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purpose of conceptual framework

to narrow differences in financial reporting of different entities through regulations, accounting standards, and procedures in preparation

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International Accounting Standards Boards

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International Financial Reporting Standards, set by IASB

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primary users

existing and potential investors, lenders, creditors, they are able to make appropriate economic decisions given the information

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other users

employees, government agencies, the public

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necessary information in financial statements

financial position, financial performance, cash flows, changes in equity, other supplementary information

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financial position

data on economic resources controlled by enterprise and its capacity to modify these resources; includes company liquidity and solvency

  • assets, liabilities, and equity

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financial performance

data on profitability which provide evaluation on potential changes in economic resources and information on company capacity to generate cash flows

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cash flows

helps assessing the company’s investing, financing, and operating activities

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changes in equity

changes in asset and liability balances and the effect on the equity balance of operational activities

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two fundamental qualitative characteristics of use financial information

relevance and faithful representation

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two values from the relevance of a financial statement

confirmatory value and predictive value

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three qualities of faithful representation

completeness, neutrality, freedom from error

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predictive value

if the information can help users predict future outcomes

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confirmatory value

if the information confirms or changes previous evaluations (predictions)

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information that influences decisions of the primary users; entity-specific aspect of relevance based on the nature and/or magnitude

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complete depiction

includes all information necessary for a user to understand the phenomenon being depicted

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neutral depiction

without bias in the selection or presentation of financial information; supported by prudence

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exercise of caution when making judgements under conditions of uncertainty, assets and income are not overstated and liabilities and expenses are not understated

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freedom from error

no errors or omissions in the description of the phenomenon

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four ways to enhance qualitative characteristics of financial statements

verifiability, comparability, understandability, timeliness

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direct verification

through direct observation, counting cash

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indirect verification

checking inputs to a model, formula, or other technique and recalculating the outputs using the same methodology

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assures users that information faithfully represents the economic phenomena it purports to represent

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enables users to identify and understand similarities in, and differences between items

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not the same as comparability; use of the same methods for the same items, either from period to period within a reporting entity or in a single period across entities

  • Comparability is the goal; consistency helps to achieve that goal.

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Classifying, characterizing and presenting information clearly and concisely makes it understandable.

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problem with understandability

complex phenomena cannot be made easy to understand

  • omission of reports to make it understandable could make it misleading

  • financial reports are made for users knowledgeable though they may still even need an adviser

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having information available to decision-makers in time to be capable of influencing their decisions.

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The Cost Constraint Principle

Reporting financial information imposes costs, and it is important that those costs are justified by the benefits of reporting that information

  • cost<=benefits

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Materiality Constraint

information that is significant enough to affect a user’s decision making. The level of materiality is relative to each user. the constraint is in making informed decisions, one should only consider using an information if it is material enough to be included in making informed decisions.

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what are provided in financial statements in a specified reporting period

Assets and liabilities (including unrecognized assets and liabilities) and equity that existed at the end of the reporting period, and income and expenses for the reporting period

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fiscal year vs calendar year

  • accounting period of twelve (12) months ending on the last day of any month other than December

  • accounting period of twelve (12) months ending on December 31

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The Going Concern Principle

assumption that the reporting entity is a going concern and will continue in operation for the foreseeable future.

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elements of financial statements under “statements of financial positions”

assets, liabilities, equity/capital

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resource controlled by the entity as a result of past events from which future benefits would flow to the entity

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present obligations arising from past events which its settlement would cause outflow of resources

  • financial obligation that a entity has to pay at the end of an accounting period to a person or a business as a result of past events

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residual interest in the assets of the entity after deducting all its liabilities.

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elements of financial statements under “statement of comprehensive income”

income and expenses

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increase in economic benefits during the accounting period in the form of

  • inflow or increase in asset or

  • decrease in liability that results in increase in equity,

other than contribution from equity participants.

  • includes revenues and gains

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decrease in economic benefit during the accounting period in the form of an

  • outflow or decrease in asset or

  • increase in liability that results in decrease in equity,

other than distribution to equity participants.

  • includes expenditures and losses

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  • illustration of basic accounting equation, representing increase and decreases of each account, and its total balance

  • to aid in preparation for financial statements

<ul><li><p>illustration of basic accounting equation, representing increase and decreases of each account, and its total balance</p></li><li><p>to aid in preparation for financial statements</p></li></ul>
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what does the left and right portion of the account contain?

  • left: debit (asset, expense)

  • right: credit (liabilities, equity, income)

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normal balance

  • Account balance- difference between total debits and total credits

Usual balance assuming proper accounting has been made

If total debits exceed total credits, the account balance is called a debit balance, otherwise, it is called a credit balance.

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journal vs ledger

  • journal- systematic and chronological record of all transactions; “Books of Original Entry”

  • ledger- entire set of accounts where transactions are summarized in individual accounts; “Book of Final Entry”

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steps of the accounting cycle

  1. transactional analysis

  2. journal entry

  3. ledger posting

  4. trial balance

  5. adjusting entries

  6. 10-column worksheet

  7. financial statement

  8. closing entry

  9. post-closing trial balance

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transaction analysis

involves analysis of proper selection and classification of the accounts involved, possible effects of transactions on a business' assets, liabilities, equity

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journalizing transaction

summarizes the normal balances on each element of the financial statement

- ex: purchase of assets on account result to increase in asset and increase in liability

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double-entry bookkeeping system

dual effects of a business transaction is recorded

for every debit entry, there must be a corresponding credit entry

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business entity

businesses are considered distinct and separate from the owners of the business

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accounting entity

an organization or section of an organization that is accounted for as a separate economic unit

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matching principle

profit or loss that is computed by deducting the expenses incurred from the income earned during an accounting period

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monetary unit

assumes that the business events are quantifiable in those terms

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historical cost

most commonly and objectively used measurement,

  • cash or its equivalents that was given up to acquire the assets

  • amount of proceeds, cash or its equivalents in exchange for the obligation that is expected to be paid to satisfy the liability

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revenue recognition principle

method to determine whether or not income has met conditions of being earned and realized

  • sale of goods- revenues recorded at date of delivery or receipt

  • sale of service- revenue recorded at completion of service or important progress if service is meant for a long period

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materiality principle

information is material if omitting or misstating it could influence the decision of users

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cost must be justified by the perceived benefits from reporting and using the information

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simple vs compound journal entry

  • simple entry- only one account is debited; one account is credited

  • compound entry- more than one account is involved in either both the debit and credit

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chart of accounts

list of all accounts and their respective account numbers

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six basic end-of-period adjustments

  1. accrued expense

  2. accrued income

  3. prepaid expense

  4. unearned income

  5. depreciation

  6. doubtful accounts

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accrual method

recognize the asset and liability; only recognize expense and income once there is the delivery of goods or service

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deferral method

recognize when payment is given or provided, make adjustments for when goods and services are delivered

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in the perspective of the customer to receive the goods or service; either asset or expense method; accrued expense and deferred expense

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in the perspective of the seller to deliver the goods or service; accrued income and deferred expense

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normal wearing out or loss of usefulness of a long-term asset

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residual value

at the end of the economic useful life of the asset, it may still command a price

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straight line method

method for determining depreciation,

annual depreciation = (cost-residual value)/useful life

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accumulated depreciation

contra-asset account, provides retainment of the cost of depreciation while allowing for continual depreciation

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carrying value or book value

difference between asset’s cost and the accumulated depreciation

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doubtful accounts or bad debts

existing customer credits which a company doubts would ever be settled and rather considers it as uncollectible in the future

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direct write-off method

expense attributed to the doubtful account is recorded by direct transfer from asset to expense account

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allowance method

allowance as contra-account for doubtful accounts to accumulate uncollectible accounts

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columnar device to facilitate preparation of financial statements to transfer data from trial balance to the financial statements

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content statement of comprehensive income

revenues, expenses, miscallenous expense, finance cost (interest expense, interest income, income tax expense)

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content of statement of changes in equity

beginning of balance of equity, additional investments, profit or loss, withdrawals, ending balance of equity

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contents of statement of financial position

formal statement of the assets, liabilities, and owner’s equity as of given date

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closing entries

separate accounts for income, expense, and withdrawal are set to facilitate in preparation of income statement (profit or loss) and would be closed to the equity account

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procedure for closing nominal accounts

  • income summary

    • debit income and credit income summary

    • credit expense and debit income summary

  • closing income summary

    • conclude whether it is a profit or loss balance

    • profit: debit withdrawal

    • loss: credit withdrawal

  • capital accounting

    • debit withdrawal; credit to capital (would increase equity)

    • credit withdrawal; debit to capital (would decrease equity)

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post-closing trial balance

to check equality of debits and credits in the ledger after adjusting and closing entries

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organization formed to engage in commercial transactions and exchange of goods and/or services with the primary objective of earning profit

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forms of business enterprise

service, merchandising, manufacturing

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service business

sale of services to customers; main way of generating revenue is through charging fees

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merchandising business

trading of goods by simply buying the goods and selling the same to its customers; they earn revenue by imposing mark-ups from the supplier

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manufacturing business

sale of finished goods which were processed by the enterprise itself; involves purchase of material and labor with the transformation

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legal forms of businesses

sole proprietorship, partnership, corporation

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sole proprietorship

owned by proprietor, minimal regulatory from Department of Trade and Industry (DTI)

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owned by partners, regulated by Securities and Exchange Commission (SEC), involves 2 or more persons, profit is divided according to agreement, can dissolve through agreement, withdrawal, death or incapacity

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limited partnership

lower share to business profit and lower risk of business loss

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general professional partnership

partnership for exercise of profession are exempt from income tax, while general partnerships are taxable as a corporation

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owned by stockholders or shareholders (min. of 2), created by operation of law and its purposes provided, regulated by Securities and Exchange Commission (SEC), managed by Board of Directors, greatest capacity to raise capital, distribution of profit to stockholders through dividends

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one person corporation

corporation with one person as stockholders

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assets of an enterprise that are:

  1. held for sale in the ordinary course of business

  2. in the form of production for such sales, or

  3. in the form of materials or supplies to be consumed in the production process or in the rendering of services

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property, plant, equipment (PPE)

tangible items that are:

  • held for use in the production or supply of goods and services, for rental to others or for administrative purposes

  • expected to be used during more than one period

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  • items used to carry out tasks in a company’s operations outside of manufacturing, production, or plant

  • current assets consumed within a 1 year period

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inventory accounts maintained by merchandising entities

  • inventory of goods for sale (merchandise inventory)

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inventory accounts maintained by manufacturing entities

  • inventory of raw materials (materials or raw materials inventory)

  • inventory of goods undergoing manufacturing (work-in-progress inventory)

  • inventory of goods ready and available for sale (finished goods inventory)

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how can inventory of a service business be presented

inventories referring to direct materials usable in rendition of services (although some companies refer to them as supplies instead)

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cost of inventory

  • purchase cost

  • conversion costs

  • other costs

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what are the other costs of inventory

those costs necessary to bring inventories to their present location and condition

  • storage costs after delivery or completion

  • insurance costs after delivery or completion

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costs of purchase

  • purchase price

  • import duties and other direct taxes

  • transport and handling costs

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