subject lower than 65%

Conditional credit – must retake subjects lower than

65% and should pass it

After 2 failed attempts in the boards, candidates should

enroll 24 units of the subjects again

Sectors Of Accounting Practice

Public Practice – includes individual

practitioners, small accounting firms, medium

sized and multinational accounting firms that

render independent professional accounting

services to the public; CPAs charge professional

fees

Examples of services by CPAs

Auditing – the most common service being

provided by CPAs; involves the independent

examination of financial statements for the

purpose of expressing an opinion on the fairness

of these statements

Tax services – this includes the preparation of

tax returns for various clients, provision of advice

on tax matters, and representation of clients in tax

cases

Management consulting services – involves

providing/ consulting services to clients on

matters of accounting, finance, business policies,

organization procedures, budgeting, product

costing and the conduct of operations

Commerce And Industry – Accountants in

commerce and industry assist management in

planning and controlling a company’s operations

Comptroller – highest accounting officer

in a business organization

Education – employs accountants as professors,

reviewers or researchers; they take steps to clarify

ad address emerging accounting issues

encountered by accountants in other sectors

Government – may be hired as staff, auditor,

budget officer, or consultant in government units

like CoA, BIR, DF, DBM, and SEC

Brief History Of Accounting

Accounting traces its roots to the Middle East region,

where as early as 850BC, tradesmen use clay objects to

represent commodities such as flocks of sheep, jars of

spices and oil, bolts of clothing and other goods

The ancient civilizations of Babylon, Greece and

Egypt also used clay tablets (in later years, papyri were

used as the medium for record-keeping)

13th to 15th centuries – growth of trade, more

systematic recordkeeping methods were developed;

FLORENTINE, VENETIAN and GENOAN

merchants used these methods to keep trac of their

business. DOUBLE ENTRY RECORDS first

appeared in Genoa in 1340AD

Luca Pacioli And The Summa

1494 – Friar Luca Pacioli wrote a book which contains

discussions on the double-entry bookkeeping entitled

Summa De Arithmetica Geometria, Proportioni

Et Proportionalita (Everything about Arithmetic,

Geometry, Proportions and Proportionality). This is a

summary of the existing mathematical knowledge at

that time. He was considered the “Father Of Double-

Entry Bookkeeping” because of this.

The Industrial Revolution

Mid 18th to mid 19th century – from craftsmen

method to assembly-line method; overhead costs

became problematic. To solve this, cost accounting

was developed.

Cost Accounting – specialized field of accounting

which deals with the allocation of costs to products.

The corporate form of business organization was

created to accommodate the need for increasingly large

amounts of funds which are required to finance the

expansion of business during this period

Fields Of Accounting

Financial Accounting – focuses on the

preparation and presentation of general-purpose

financial statements with the aim of meeting most

of the needs of external users

Management Accounting – is concerned

primarily with financial reporting for internal users,

such as management. These users have control over

the accounting system and can specify precisely the

type of reports needed for use in decision-making

Cost Accounting – measures a business’s costs to

help management in controlling expenses. Cost

accounting records guide managers in setting prices

for their products and services to achieve greater

profits

Tax Accounting – has two aims: compliance

with the tax laws and minimizing the company’s tax

bill through legal means. Accountants provide tax

planning and tax consultancy services, such as giving

advice to clients on what type of investments to

make and on how to structure business transactions

Government Accounting –the focus is the

proper custody, disposition and accounting for

public funds

Basic Accounting Concepts & The Financial

Statements

Financial Statements – are the means by which the

information accumulated and processed in financial

accounting is communicated to users on a timely

basis.

Accountants/ Bookkeepers accumulate financial

information thru the preparation of financial

statements

GAAP “Generally Accepted Accounting Principles”

-comprises the conventions, rules, processes,

principles, standards, and underlying assumptions that

are used in preparing financial statements

-not rigid or unchanging – accounting principles

continue to evolve as a response to the changes in the

financial information needs of business stakeholders

Financial Reporting Standards Council

FRSC – is the official accounting standard setting

body in the Philippines

Upon recommendation of BoA, the PRC created

FRSC

Primary Task: – improve and establish accounting

standards that will be generally accepted in the

Philippines

Structure: – has a chairman and 14 representatives

BSP – 1

BOA – 1

BIR – 1

COA – 1

Major organization of preparers and users of

financial statements – 1

SEC – 1

Accredited Nat’l Professional Organization of CPAs

in Commerce and Industry – 2

Public Practice – 2

Academe – 2

Government – 2

Total – 14

Chair and members – serve a term of 3 years which

is renewable

Philippine Financial Reporting Standards( FRSC) -

pursuant to its task, issues accounting standards called

Philippine Financial Reporting Standards

PFRS - constitute the generally accepted accounting

standards observed in the Philippines

PFRS includes the following:

- PAS – Philippine Accounting Standards

- PFRS

- Philippine Interpretations developed by the

Philippine Interpretations Committee

Basic Accounting Concepts

-Accounting calls for scientific approach toward the

recording of innumerable business transactions

Business Entity Principle –the business is

considered distinct and separate from the owners

of the business; business is a separate accounting

entity

Accounting Entity – is an organization that is

accounted for as a separate economic unit

Matching Principle- profit or loss is computed

by deducting the expenses incurred from the

income earned during an accounting period.

- This means that the income recorded and reported

in one accounting period should be matched against

the expenses that directly

Accrual Basis – income is recognized when it is

earned, regardless of when cash is received.

Expenses are recognized when incurred, regardless

of when cash is paid

Cash Basis Of Accounting – income is

recognized when cash is received, and expenses are

recognized when cash is paid

Stable Monetary Unit – business transactions

must be expressed in terms of a uniform means of

measurement

- Transactions which do not involve cash are

assigned values according to acceptable bases for

measurement

- Accounting assumes that the peso is not materially

affected by inflation

Periodicity (Time Period Concept) – assumes

that the operating life of an enterprise may be

conveniently divided into time periods of equal

length, called accounting period

Types: Calendar and Fiscal Accounting Period

Going Concern (Continuity Assumption)

– The financial statements are normally prepared

on the assumption that an enterprise is a going

concern and will continue in operation for the

foreseeable future. It is assumed that the enterprise

has neither the intention nor the need to liquidate or

curtail materially the scale of its operation

The Accounting Framework

-sets out the concepts that underlie the preparation

and presentation of financial statements for external

users

Purposes Of The Framework

a) Assist the FRSC in developing accounting

standards that represent GAAP in the Philippines

b) Assist the FRSC in its review and adoption of

existing International Financial Reporting Standards

c) Assist preparers of financial statements in applying

FRSC Philippine Financial Reporting Standards and

in dealing with topics that have yet to from the

subject of an FRSC Statement

d) Assist auditors in forming an opinion as to

whether financial statements conform with

Philippine GAAP

e) Assists users of financial statements in interesting

the information contained in financial statements

prepared in conformity with Philippine GAAP

f) Provide those who are interested in the work of

the FRSC with information about its approach to the

formulation of Philippine Financial Reporting

Standards

Is The Framework Part Of Accounting

Standards?

– The Framework is not a PFRS and hence does not

define standards for any particular measurement or

disclosure issue. In case of CONFLICT,

requirements of PFRS shall prevail.

Scope of the Framework

a) Objective of financial statements

b) Underlying assumptions in the preparation of

financial statements

c) Qualitative characteristics that determine the

usefulness of information in financial statements

d) Definition, recognition and measurement of the

elements of the financial statements

e) Concepts of capital and capital maintenance

Financial Statements – are the means by which

the information accumulate in and processed by

financial accounting is communicated to users on a

periodic basis; the END-PRODUCT of the

financial accounting process

Complete set:

a) Statement of Financial position or balance sheet

b) Statement of comprehensive income

c) Statement of changes in equity

d) Statement of cash flows

e) Notes to the financial statements

Users Of Financial Statements

1. Investors

- “providers of risk capital”;

- Concerned with the risk inherent and in return

provided by, their investments;

- Need information to help them determine whether

they should buy, hold, or sell their investments

-In the case of corporations, shareholders are also

interested in information, which enables them to

assess the ability of the enterprise to pay dividends

2. Employees

-Interested in information about the stability and

profitability of their employers

- Interested in information which enables them to

assess the ability of the enterprise to provide

remuneration, retirement benefits and employment

opportunities

3. Lenders - Interested in information that enables

them to determine whether their loans and the interest

attaching to them, will be paid when due

4. Suppliers And Other Trade Creditors

- Interested in information that enables them to

determine whether amounts owing to them will be

paid when due

-Trade creditors are likely to be interested in an

enterprise over a shorter period than lenders unless

they are dependent upon the continuation of the

enterprise as a major customer

5. Customers - Interest in information about the

continuance of an enterprise especially when they

have a long term involvement with, or are dependent

to the enterprise

6. Government And Their Agencies

- Interested in the allocation of resources, and

therefore the activity of the enterprise

- Require information in order to regulate the

activities of enterprises, determine taxation policies

and as the basis for national income and similar

statistics

7. The Public - Providing information about the

trends and developments in the prosperity of the

enterprise and the range of its activities

Main Users Of Financial Statements –for the use

of INVESTORS and CREDITORS

Information Provided By Financial Statements –

aim to provide information about the FINANCIAL

POSITION, FINANCIAL PERFORMANCE,

AND CASH FLOWS of an entity that is useful to a

wide range of users in making economic decisions

Financial Position

- the condition of a business, in monetary terms, as

of a given date or point in time

- Information about this is primarily provided in a

statement of financial position or BALANCE

SHEET

-Financial position is affected by the economic

resources it controls, its financial structure, its

liquidity and solvency, and its capacity to adapt to

changes in the environment in which it operates

Liquidity – availability of cash in the near future to

cover currently maturing liabilities or obligations

Solvency – is the availability of cash over the long

term to meet obligations when they fall due

Capacity For Adaptation - is the ability of the

enterprise to use its available cash for unexpected

requirements and investment opportunities

Performance Or Profitability

– refers to whether a company is able to generate

profit or incur a loss during a particular accounting

period; this is usually provided in a STATEMENT

OF COMPREHENSIVE INCOME; it has two

parts

Profit/loss portion

Other comprehensive income portion

Income Statement/ Result Of Operation/

Statement Of Performance/– is a useful tool for

evaluating management’s stewardship of the

resources of the enterprise; also useful in assessing

the inflow and outflow of cash

Changes In Financial Position

- useful in order to assess its investing, financing and

operating activities during the reporting period.

Statement of Changes in Equity - shows the

balance of the owner’s investment in the business

at the beginning of the accounting period,

additional investments made by the owner,

withdrawals by the owner for personal use, the

profit or loss for the period and the balance of the

owner’s investment at the end of the accounting

period.

Statement of Cash Flows - summarizes cash

activity (inflow and outflow) for the period,

classified according to the nature of activity

(Operating, Investing Or Financing)

Frequency Of Preparation Of Financial Statements

-Financial statements are prepared at least annually

-Financial statements for periods of less than one

year may also be prepared, such as monthly,

quarterly or semi-annually

-Shorter-period financial statements are called

Interim Financial Statements

-The frequency of preparation depends on the

needs of users and the cost-benefit consideration

-The cost of preparing financial statements more

frequently must not exceed the benefits obtained

from the use of these financial statements

Responsibility For Financial Statements

-The management of an enterprise has the primary

responsibility for the preparation and presentation

of the financial statements of the enterprises

-Management is also responsible for selecting and

applying the accounting policies and principles

which are appropriate for the company

The Elements Of The Financial Statements

- Financial statements portray the financial effects of

transactions and other events by grouping them into

broad classes(“Elements Of Financial Statements”)

according to their economic characteristics

Assets, liabilities, equity – elements directly

related to the measurement of financial position

Income, expense – elements directly related to

the measurement of performance

Statement of changes in equity and statement

of cash flows – reflect a combination of all these

elements

Elements Pertaining To Financial Position

Assets – resources owned and/or controlled by

the enterprise

-Expected to provide future economic benefits to the

enterprise

Examples:

Cash – money on hand, or in banks, and other

items considered as medium of exchange in

business transactions

Accounts Receivable – valid claims from

customers or clients arising from the provision

of services or delivery of goods in the ordinary

course of business, where the price for these

services or goods have not yet been paid (on

account or on credit)

Supplies On Hand – refers to supplies

purchased by an enterprise which are unused

as of the reporting date

Merchandise Inventory – goods which have

been bought from suppliers for resale to

customers at a price higher than cost

Property, Plant And Equipment – long lived

assets that have been acquired for use in

operations. Land, building, machinery,

furniture, fixtures, equipment, transportation

or delivery vehicles are examples of PPE.

Liabilities – present obligation of the enterprise

arising from past events, which are to be settled in

the future; debts of the business

Examples:

Accounts Payable – amounts due, or payable

to, suppliers for goods purchased on account or for

services received on account

Salaries Payable – salaries due to employees

which are unpaid as of reporting date

Utilities Payable – amounts due, or payable

to, utility companies for electricity, heat, light, and

water changes

Advances From Customers – amounts

received from customers, in advance, for the delivery

of goods or provision of services

Loans Payable – obligations of an enterprise

to lenders to be paid on demand or at a specified

future date agreed between the enterprise and the

lender

Equity – means a claim; technically, creditors and

owners both have claims on the assets of the

enterprise

- residual interest in the assets of the enterprise after

deducting all its liabilities

Elements Pertaining To Performance Or Profitability

Income – refers to increases in economic benefits

during the accounting period in the form of inflows

or enhancements of assets or decrease of liabilities

that result in increase in equity, other than those

relating to contributions from equity participants.

Revenue arises in the course of the ordinary

activities of an enterprise and is referred to by a

variety of different names including sales, fees,

interest, dividends, royalties, and rent

Gains represent other items that meet the

definition of income and may, or may not arise

in the course of the ordinary activities of an

enterprise

Expenses - refer to decreases in economic benefits

during the accounting period in the form of

outflows, or depletion of assets or incidences of

liabilities that result in decrease in equity, other

than those relating to distributions to equity

participants.

Losses represent other items that meet the

definition of expenses and may or may not

arise in the course of the ordinary activities of

the enterprise

Recognition Of The Elements Of The Financial

Statements

Recognition – process of incorporating in the

statement of financial position or statement of

comprehensive income an item that meets the

definition of an element and satisfies the criteria

for recognition

Criteria For Recognition

An item that meets the definition of an element

should be recognized if:

1. It is probable that any future economic benefit

associated with the item will flow to or from the

enterprise

2. The item has a cost or value that can be

measured with reliability

Following these two main criteria, we can

summarize the recognition principles for each

element, as follows:

-An asset is recognized in the statement of financial

position when it is probable that the future

economic benefits will flow to the enterprise and

the asset has a cost or value that can be measured

reliably.

-A liability is recognized in the statement of

financial position when it is probable that an

outflow of resources embodying economic benefits

will result from the settlement of a present

obligation and the amount at which the settlement

will take place can be measured reliably.

-Income is recognized in the statement of

comprehensive income when increase in future

economic benefits related to an increase in an asset

or a decrease of a liability has arisen that can be

measured reliably.

-Expenses are recognized in the statement of

comprehensive income when a decrease in future

economic benefits related to a decrease in an asset

or an increase of a liability has arisen that can be

measured reliably.

Measurement Of The Elements Of The Financial

Statements

-measurement is the process of determining the

monetary amounts at which the elements of the

financial statements are to be recognized and carried

in the financial statements

Measurement Bases

Historical Cost

– Assets are recorded at the amount of cash or cash

equivalents paid or the fair value of the

consideration given to acquire them at the time of

their acquisition

-Liabilities are provided at the amount of proceeds

received in exchange for the obligation or in some

circumstances (ex, income taxes), at the amounts of

cash or cash equivalents expected to be paid to

satisfy the liability in the normal course of business

-Most commonly used measurement basis in

accounting because it is deemed as the most

objective basis

Current Cost

-Assets are carried at the amount of cash or cash

equivalents they would have to be paid if the same

or an equivalent asset was acquired currently.

-Liabilities are carried at the undiscounted amount

of cash or cash equivalents that would be required

to settle the obligation currently

Realizable (Settlement) Value

-Assets are carried at the amount of cash or cash

equivalents that could currently be obtained by

selling the asset in an orderly disposal.

-Liabilities are carried at their settlement values; that

is the undiscounted amounts of cash or cash

equivalents expected to be paid to satisfy the

liabilities in the normal course of business

Present Value

-Assets are carried at the present discounted value

of the future net cash inflows that the item is

expected to generate in the normal course of

business

- Liabilities are carried at the present discounted

value of the future net cash outflows that are

expected to be required to settle the liabilities in the

normal course of business

Qualitative Characteristics Of Financial Statements

- attributes that make the information provided in

financial statements useful to users

-Relevance and reliability – refer to content of FS

-Understandability and comparability – refer to

the way FS are presented

2 Fundamental or Primary Qualitative Characteristics

(1) Relevance -Information has the quality of relevance

when it influences the economic decisions of users by

helping them evaluate past, present, or future events, or

confirming or correcting their past evaluations

Ingredients of Relevance

Predictive Role (Value)– information is

relevant if it is used to make predictions of, say,

future cash inflows or income in future periods

Confirmatory Role (Feedback Value) –

information is relevant if it used to confirm or

correct the earlier expectations of a financial

statement user

Materiality – information is material if its omission

or misstatement could influence the economic

decisions of users taken on the basis of the financial

statements; there is no clear-cut amount considered

to be material – what is material to one company

may be immaterial to another

(2) Faithful Representation –information must

represent faithfully the transactions and other events it

either purports to represent or could be reasonably

expected to represent; this means that the actual effects

of transactions should be properly accounted for and

reflected in the financial statements

Completeness - includes all information,

including all necessary descriptions and

explanations necessary for a user to understand

the phenomenon being depicted.

Neutral – one without bias in the selection or

presentation of financial information

Free from error - no error or omissions

4 Enhancing or Secondary Qualitative Characteristics

(1) Comparability – enables users to identify and

understand similarities in, and differences among items

(2) Verifiability – helps assure that information

faithfully represents the economic phenomena that it

purports to depict

(3) Timeliness – information is available to decision-

makers in time to be capable of influencing their

decisions

(4) Understandability – information is made

understandable by classifying, characterizing and

presenting it clearly and concisely

The Accounting Equation And The Double-Entry

Bookkeeping System

Business Transaction – an exchange of values

(expressed in terms of money) involving two parties

(for external transactions) or within the enterprise; it is

an economic activity that causes increases and/or

decreases in the elements of the financial statements

External Transactions – include the

sale of goods to customers or the

provision of services to clients

Internal Transactions – include the

manufacture of goods for sale and

incurrence of losses by the company

resulting from fire or flood (casualty

losses)

-Not all events in business enterprise are considered

accountable; only if it has an effect on the elements of

the financial statements

Source Documents – is the original record of a

business transaction; at a minimum, source documents

contain the following: date of transaction, nature of

transaction, and the amount involved; also contains

names of parties involved Control Over Source

Documents

-All business transactions that are taken up in the

accounting records of the enterprise should have

supporting source documents

-Usually, the source documents supporting the

transactions for the day are collected, classified, and

filed in CHRONOLOGICAL ORDER or

SEQUENTIAL ORDER

Examples Of Source Document:

Sales Invoice – a cash sales invoice is issued to

evidence a sale for cash; a charge sales invoice or

credit sales invoice is issued to evidence a sale

where goods are sold on account or on credit

Delivery Receipt – a document prepared by the

enterprise and signed by the customer to

evidence the acceptance/ receipt of the goods

delivered to the customer

Official Receipt – issued by the business to

evidence the receipt of cash from customers, the

proprietor, and other parties

Vendor’s Invoice – this is actually a “Sales

Invoice”, except that it is issued to the enterprise

by the enterprise’s suppliers or vendors; a bill for

goods purchased or services availed

Purchase Requisition Forms – source

document which evidences an employee’s

request for the purchase of needed goods or

supplies; purchase requests must be approved by

the company management before an actual

purchase is made

IOUs – a note acknowledging indebtedness to

the enterprise; usually prepared, signed, and

issued by employees who request and receive

cash advances from the enterprise

Promissory Notes – an unconditional promise

in writing made by one person (called the maker)

to another, signed by the maker, engaging to pay

on demand, or at a fixed or determinable future

time, a sum certain in money to order or to

bearer

Bank Statements – a summary of all financial

transactions occurring over a certain period

(usually a month) on a bank account; it shows

the beginning balance of the account, any

increases or decreases (with brief explanation)

and the ending balance of the account

Minutes Of Meetings – written record of a

meeting

Business Letters – business correspondence

with government agencies, customers, suppliers

or other parties

Job Time Tickets – forms containing

information on time spent working at a particular

customer order (job)

Certificates Of Stock – documents evidencing

ownership of shares in a corporation

Time Records/ Timesheets – a detailed record

showing time-in and time-out of employees for a

particular period of time (usually every half-

month)

Check Voucher – form used to facilitate the

authorization of cash disbursement transactions;

a voucher contains the name of the payee, the

reason for disbursement, and the amount

involved; management affixes its signature on the

voucher, evidencing approval of the cash

disbursement

Journal Voucher – document used for

transactions and journal entries for which there is

no other source document; usually prepared in

connection with year-end adjustments to the

accounting records and for correcting errors in

the records

The Basic Accounting Equation

Assets = Liabilities + Equity

Business Transactions And The Accounting Equation

In analyzing business transactions for purposes of

recording, remember the following

-In every transaction, VALUE RECEIVED = VALUE

PARTED WITH. The two values must always be equal

-The basic accounting equations must always be

maintained

Business transactions, therefore, have the following

possible effects on the accounting equation:

a) Increase Assets= Increase Liabilities

b) Increase Assets= Increase Equity

c) Increase Asset = Decrease Asset

d) Decrease Assets = Decrease Liabilities

e) Decrease Asset = Decrease Equity

f) Increase Liabilities = Decrease Equity

g) Increase Equity = Decrease Liability

h) Increase Liability = Decrease Liability

i) Increase Equity = Decrease Equity

Expanded Accounting Equation – includes the elements

of income and expense

Assets = Liabilities + Equity + Income – Expenses

The Account – This is the basic summary device

of accounting; separate accounts are maintained for

each element; an account records the increases,

decreases, and balance of each element of the

financial statements

Debit – left side of an account

Credit – right side of an account

Common Examples Of Account Titles Used

Asset Accounts

Cash – the medium of exchange for business

transactions; it is accepted by a bank for deposit and

immediate credit at face value; cash includes:

currency and coins, checks, money orders, bank

drafts, and demand deposit accounts

Held For Trading Securities – Temporary

investments of excess cash which are primarily held

for short-term gain; technically, this account is

known as “Investments At Fair Value Through

Profit Or Loss”

Loans And Receivables – loans and

receivables include trade receivables and non-trade

receivables; trade receivables are claims against

others which arise in the ordinary course of doing

business;

Examples:

Trade Accounts Receivable – these are

claims against customers arising from the

provision of services or delivery of goods

on credit

Trade Notes Receivables – a note

receivable is a written promise from the

customer to pay a fixed amount of money

on a certain future date; being a formal and

written document, it offers more security

than accounts receivable

Non-Trade Receivables – represent all

other claims which are not trade; they may

be nontrade accounts receivable or non-

trade notes receivable

Inventories – these are assets which are (a) held

for sale in the ordinary course of business; (b) in

the process of production for such sale; or (c) in

the form of materials or supplies to be consumed

in the production process or in the rendering of

services

Prepaid Expenses – these are expenses paid

for by the business in advance; prepaid expenses

are assets when they are paid for. Subsequently,

they become expenses.

Long-Term Investments – an investment as

an asset held by an enterprise for the accretion of

wealth through capital distribution, such as interest,

royalties, dividends and rentals, for capital

appreciation or for other benefits to the investing

enterprise such as those obtained through trading

relationships

Property, Plant And Equipment – these are

tangible assets held by an enterprise for use in the

production or supply of goods and services, or for

rental to others, or for administrative purposes and

which are expected to be used during more than

one accounting period; examples: land, building,

transportation and delivery vehicles, furnitures and

fixtures, machinery and equipment

Intangible Assets – these assets are

identifiable, non-monetary assets without physical

substances; examples: patents, copyrights, licenses,

franchises, and trademarks

Liability Accounts

Accounts Payable – this account is the

opposite of accounts receivable

Notes Payable – note payable is like a note

receivable, except that this time the enterprise is

the one who promises to pay

Accrued Liabilities – these are amounts owed

to others for unpaid expenses; they are similar to

accounts payable, except that accounts payable are

for items which have already been consummated,

while accrued expenses are for items which are

continuing in nature (such as utility services);

examples are: salaries payable, interest payable,

taxes payable, accruals for utility expenses

Unearned Revenues – sometimes the

enterprise receives payments before providing its

customers with goods or services; this creates an

obligation on the part of the enterprise to deliver

goods or provide services; once the enterprise

complies with what is required of it, the advance

collections from customers are already earned and

become part of income

Mortgage Payable –used for recording long-

term debt of an enterprise for which the company

has pledged certain assets as security for the debt

(collateral). In the event that the debtor could not

pay the obligation, the creditor can FORECLOSE

or cause the mortgaged asset to be sold and the

proceeds are used to settle the debt.

Bonds Payable – large sums of money are

often required by a business for working capital

and expansion purposes. An enterprise often

obtains the needed funds by issuing (floating)

bonds. A bond is a contract between the issuer

and the lender specifying the terms of repayment

as well as the interest to be paid. Interest is

normally paid on an annual, semi-annual or

quarterly basis Equity Accounts

Equity – “capital”, is used to record the

original and additional investments of the owner

of the business entity. Capital is increased by net

income earned during the year. Conversely, a net

loss decreases capital.

Withdrawals – when the proprietor withdraws

cash or other assets for non-business use, such

withdrawals are reflected in the Withdrawals

account.

Income Summary – it is a temporary account

used to summarize all income and expenses for a

given period.

Service Income Or Fees Income – revenues

earned by performing services for customers

Sales – revenues earned as a result of sale of

merchandise

Expense Accounts

Cost Of Sales – the cost incurred to purchase

or to produce the products sold to customers

during the period. For a service business, any

expense which could be directly attributed to

the provision of services is called cost of

services

Salaries And Wages Expense – includes all

payments as a result of an employer-employee

relationship such as salary or wages, 13th

month pay, and other related employee

benefits. Salaries are normally paid for workers

who use analytical skills (white-collar

employees) on the other hand, wages are paid

to workers who use manual labor (blue-collar

employees)

Utilities Expense (Telephone, Electricity,

Fuel And Water Expense) – expenses related

to use of communication facilities, the

consumption of electricity and water

Rent Expense – expense for leased office

space, equipment or other assets rented from

other

Supplies Expense –used for recording the

usage of supplies in the normal course of

business

Insurance Expense – portion of premiums

paid on insurance coverage which has expired

Depreciation Expense – the portion of the

cost of a tangible asset allocated or charged as

expense during an accounting period

Bad Debts Expense – the amount of

receivables estimated to be uncollectible and

charged as expense during an accounting

period.

Interest Expense – an expense related to use

of borrowed funds. This is also known as

“Finance Cost”.

The Double-Entry Accounting System

Under the double-entry accounting system the DUAL

EFFECTS of a business transaction is recorded (both

the value received and the value parted with). The

following summary would prove useful in applying the

system:

1. For every debit (Dr.) entry, there must be a

corresponding credit (Cr.) entry. The accounting

equation must always be maintained

2. Each transaction affects at least two accounts

(one debited, one credited)

3. Total debits for a transaction must equal total

credits

4. An account is debited when an amount is

entered on the left side of the account and

credited when the amount is entered on the right

side

5. The account type determines how increases or

decreases in it are recorded. Increases are

recorded on the side of an account based on its

position in the accounting equation

a. Since assets are on the left side of the

accounting equation, increases in assets are

recorded as debits (left side), while decreases are

recorded as credits (right side)

b. Since liabilities and equity are on the right side

of the accounting equation, increases in liabilities

and equity are recorded as credits (right side) and

decreases are entered as debits (left side)

c. Income increases equity, hence, income is

recorded in the same manner as equity (credit to

increase, debit to decrease)

d. Expense decreases equity, hence, increases in

expenses are debited, while decreases are credited

T-Account – is a simplified form of an account.

Using this, the rules of debit and credit are

presented as follows:

Account Balances

-The difference between the total debits and the

total credits of each account is called an account

balance

-If the total debits are greater that the total credits,

the account balance is called a Debit Balance

-If the total credits are greater that the total debits,

the account balance is called a Credit Balance

Normal Balances – is the usual balance of an

account assuming proper accounting has been

made

Normal Debit Balances – assets and expenses

Normal Credit Balances – liabilities, equity, and

income

If an account has an abnormal balance, it is usually an

indication of possible errors in the recording of business

transactions. Abnormal balances require investigation by

the company regarding the cause of the abnormality,

followed by adjustments or corrections to bring the

account into normal balance.

Accounting Cycle – Service Business

Steps In The Accounting Cycle

I. Analyzing business transactions through source

documents

II. Journalizing, or the recording of transactions in

a journal

III. Posting or transferring of the entries from the

journal to the ledger

IV. Preparing the trial balance

V. Preparing a 10-column worksheet and making

the necessary adjusting journal entries

VI. Preparing the financial statements based on

adjusted account balances

VII. Recording adjusting entries to the journal and

posting the same to the ledger

VIII. Recording and posting of closing entries

IX. Ruling and balancing real and nominal

accounts

X. Preparing a post-closing trial balance

XI. Preparing reversing entries

Book Of Accounts

The Journal

-the book where transactions are initially

recorded in a systematic and chronological order

(hence, journals are called the “books of original

entry”)

-For each transaction, a journal shows the debit

and the credit effect of transactions on specific

accounts

General Journal – the most basic form of a

journal; the journal may be part of either a

manual accounting system or a computerized

accounting system

Procedures For Recording Journal Entries

The following procedures are used when recording

journal entries in a two-column general journal,

assuming a manual accounting system is in place:

1. Analyze The Business Transactions – the

entry to be made should reflect a transaction’s

economic substance rather than its legal form.

Proper analysis of a transaction can only be done

by reviewing the source documents that support

the transaction

2. Write The Date Of The Entry In The Date

Column – the date can be readily determined

based on the date per source document

Write the year in small figures at the top

of the column. The month is written

below the year, on the first line.

Write the day of the month on the first

line in the second column immediately

after the name of the month

The date is written only once for each

entry. The month need not be repeated

for other entries within the same month

3. Record The Debit Part Of The Entry

Write the account title at the extreme

left edge of the Account Title column. Write

the amount of the amount in the Debit column

4. Record The Credit Part Of The Entry

Indent each account title about one-half

inch from the left edge of the Account Title

column. Write the amount of the credit item in

the Credit column.

5. Provide A Brief Description Of The

Transaction To Explain The Journal Entry

Made

Indent each line of the description about one

inch from the left edge of the Account Title

column.

Other Things To Remember When Recording Entries

1. The accountant should have a clear

understanding of what the transaction is all about in

order to permit the selection of the appropriate

accounts to debit and to credit

2. If there is only one account debited and one

account credited, the entry is known as a Simple

Journal Entry. Where more than one account is

involved in a single entry, it is known as a

Compound Journal Entry

3. Using peso signs in columnar books of accounts

is NOT REQUIRED – unless otherwise stated, the

amounts are assumed to be in Philippine peso

4. Sometimes, the accountant makes an entry in

narrative format – there are no accounts debited or

credited. An entry which has no debit or credit

which shows only the date and a brief explanation

or reminder, is known as a Memorandum Entry

5. If an error is made in writing any part of the

entry, the entry is corrected by drawing a line

through the incorrect part and writing the

correction immediately above it

The Chart Of Accounts

-list of all the accounts of the business and their

respective account numbers.

-Using this would reduce confusion as to the choice

of account titles and permits uniformity in recording

routine transactions

-The accounts are arranged in the following

order: Assets, Liabilities, Equity, Income,

Expenses.

-Ordinarily, the chart of accounts is prepared

by the accountant who set up the accounting

system of the business

-The group of accounts is called a Ledger

-It is also known as the book of Final Entry

-A general ledger contains the entire set of

accounts used by a business

-The effects of business transactions are

summarized in individual accounts and each

account has an individual record in the ledger

Procedures For Posting Journal Entries

-The process of transferring the entries from the journal

to the accounts in a ledger is called Posting

-Normally, posting is done at the end of the month,

when all journal entries for the month have been

recorded

The following steps are observed during posting:

1. Using the ACCOUNT NUMBER (as provided

for in the chart of accounts) locate the account

title in the ledger

2. Write the DATE of the journal entry in the date

column of the ledger

3. Write in the REFERENCE COLUMN

(JOURNAL REFERENCE OR JR) of the ledger

the page of the journal where the journal entry

came from

4. Transfer the DEBIT AMOUNT from the journal

entry to the DEBIT COLUMN per ledger, and

the CREDIT AMOUNT per journal entry to the

CREDIT COLUMN per ledger

5. Enter the account number in the REFERENCE

COLUMN (POSTING REFERENCE OR PR)

the account number once the figure has been

posted to the ledger

Trial Balance

-After all transactions for the period have been

posted to the ledger accounts, the balance for each

account is determined

-Every account will either have a debit balance, a

credit balance, or a zero balance

-A trial balance is a list of all accounts and their

balances

-It indicates whether total debits equal total credits

-This only proves, however, that all entries

recorded have equal debits and credits; it does not

guarantee that all transactions have been recorded

Footing The Accounts

Footing – adding all the debits and the credits; this

is done after all the entries are posted from the

journal to the ledger

Trial Balance – is a summary of accounts with

open balances (accounts with a debit/ credit

balance); commonly taken every MONTH-END

(after posting procedures) to check the equality of

debits and credits

Open Account – if it has a balance, either on the

debit or credit side

Closed Account – if the debits equal the credits

Procedures For Preparing A Trial Balance

1. On a separate sheet of paper, indicate the

HEADING. The heading is composed of

three items, namely, the NAME OF THE

COMPANY, THE TITLE OF THE

REPORT AND THE DATE

2. Review the general ledger and note all open

accounts

3. Immediately below the heading, transfer the

account numbers, account titles, and

account balances of all accounts with open

balances. List down the accounts in the

following order: Assets, Liabilities, Equity,

Income, Expenses

4. Determine the total debits and the total

credits. Both totals should be equal.

When The Trial Balance Is Not Balanced

If total debits and credits do NOT balance, it signifies

that there was an error committed along the process,

which may be any of the following:

a) Error in footing the debit and credit

columns

b) Error in transferring from the ledger to the

trial balances

c) Errors in posting, say posting a debit entry

to the credit side of an account

d) Error in journalizing, for example, if the

debit side is not equal to the credit side of an

entry

e) Error of omission, when the debit is posted

but the credit is not posted

The Working Back Method proves effective in

locating the error. This means that you start re-checking

the correctness of the accounting procedures you

performed in REVERSE chronological order, i.e., start

with the trial balance and work backwards towards the

entries in the general journal

Working-Back Method

1. Recheck the footing of the debit columns and credit

columns of the trial balance If the footings are correct

and totals are not equal, determine the difference

between debit and credit columns. A possible reason

for the difference would be erroneously listing a debit

balance account as part of the credit column, or vice

versa. An error of this type would cause a difference

between debits and credits which is twice of the

amount involved.

2. If the error is still not located, check if the difference

between debit and credit columns is divisible by 9. If it

is divisible by 9, this suggests either a transplacement

error, or a transposition error.

3. Where the error is still not located, perform the

following:

a. Compare the amounts and accounts in the

trial balance with those in the ledger and

correct any discrepancies or omissions

b. Recheck the footing of the accounts in the

general ledger

c. Trace the postings from the journal to the

ledger. Be alert for possible omissions

d. Recheck the entries made in the journal and

ensure that total debit amounts are equal to

total credit amounts

Adjusting Journal Entries

Accrual basis accounting – recognizes transactions

as they occur. Income is recognized when earned and

expenses are recognized when incurred, regardless of

the inflow or outflow of cash.

Cash basis accounting – recognizes income only

when cash related to income is collected and expenses

are recognized only when paid.

Adjusting process is made in order to comply with the

GAAP regarding revenue recognition and matching

principles.

Adjusting entries – adjustments used to bring the

assets, liabilities, revenues and expenses up-to-date at

the end of accounting period.

-They are usually made at the end of the accounting

period.

-Necessary to properly report the truthful net income or

loss at the end of the accounting and to appropriately

report assets, liabilities, and equity.

Why is there a need to adjust the accounts at the end of the period?

Because, during the reporting period, cash receipts and

cash payments primarily serve as the bases for recording

income and expenses, the accounting records need to be

updated for revenues and expenses earned and incurred

but not yet collected or paid and for cash receipts and

cash payments made during the period but are not yet

earned or incurred.

Journalizing and Posting Adjusting Entries

-Follows the principle of accrual basis of accounting.

-Follows the principles of matching (properly match

revenues earned for the period with expenses incurred

for same period) and going concern (the entity is

assumed to continue its operations for an indefinite

future period of time, unless liquidation appears

imminent).

-The going concern assumption provides the basis for

the recognition of depreciation and deferrals.

-An adjusting entry affects both real and a nominal

account.

Calendar year – one where the period ends in

December 31.

Fiscal year – a period of 12 months that ends at any

time except December 31.

Types of adjusting entries:

1. Accruals – means to recognize revenue earned and

expenses incurred, regardless of inflow or outflow

of cash.

Accrued expenses – expenses incurred during

the accounting period but has not been paid and

is still unrecorded at year-end.

-Affects 3 concepts: (1) Expense recognition principle

(2) liability recognition principle (3) accrual basis

assumption

-If not adjusted, expenses will be understated, profit

will be overstated, Liabilities will be understated,

Equity will be overstated.

AJE:

Expense xx

Liability(Payable) xx

JE: (following year)

Expense xx

Liability xx

Cash xx

Accrued revenues – revenue earned during

the accounting period for which no cash has

been collected yet.

-If not adjusted, income will be understated, profit will

be understated, assets will be understated, Equity will

be understated.

-Affects 3 concepts: (1) income recognition (2) asset

recognition principle (3) accrual basis assumption

AJE:

Asset(Receivable) xx

Income(Revenue) xx

JE: (following year)

Cash xx

Revenue xx

Receivable xx

2. Deferrals - receipts of assets or payments of cash in

advance of revenue or expense recognition.

Prepayments – cash paid not but not yet

incurred.

- Opposite of accrued expense.

-3 concepts are involved: (1) expense

recognition principle (2) asset recognition

principle (3) accrual basis assumption

Asset Method

OJE:

Prepaid asset xx

xx

Cash xx

Recognize the used portion

xx

AJE:

Expense xx

Prepaid Asset xx

Expense method

OJE:

Expense xx

Cash xx

Recognize the unused portion

AJE:

Prepaid Asset xx

Expense xx

Deferred revenues – cash received but not yet

earned.

-Opposite of accrued income.

-3 concepts are involved: (1) income recognition

principle (2) liability recognition principle (3) accrual

basis assumption.

Liability Method

OJE:

Cash xx

Unearned income xx

Recognize the earned portion

AJE:

Unearned income xx

Revenue xx

Income Method

OJE:

Cash xx

Revenue xx

Recognize the unearned portion

AJE:

Revenue xx

Unearned income xx

Adjusting entries involving estimates

1. Depreciation

-The concept of depreciation involves the systematic

and rational allocation of the cost of long-lived assets

over multiple accounting periods it is used to generate

revenue (cost allocation, not valuation concept).

-Follows the matching principle.

-PPE, with the exception of land, are subject to

depreciation.

Straight-Line method of depreciation: (the simplest

and most widely used method of depreciation)

AJE:

Depreciation Expense xx

Accumulated Depreciation xx

Annual Depreciation=

-The use of the contra account allows the disclosure of

the original cost of the asset in the statement of

financial position.

-Carrying value of PPE is computed as the difference

of the cost and the accumulated depreciation account.

2. Bad Debts Expense

-Estimating uncollectible accounts on receivable

accounts.

-Also known as “Impairment of Receivables”.

-The total amount of uncollectible accounts is an

expense that arises by selling on credit.

-Net realizable value of Accounts receivable is equal

to the difference of Accounts receivable ending balance

and Allowance for doubtful accounts balance.

Two methods of recording bad debts:

1. Direct Writeoff – directly removes the estimated

uncollectible amount from receivables whether it is

probable or not that the amount will not be

collected.

o The only method allowed for income

tax purposes.

(write-off AR/ Recognition of bad debts)

Bad Debts Expense xx

Accounts Receivable xx

(Bad debts recovery)

Accounts receivable xx

Bad debts recovery xx

Cash xx

Accounts receivable xx

Bad debts recovery - other income account

2. Allowance Method – a more prudent method of

estimating uncollectible accounts. It sets up first an

allowance account for the estimation of

uncollectible accounts. Once it is probable that the

account is uncollectible, derecognize the allowance

and remove the amount from receivables.

-The accounts receivable account is not directly

credited,

-If the base used for estimating uncollectible account

is:

o A balance sheet account, the amount estimated is

the required balance of the allowance account.

o An income statement account, the amount

estimated is an addition to the balance of the

allowance account.

-In contrast to the direct write-off method, recording

write-offs and recoveries under the allowance method

does not affect profit.

(Recognition of bad debts)

Bad debts expense xx

Allowance for bad debts xx

(write-off of AR)

Allowance for bad debts xx

Accounts receivable xx

(recovery of accounts written-off)

Accounts receivable xx

Allowance for bad debts xx

Cash xx

Accounts receivable xx

Aging analysis of receivables – bad debt expense is

computed under the premise that the longer an amount

is past due, the more likely it is to be uncollectible.

- Higher percentage (%) will be assigned to older

receivables and the lowest percentages to new

receivables or to those which are not yet due.

Completing The Accounting Cycle

Adjusted trial balance is prepared

-After journalizing and posting the adjusting entries,

adjusted trial balance can be prepared. The amounts

here are all adjusted and updated. A worksheet is

necessary to complete this step.

Closing entries -Journal entries that bring temporary

accounts to zero balance and transfer their balances to

the permanent capital account at the end of the

accounting period.

-Temporary accounts include all Statement of

Comprehensive Income accounts and withdrawal

account. They are known as nominal accounts.

-Permanent accounts carry forward their ending

balances to the next accounting period. They are known

as real accounts. They comprise items in the Statement

of Financial Position.

Income summary account – used as another

temporary account in which the revenue and the

expense accounts are closed to determine whether the

business operations results to income or loss. Also

known as Revenue and Expense Summary

-There is net income if the resulting balance of the

Income summary account (after closing revenues and

expenses) is credit balance (Revenues > Expenses)

otherwise, there is net loss.

Procedures in closing the nominal accounts:

1. Close all revenue accounts by debiting the

amount and crediting income summary account.

2. Close all expense accounts by crediting the

amount and debiting income summary account.

3. Close the balance of the income summary

account to the capital account, which balance

represents profit (credit balance) or loss (debit

balance) for the period.

4. Close the drawing account to the capital

account.

Post-closing trial balance is prepared

-The purpose is to check the equality of debits and

credits in the ledger after the adjusting and closing

entries are recorded and posted.

-At this point, the only accounts with balances are

assets, contra accounts, liabilities, and capital.

Reversing entries

- Optional because it does not change the

amount reported in the financial statements.

- Journal entries made at the beginning of the

next accounting period and are exactly the

reverse of some adjusting entries.

- They are made after the preparation of FS and

closing the books of accounts, but before the

recording of the regular transactions for the

next accounting period.

- Purpose: Not to correct the AJE but to

simplify the recording of recurring transactions

of the next accounting period.

- Also for consistency in the recording of

income and expenses.

Rules in reversing journal entries

General rule: a reversing entry is made if an

adjustment previously entered increases the

SFP account totals.

Reversing entries are prepared for:

1. Accrued expenses

2. Accrued income

3. Prepayments under expense method

4. Deferred income under income method

The rest will not need any reversing entry.

Merchandising Business

Merchandise inventory – goods intended for sale;

asset (unsold)

Sales - revenue from selling merchandise

Cost of Goods Sold - cost of buying and preparing the

merchandise; expense(sold)

Operating expenses – merchandiser’s expenses

Point of Sale – most common point of income

recognition

Beginning Inventory – “opening stock”

- represents the cost of goods that are still unsold as of

the start of the period

Net purchases – cost of acquiring inventories during

the period

Ending inventories – “closing stock”

-inventory at the end of the period

Inventory system used for merchandising

transactions

Periodic Inventory System - CGS is determined only

at the end of an accounting period

Cash/AR xx

Sales xx

Sales returns – customers who may return all or a

portion of the goods that they purchased, due to wrong

specifications, poor quality of the merchandise, or

erroneous merchandise being delivered

Sales allowance - customer is willing to accept the

goods despite certain defects, in exchange for an

allowance or price adjustments granted by the seller.

Sales returns & allowances – only one account title;

contra-revenue accounts

Credit memorandum – document which informs a

customer that a credit has been made to the customer’s

account receivable for a sales return or allowance

Sales returns & allowances xx

Cash/AR xx

Sales discounts – contra-revenue account

- If payments are received within a certain number of

days from the date of sale, the seller reduces the amount

to be paid by the buyer

Example:

2/10, n/30

2% may be deducted from the amount due if the

customer pays within 10 days from the date of sale.

If customer doesn’t pay within 10 days, he/she must

pay the full price within 30 days from the date of sale.

Cash xx

Sales discount xx

Accounts receivable xx

Trade discount – used to reduce the list price to

actual sales price which may be due to the volume of

transactions

-not recorded; the amount recorded is always net of the

trade discount

Purchases – goods purchased for resale

Purchases xx

Cash/AR xx

Purchase return – if a buyer decides to return

purchased goods

Purchase allowances – when the company is still

willing to accept the said goods, but with a reduction

price

Debit memorandum – a document the purchaser

issues to inform the supplier of a debit made to the

supplier’s account including the reason for the return

of allowance

AP/cash xx

Purchases return & allowances xx

Purchase discount – sales discounts from the buyer’s

viewpoint

-contra account having a normal credit balance

3 alternative methods:

(1) Gross Price Method – purchases and AP are

recorded at gross; Purchase discount are recorded

only when taken.

(2) Net Price Method – purchases and AP are

recorded at net of the discounts offered; Purchase

discounts lost is used to record purchase discounts

which have been forfeited.

(3) Allowance Method – purchases are recorded at net

and AP at gross.

Shipping Charges on Merchandise Purchased or

Sold

point of passage title – point of transfer of

ownership

freight terms:

(1) Free on board(FOB) destination

- seller has agreed to pay all the shipping costs and the

purchaser receives title to the goods at the point of

destination.

Freight out/transportation cost xx

Cash xx

FOB destination, freight prepaid

- freight cost is chargeable to the seller who pays the

shipping company

Seller’s book: Buyer’s book

AR/cash xx Purchases xx

Sales xx AP/cash xx

Freight out xx (No JE for the freight cost)

Cash xx

FOB Destination, freight collect

-freight cost is chargeable to the seller but the buyer

has to pay the shipping company upon receipt of the

goods

Seller’s book: Buyer’s book

AR/cash xx Purchases xx

Sales xx AP xx

Freight out xx AP xx

AR/cash xx cash xx

(2) FOB Shipping Point

- purchaser has agreed to shoulder all the shipping

costs and the purchaser receives title to goods at

shipping point

FOB shipping point, freight collect

Seller’s book: Buyer’s book

AR/cash xx Purchases xx

Sales xx AP/cash xx

(No JE for freight) Freight-in xx

Cash xx

FOB shipping point, freight prepaid

- all the shipping cost is for the account of the buyer but

the seller advanced the payment to the shipping

company

Seller’s book: Buyer’s book

AR/cash xx Purchases xx

Sales xx AP/cash xx

AR xx Freight-in xx

Cash xx AP/cash xx

Perpetual Inventory System

- records are kept of the quantity and cost of each item

as it is bough, held in inventory and sold.

- the cost of each item is debited to the merchandise

inventory account upon purchase

- at the time of sale, the cost of each item is transferred

from the merchandise inventory account to the cost of

goods sold account

CGS xx

Merch. Invty. xx

End of Period Adjustments and Completion of

Accounting Cycle

Adjusting Entries

Cost of goods method - method of adjusting

merchandise inventory

1. Removing the beginning inventory from the

merchandise inventory account

CGS xx

Merch invty, beg xx

2. Closing the purchases account and purchase-related

accounts

CGS xx

Purch R&A xx

Purch disc xx

Purchases xx

Freight-in xx

3. Setting up the ending inventory figure

Merch invty xx

CGS xx

Preparation of a worksheet

(1) CGS method

(2) Direct extension method

Filling up the worksheet of a merchandising business

(1) Unadjusted Trial Balance Columns

CGS DE

Transfer the unadjusted ledger balances to the

columns of the worksheet

(2) Adjustment Columns

CGS DE

CGS xx

Merch invty, end xx No AJE to set up CGS

Purch R&A xx

Purch disc xx

MI, beg xx

Purchases xx

Freight-in xx

(3) Adjusted Trial Balance Columns

CGS DE

MI – contains ending no CGS account

balance MI – beginning bal

Purch and Purch R&A Purch and PurchR&A

are closed are still open

MI and CGS –

Remaining open

(4) Income statement and Balance sheet columns

CGS DE

CGS – debit bal sheet Purch and Freight-in

- debit inc statement - debit inc statement

MI – debit bal sheet Contra-purch – credit

inc statement

MI, beg – debit inc

statement

MI, end – credit inc

statement, DE to debit

bal sheet

Preparation of AJE and CE

CGS method – purchases and purch related

accounts have already been closed to CGS

CE:

Sales xx

Sales R&A xx

Sales discount xx

Expenses xx

CGS xx

Inc summary xx

Inc summary xx

Drawing xx

Drawing xx

Capital xx

DE method – “closing entry method”

MI, end xx

Sales xx

PR&A xx

PD xx

Inc summary xx

Inc summary xx

MI, beg xx

Sales R&A xx

Sales disc xx

Purchases xx

Freight-in xx

OPex xx

Inc summary xx

Drawing xx

Drawing xx

Capital xx

Remember:

Freight-in – account debited by the buyer

- added to purchases

Freight-out – account debited by the seller

- selling expenses

FOB Shipping Point – buyer

FOB Destination – seller

Freight Prepaid - seller paid cash to shipping

company

Freight collect – buyer paid cash to shipping company

Credit memorandum – sales R&A

Debit memorandum – purch R&A

Income statement:

Purchase

+ Freight –In

Gross Purchases

- Purchase Returns&Allowances

- Purchase Discounts

Net Purchases

+ Merchandise Inventory, Beginning

Cost Of Goods Avabilable for Sale

- Merchandise Inventoty, Ending

Cost of Goods Sold

Sales

- Sales Returns & Allowances

- Sales Discount

Net Sales

- Cost of Goods Sold

Gross Profit

- Operating Expenses

Operating Income

+Other Income

-Other Expense

Net Income

Special Journals and Subsidiary Ledgers

Purchase Journal – use to record purchases on

account

Sales Journal – use to record sales on account

Cash Receipt Journal - record all receipt of cash from

any source

Cash Disbursement Journal - record all disbursement

of cash

Subsidiary Ledgers – group of accounts with common

characteristics

-frees the general ledger from the details of individual

balances

Controlling account – summary account in the general

ledger

Manufacturing Business

3 Departments:

(1)Production Department(production area) - in

charge of manufacturing the finished products of the

company

(2) Administrative Department(non-production area)

(3) Sales Department(non-production area)

Classifications of Manufacturing costs

Direct materials – essential part of finished product

-easily traced to the product

Direct labor – directly incurred in manufacturing the

product

-easily traced to specific product

Manufacturing Overhead – “factory overhead”

– all manufacturing costs or expenses incurred in the

manufacturing or production department.

-excludes direct materials and direct labor

-cannot be easily traced

Indirect materials – raw materials that are

part of finished product; cannot be easily

traced

Indirect labor costs – cannot be directly

traced to the production of the products

Classifications of Non-Manufacturing costs

(1) Selling Costs - all costs to sell the finished

products

(2) Administrative costs - organizational and

executive costs related with the administration of an

organization

Product costs – “inventoriable cost”

– all the costs that are incurred in manufacturing a

product

-includes direct materials, direct labor and

manufacturing overhead

Period costs - includes administrative and selling

expenses

- recognized as expense in the period incurred

Prime cost – sum or total of direct materials and direct

labor

Conversion cost - sum or total of direct labor and

factory overhead costs

Journal Entries for a Manufacturing Company

Purchase of raw materials:

Raw materials xx

Cash/AP xx

Direct raw materials used in the production:

Work in proces xx

Raw materials xx

Indirect raw materials used in the production:

FOH xx

Raw Materials xx

Direct labor incurred in the production:

Work in Process xx

Cash/salaries and wages payable xx

Indirect labor incurred in the production:

FOH xx

Cash/ salaries and wages payable xx

Expenses incurred in the manufacturing or production

department other than direct material, indirect material,

direct labor, indirect labor:

FOH xx

Various accounts xx

Administrative expenses:

Expenses-G&A xx

Various accounts xx

Selling expenses:

Expenses-selling xx

Various accounts xx

Raw Materials Inventory- goods a company acquires

to use in making products

-direct and indirect materials

Goods In Process Inventory – “Work In Process

Inventoy”

- products in the process of being manufactured but not

yet complete.

Finished Goods Inventory – completed products

ready for sale

Formulas:

Purchases

+ Freight-In

Gross Purchases

- Purchase Return&Allowances

- Purchase Discounts

Net Purchases

+ Raw Materials, Beginning

Total Raw Materials Available For Production

- Raw Materials, End

Total Raw Materials Used

+ Direct Labor

+ Factory Overhead

Total Manufacturing Cost

+ Work In Process, Beginning

Total Goods Put Into Production

- Work In Process, End

Cost of Goods Manufactured

Finished Goods, Beginning

Cost Of Goods Available for Sale

+ Finished Goods, End

Cost of Goods Sold

Sales

- Sales Returns & Allowances

- Sales Discount

Net Sales

- Cost of Goods Sold

Gross Profit

- Operating Expenses

Operating Income

+ Other Income

- Other Expense

Net Income

Direct Materials

+ Direct Labor

Prime Cost

Direct Labor

+ Factory OverHead

Conversion Cost