FAR & BKP (Prelims) ˚ʚ🧸ɞ˚

Definition of Accounting

• ASC (Accounting Standard Council)

• AAA (American Accounting Association)

• AICPA (American Institute of Certified Public Accountants)

ASC (Accounting Standard Council)

service activity that provides quantitative information, primarily financial in nature, useful for making economic decisions

AAA (American Accounting Association)

process of identifying, measuring, and communicating economic information to permit informed judgements and decisions

AICPA (American Institute of Certified Public Accountants)

art of recording, classifying, and summarizing financial transactions and interpreting results

Components of Accounting

• Identifying

• Measuring

• Recording
  - Recording (Journalizing)
  - Classifying (Posting)
  - Summarizing (Preparing Financial Statements)
  
  

Identifying

recognizing accountable events

Measuring

assigning peso amounts

Communicating

preparing and distributing accounting reports (Recording, Classifying, and Summarizing)

Nature and Purpose of Accounting

To provide quantitative information, primarily financial in nature, about economic entities for making economic decisions

Accounting as…

• an Information System

• Science or Art

• a Language

• a Social Force

• a Service Activity

• a Profession

Accounting as an Information System

Turns accountable events into useful financial reports

Accounting as Science or Art

Based on principles, knowledge, and skill

Accounting as a Language

Language of a business that communicates financial information

Accounting as a Social Force

Helps solve public issues such as price determination and control

Accounting as a Service Activity

Helps users make economic decisions

Accounting as a Profession

Requires specialized education before rendering service

Information and Users of Accounting

• Investor or Lender → Audited Financial Statements

• Manager → Sales analysis or budget report

Types of Information Provided by Accounting

• Quantitative Information

• Qualitative Information

• Financial Information

Quantitative Information

expressed in numbers, quantities, or units

Qualitative Information

expressed in words or descriptive form; often found in notes to financial statements

Financial Information

expressed in money

Users of Accounting Information

• Internal Users

• External Users

Internal Users

Business owners involved in management, board of directors, managerial personel

External Users

• Investors, lenders, and creditors

• Government Agencies, non-managerial employees, customer, and the public

General purpose accounting information

meets the common needs of most users, mainly external users, provided by financial accounting

Special purpose accounting information

meets the specific needs of particular users, mainly internal users, provided by management accounting

Common Branches of Accounting

• Financial Accounting

• Management Accounting

• Government Accounting

• Auditing

• Tax Accounting

Financial Accounting

General record keeping and preparation of general-purpose financial statements

Management Accounting

Tailored reports for planning, performance management, and decision-making

Government Accounting

Recording and reporting government funds, property, budgets, and accountability

Auditing

Examination of accounting reports to express opinion on fairness and reliability

Tax Accounting

Preparation of tax returns and tax advice for compliance

Common Branches of Accounting (Part 2)

• Cost Accounting

• Accounting Education

• Accounting Research

Cost Accounting

Collection, analysis, allocation, and control of production or service costs

Accounting Education

Formal teaching of accounting and related subjects

Accounting Research

Careful study and publication that generate new accounting knowledge

Legal Forms of Business Organization

• Sole Proprietorship

• Partnership

• Corporation

• Cooperative

Sole Proprietorship

One owner; registered with DTI (Department of Trade and Industry)

• Advantages: Easy and low-cost to form, with full control of decisions.

• Disadvantages: Limited resources and unlimited liability.

Partnership

Two or more person; registered with SEC (Securities and Exchange Commission)

• Advantages: Provides more capital, combined skills, and division of labor.

• Disadvantages: May involve mutual agency, disputes, and dissolution when a partner withdraws or dies.

Corporation

An artificial being created by law; registered with SEC (Securities and Exchange Commission)

• Advantages: Has limited liability, continuous existence, and transferable shares.

• Disadvantages: More costly and highly regulated, with shareholders having little direct participation in management.

Cooperative

Member-owned association; registered with CDA (Confidential Disclosure Agreement)

• Advantages: Offers lower prices and encourages member participation.

• Disadvantages: Has limited capital, non-transferable shares to non-members, and management may be less efficient.

Types of Business According to their Activities

• Service Business

• Merchandising Business

• Manufacturing Business

• Hybrid Business

Service Business

Engaged in the rendering of services as their major operation (CPA, Lawyers, School, etc.)

Merchandising Business

Engaged in the buying and of selling goods without changing their physical form (Grocery, Sari-Sari, Retail, etc.)

Manufacturing Business

Engaged in the production of items to be sold (Shoe factory, food processing, etc.)

Hybrid Business

Engage in more than one type of activity. (Restaurant, Café, etc.

Accounting Equation

Expresses the relationship among the economic resources, the obligations owed, and the residual interest.

It is the organizing logic behind the statement of financial position and the later double-entry system

Assets = Liabilities + Equity

Assets

Resources controlled by the entity

Liabilities

Present obligations of the entity

Equity

Residual interest in the assets after deducting liabilities

Why the equation must be balanced

• Asset is financed by someone

• Creditors finance part of the asset through liabilities

• Owners finance the remaining part through equity
  
  Assets = Resources Liabilities & Equity = Claims

Rearranging the equation

If the asset is present, then minus it to its following element if Liabilities / Equity are missing

Expanded Accounting Equation

Assets = Liabilities + Owner’s Capital + Income/Revenue - Expenses - Drawings

Key principle: Income - producing activities increase equity, while expenses and withdrawals decrease equity

Net income and Owner’s equity

Net Income = Income/Revenue - Expenses

Ending Equity = Beginning Equity + Investments + Net Income - Withdrawals

Revenue

Money earned from sales

Expenses

Cost of running the business

Net income

Revenue minus Expense

Investments

Additional cash from owner

Withdrawals

Cash taken by owner

Distinguishing Similar Transactions

Payments of rent | Expense | Reduces Equity because rent is consumed for the period

Payment to supplier for an old payable | Liability settlement | Does not create a new expense; it reduces cash and liability

Owner Withdrawal | Drawing | Not an expense; it is a distribution to the owner

Purchase of equipment for cash | Asset Exchange | Not immediately expense; equipment is an asset

Collection from customer | Asset Exchange | Cash increase and AR decreases; revenue was recognized earlier if earned on account

Borrowing Cash | Liability Financing | Not revenue; the business must repay it

Account

individual accounting record used to accumulate increases, decreases, and the resulting balance of a particular item

Account Title

Name of the account that identifies the item being recorded

Account Balance

Difference between total increases and decreases in an account

Chart of Accounts

List of all accounts used by a business, usually arranged in a logical order

Why Business need separate Accounts

• To know how much cash is available

• Know how much customer owes the business

• The business owes suppliers or lenders

• To measure specific revenue and expense

• Determine Balance

• Reporting
  
  Key point: Tracking, Controlling, Reporting

T-account: Parts and Meaning

• Account Title (On top of the T)

• Debit (Left side)

• Credit (Right side)

• Balance (Depending on which is higher (Dr./Cr.))

Debit

Referred to as the value received

Credit

Referred to as the value parted with

Balance

Difference between the total debits and credits in the account represents the balance of the account

Major Account Groups or Element

• Asset (Resources)

• Liabilities (Obligations)

• Equity (Owner’s residual interest)

• Income/Revenue (Earnings from service)

• Expense (Costs consumed)

• Drawings (Owner withdrawals)

Asset Accounts

Represent the economic resources of the entity.

Current vs Non-Current Asset

Current Asset - Generally expected to be realized, sold, consumed, or converted to cash within the normal operating cycle or within twelve months (short term)

ex. Prepaid Insurance, Cash, Supplies, Inventory, AR

Non-Current Asset - Assets the do not meet the current classification and usually support operation beyond the current period (Long-term)

ex. Land, Building, Furniture and Fixtures, Office Equipment, Delivery Equipment

Property, Plant, and Equipment (PPE)

Tangible resources used in business operations and generally expected to benefit more than one accounting period

NOTE: Buying equipment is not automatically and expense. When future benefits extend beyond the current period and capitalization criteria are met, it is recorded as an asset

Contra Asset Accounts

Associated with an asset but carries a balance that reduces the related asset’s carrying amount

ex. Accumulated Depreciation: It reduces the carrying amount of related assets

Liability Accounts

Present obligation to outsiders

ex. Payables, Unearned Revenue

Current vs Non-Current Liabilities

Current Liabilities: Generally obligations expected to be settled within the normal operating cycle or with twelve months (short-term)

ex. Accounts Payable, Salaries Payable, Utilities Payable, Unearned Revenue

Non-Current: Other obligations, those not due for settlement in the near term

Receivable vs Payable

Receivable → They owe us | right to collect

Payable → We owe them | obligation to pay

Owner’s Capital

Represent the owner’s residual interest in the business. Direct owner investments increase capital

Owner Investment → Capital

Revenue → Equity increases

Expenses & Drawing → Equity decreases

Income and Revenue Accounts

Account used to record earned amounts

ex. Service Revenue, Consulting Revenue, Sales Revenue, Professional Fees, Commission Revenue, Interest Income

Revenue arises from earning activities—not from owner contributions or borrowing

Expense Accounts

Reduces equity because they are costs incurred in earning revenue

ex. Salaries, Rent, Utilities, Supplies, Insurance, Advertising, Repairs and Maintenance, Depreciation, Transportation, and Interest Expense

Depreciation Expense → periodic allocation of the depreciable amount of a depreciable asset

Drawings

Withdrawals by the owner for personal purposes (NOT EXPENSE)

Sole proprietorship (only) → reduce the owner’s equity

Chart of Accounts

formal list of account titles used by an entity, usually arranged by major classification and assigned account numbers or codes

Why? to promote consistency, makes posting easier, and helps organize the general ledger

Suggested code ranges

Assets → 100-199

Liabilities → 200-299

Equity → 300-399

Income / Revenue → 400-499

Expenses → 500-599

Financial Statements

• Statement of Financial Position (Balance Sheet) → Assets, Liabilities, and Equity

• Statement of Changes in Equity → Equity

• Statement of Profit or Loss / Statement of Comprehensive Income (Income Statement) → Income/Revenue and Expenses

• Statement of Cash Flow (Cash Flow Statement) → Operating, Investing, Financing Activities

• Notes to Financial Statement → Additional explanations and details supporting the financial statements.
  
  Drawings are related to Owner's Equity in the Statement of Financial Position. However, they are usually not shown as a separate major element like Assets or Liabilities.
  
  

Qualitative Characteristics of useful financial information

Conceptual Framework are the qualitative characteristics of useful financial information

Qualitative Characteristics

Traits that determine whether an item of information is useful to users.

No Characteristics → Useless Information

Types of Qualitative Characteristics

• Fundamental Qualitative Characteristics

• Enhancing Qualitative Characteristics

Fundamental Qualitative Characteristics

Characteristics that make information useful to users. Relevance and its Faithful presentation

Relevance

Information is relevant if it can affect the decisions of users. Irrelevant if trait doesn’t meet.

Aspects of Relevance

• Predictive Value

• Confirmatory Value

• Materiality

Predictive Value

If It helps users to make predictions about future outcomes

Confirmatory Value (Feedback value)

If it can help users to confirm their past predictions

Materiality

Entity-specific, meaning depends on the facts and circumstances surrounding a specific entity

Faithful Representation

If it is factual, meaning it represents the actual affects of the events that have taken place

Aspects of Faithful Representation

• Completeness

• Neutrality

• Free from error

Completeness

Information must have complete understanding of the financial statements is provided

Neutrality

Information is selected or presented without bias

Free from Error

information is not materially misstated. does not mean accounting information must be perfectly accurate

Enhancing Qualitative Characteristics

• Characteristics that support the fundamental characteristics.

• Enhances the usefulness of information
  
  Comparability, Verifiability, Timeliness, Understandability

Comparability

If it can help users identify similarities and differences between different sets of information