Financial Accounting and Reporting 1

From Synchronous Lesson I. DEFINITION OF ACCOUNTING 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 decisions Definition from ASC (Accounting Standards Council)

Accounting is an art of

1. Recording

2. Classifying and

3. Summarizing in a significant manner and in terms of money, transactions and events which are in part at least of a financial character and

4. interpreting the results thereof Definition from AICPA (American Institute of Certified Public Accountants) Accounting is the process of

5. Identifying

6. Measuring and

7. Communicating economic information to permit informed judgment and decisions by users of the information. Definition from AAA (American Accounting Association) II. NATURE OF ACCOUNTING Accounting is a service activity because it provides information to decision makers to assist them in arriving at a decision concerning their business activities is an art because the individual providing information has to think and design the presentation of the information that would be easily understood by the users

is process because it involves several steps such as identifying, accumulating, recording, processing and finally communicating financial information leading to the preparation of financial reports that are useful in decision-making it provides quantitative information or expression in monetary terms to users in decision-making III. HISTORY OF ACCOUNTING

1. BABYLONIA AND EGYPT AROUND 4000BC clay tablets were used to record their transactions in Egypt an account was used to record the safe keeping of gold and the valuables in treasures daily reports were sent to wizards by the person in-charge monthly report to the kings Babylonia was known as the “city of commerce” where accounts were used by the people for business to uncover losses due to fraud and to uncover losses due to inefficiency

2. GREECE accounts were used to record the revenue received maintaining total receipts/payments and balance of government financial transactions in 600 B.C. coined money was introduced

3. FRA LUCA BARTOLOMEO DE PACIOLI Italian mathematician and Franciscan friar he did not invent double-entry bookkeeping, but rather described the prevalent accounting practices of the day he was regarded as the “father of double-entry accounting” he made mention that the purpose of bookkeeping was to give the trader without delay information as to his assets and liabilities he also advised the computation of a periodic profit and the closing of books SUMMA DE ARITHMETICA, GEOMETRICA, PROPORTIONI ET PROPORTIONALITA

Summary of arithmetic, geometry, proportions and proportionality Luca Pacioli, a Franciscan friar published summa in Venice (1494) includes details of calculation and recording describing double-entry bookkeeping

IV. FUNCTIONS OF ACCOUNTING

1. Recording 

translates the financial transactions and events into written accounting data deals with the writing on the books or recording of business transactions or events in the general journal [also known as the book of original entry] 2. Classifying involves the grouping of similar items together in order to make the recording of the different transactions and events more systematic this is done through the posting of accounts in the general ledger [or the book of final entry] 3. Summarizing involves the preparation of financial statements this function makes accounting as the language of business Why? It is through the financial statements (the final output) that users can get the information needed about the business such as the profitability as well as the financial condition of the business 4. Interpretation of the results this function makes bookkeeping different from accounting in as much as accounting is broader in scope it does not only record business transactions and come up with financial statements but it interprets the results contained on the financial statements

INTERPRETATION OF THE RESULTS ANSWERS THE FOLLOWING QUESTIONS:

1. How liquid is the company?

2. How stable is the company?

3. How solvent is the company?

4. How profitable is the company?

V. FINANCIAL STATEMENTS these are the means by which the information accumulated and processed in financial accounting is periodically communicated to the users without the information embodied in the financial statements, users may not be able to arrive at a sound economic decision

VI. COMPONENTS OF THE FINANCIAL STATEMENTS

Statement of Financial Position shows the financial condition or position of a business at a given moment of time it is a summary of the assets, liabilities and capital of the business Statement of Financial Operations provides about the enterprise’s results of operation summarization of the company’s revenues and expenses

Statement of Cash Flow provides information about the cash receipts and cash payments of a business entity during a specified period of time Statement of Changes in Equity shows the summary of the changes in the capital of the enterprise during the period. Notes to Financial Statements this shows the additional disclosures of certain information which are useful to the users of the financial statements in understanding the information on the financial statements

From other sources - Required Readings I I. TYPES OF ACCOUNTING INFORMATION

1. Quantitative information they are expressed in numbers quantities or units

2. Qualitative information they are expressed in non-numerical terms rather, they are descriptive such as notes to financial statements or other components of financial statements

3. Financial information they are expressed in money

II. TYPES OF ACCOUNTING INFORMATION CLASSIFIED AS TO USER’S NEEDS

1. General Purpose Accounting Information designed to meet the common needs of most accounting information users (product of financial accounting and prepared primarily for external users)

2. Special Purpose Accounting Information designed to meet the specific needs of particular accounting information users (product of management accounting and other branches of accounting prepared primarily for internal users)

III. USERS OF ACCOUNTING INFORMATION Types of Users of AI

1. EXTERNAL USERS these are individuals and others that have current potential interest in the reporting entity but are not involved in the daily operations of the entity the information needs of these users differ from one another so that only primary and general purposes financial statements are provided

external users include stockholders, creditors, customers, suppliers, government agencies, potential investors, brokers, trade associations and the public

2. INTERNAL USERS the internal users include the owners, board of directors, chief executive officers, chief financial officers, internal auditors, plant managers, and supervisors these groups of users make use of financial information to aid them in decision-making

IV. USERS’ DECISIONS AND TYPES OF INFORMATION NEEDED

1. External Users Potential Investors

• decides on whether or not to buy or invest capital shares/shares of stock

• needs the general-purpose information

• Audited Financial Statement as the basis in assessing the value of the company Existing Investors

• decides on whether to hold or sell existing investment

• needs the general-purpose information Lender decides on whether or not to groan loan to a business needs the general-purpose information Audited Financial Statement as the basis in assessing the company’s ability to pay its debt Supplier decides on whether or not to extend credit to a business needs the general-purpose information Audited Financial Statement as the basis in assessing the company’s ability to pay its debt

2. Internal Users Manager decides on whether or not to increase the sales price of a product needs the special purpose information that provides sales data in order to analyze the sales volume/sales prices and to profit decides on how much cost is required to manufacture a product needs the special purpose information that shows budget report and manufacturing trends

From other sources - Required Readings II I. FORMS OF BUSINESS ORGANIZATIONS

1. Sole or single proprietorship is the most common and simplest form of business organization it is owned by only one individual

2. Partnership a business that is formed by 2 or more people who agreed to carry on the business and divide among themselves the earnings therefrom the business owners are called partners

3. Corporation is also owned by more than one individual corporation, unlike a partnership, a corporation is created by operation of law rather than a contract ownership in a corporation is represented by shares of stocks the owners are called stockholders or shareholders

4. Cooperative an association of persons (organization) that is owned and controlled by the people to meet their common economic, social, and/or cultural needs and aspirations through a jointly-owned and democratically controlled business are designed primarily to provide services to members, rather than to produce a profit for investors accordingly, the return on investment (ROI) in the form of dividends is limited

II. TYPES OF BUSINESS ACCORDING TO ACTIVITIES

1. SERVICE generates income by providing services [for a fee] e.g. barber shop, massage therapy, travel and tour agency, law firm, accounting

2. MERCHANDISING buying and selling goods from a supplier and will sell to the customers e.g. convenience stores, fashion boutiques, and department stores

3. MANUFACTURING a company purchases raw materials which will undergo a process, until it becomes a finished product to be sold to customers e.g. restaurants,

III. INCOME MEASUREMENT

1. SERVICE Service Revenue – Operating Expenses

= Net Income (Loss)

2. MERCHANDISING / MANUFACTURING Sales Revenue – Costs of Goods Sold

= Gross Profit – Operating Expenses

= Net Income (Loss)

Summary of the Forms of Business Organization

Forms of Business Organization Ownership Formation/Registration

1. Sole proprietorship One Individual (i.e., sole proprietor)

• Registered with the DTI

2. Partnership More than one (i.e., partners)

• Formed by contractual agreement

• Registered with the SEC

3. Corporation More than one (i.e., stockholders)

• Formed by operation of law

• Registered with the SEC

4. Cooperative More than one (i.e., members

• Formed following the Cooperative Code

• Registered with the CDA

V. ADVANTAGES AND DISADVANTAGES OF THE DIFFERENT FORMS OF BUSINESS ORGANIZATIONS

1. Sole Proprietorship

Advantages you are the boss and you keep all the profits decision making is simple because you have complete control over the business relatively easier and less costly to form because there are fewer formal business requirements has lower extent of government regulation and relatively lower taxes

Disadvantages you assume all the risk of loss you take all responsibility and rely mostly on yourself in making decisions it is more difficult to raise capital because you rely mostly on your personal assets and loans to initially finance the business you are personally liable for the debts and obligation of the business

2. Partnership

Advantages better business decisions can be made because “two heads are better than one” you share the business risk and the responsibility of running the business with your partner(s) compared to corporations and cooperatives, a partnership is easier to form because only a contractual agreement between the partners is needed greater capital compared to a sole proprietorship relatively lower extent of government regulation compared to corporations

Disadvantages making business decisions may give rise to conflict among the partners you don’t keep all the profits because you need to share them with your partner(s) limited life, in the sense that a partnership can be easily dissolved by the withdrawal, retirement, death or insanity of one of the partners lesser capital compared to a corporation a partnership (other than a general professional partnership) is taxed like a corporation unlimited liability, the partners can be held liable for partnership debts up to their personal assets

3. Corporation

Advantages non-members of the corporation’s board of directors are relieved from managerial responsibilities only stockholders elected as members of the board of directors and those they hire or appoint are tasked with managerial responsibilities this can be an advantage because a regular investor does not need to work for the corporation to earn income limited liability of the owners because stockholders are liable for corporate debts only up to the amount they have invested greater capital and ease in raising additional funds because a corporation can issue shares to a wider extent of investors If the corporation is listed, you can easily transfer your shares to other investors by selling them in the stock market many investors earn profit this way – by buying shares at a cheap price, wait for prices to go up, and then sell them this activity is referred to as stock trading unlimited life, in the sense that the withdrawal, retirement, death or insanity of one of the stockholders does not dissolve the corporation although a corporation has a legal life of 50 years, this can be renewed for an indefinite number of renewals

Disadvantages your “say” on corporate affairs depends on the number of shares you own those who own more shares are the bosses and enjoy a larger share of the corporation’s profits a corporation is more difficult and more costly to form because there are more formal business requirements greater extent of government regulation and higher taxes unlike for a sole proprietorship or a partnership where business profits are easily distributed to the owner(s), in a corporation, you have to wait for the board of directors to declare dividends before you can get your share in the profits

From other sources - Required Readings III I. ACCOUNTING CONCEPTS AND PRINCIPLES

1. Generally Accepted Accounting Principles (GAAP) Philippine Financial Reporting Standards (PFRS) Philippine Accounting Standards (PAS) Adapted from IFRS and IAS

II. ACCOUNTING CONCEPTS

1. Economic Entity or Accounting Entity the personal transactions of the owner are separate from that of the business they own

2. Accrual Basis of Accounting revenue is recorded when earned Expenses are recorded when it happens (regardless of when cash is received or paid)

3. Going Concern the company will continue operating indefinitely until the foreseeable future and company closure is not imminent

4. Monetary Unit transactions are expressed in the monetary unit of measurement

5. Time Period Transactions transactions are summarized and reported at regular time intervals Calendar Year (January 1-December 31) Fiscal Year (Any starting point + 12 months)

III. ACCOUNTING PRINCIPLES

1. Cost Principle amounts shown in financial reports are historical costs

2. Full Disclosure Principle sufficient information for informed judgments follow the accounting standards to disclose every piece of information

3. Matching Principle Matching revenues with expenses to know the profit of the business

4. Revenue Recognition Principle recognize revenue when goods are sold or services are rendered, regardless of cash receipts

5. Materiality in accounting, materiality refers to the impact of an omission or misstatement of information in a company's financial statements on the user of those statements if it is probable that users of the financial statements would have altered their actions if the information had not been omitted or misstated, then the item is considered to be material usually used in auditing, not in accounting

6. Conservatism If there are two acceptable alternatives in a situation, choose the alternative that will result in lesser income or resources

7. Objectivity the recording and reporting process should be performed with independence which is free from bias in objectivity, what we follow is honesty

IV. QUALITATIVE CHARACTERISTICS OF USEFUL FINANCIAL INFORMATION

1. Fundamental Principles Relevance the information is considered relevant if it has: Predictive Value Confirmatory Value

Faithful Representation in order to achieve this, it should be Complete Neutral (related to objectivity principle) Free from error

2. Enhancing Principle (V-C-U-T)

Verifiability Comparability Intracomparability comparing financial statements to own past financial statements Intercomparability comparing financial statements to other companies to others within the same industries Understandability Timeliness

From Synchronous Lesson I. BASIC ELEMENTS OF ACCOUNTING

1. Assets

2. Liabilities

3. Owner’s Equity/Capital

II. THE ACCOUNTING EQUATION

Assets = Liabilities + Owner’s Equity A = L + OE

Left T-Side = Right T-Side Debit Side = Credit Side

Liabilities = Assets - Owner’s Equity L = A - OE

Owner’s Equity = Assets - Liabilities OE = A - L

III. RULES OF DEBIT AND CREDIT

1. Normal Balances Asset, Liability, and Equity Account

Income and Expense Account

Specific Equity Accounts

IV. INHERENT RELATIONSHIP IN THE ACCOUNTING EQUATION The accounting equation reveals the following possible changes in the elements:

Situation 1 (an asset increase coupled with an increase in either liability or capital or both) Assets = Liabilities + Capital ↑ ↑ ↑ and/or Possibilities Assets increase = Liability increase Assets increase = Equity increase Assets increase = Liability and Equity increase

Situation 2 (an asset decrease coupled with a decrease in either or both liability and equity) Assets = Liabilities + Capital ↓ ↓ ↓ and/or Possibilities Assets decrease = Liability decrease Assets decrease = Equity decrease Assets decrease = Liability and Equity decrease

Situation 3 (liabilities increase coupled with offsetting decrease in equity) Assets = Liabilities + Capital no change ↑ ↓

Situation 4 (liabilities decrease coupled with offsetting increase in equity) Assets = Liabilities + Capital no change ↓ ↑

Situation 5 (an item of an element increase while and item of the same element decrease) Assets = Liabilities + Capital ↓↑ no change

Duality Principle every transaction must alter both sides of the equation, A = C + L V. THE EXPANDED ACCOUNTING EQUATION

Assets = Liabilities + Equity + Income - Expenses - Drawings

= Net Income

Note: Income is added when expenses are deducted in the equation… …because income has the effect of increasing equity while expenses decrease equity Note: There is no separate account for Additional Investment… …it is directly recorded to the capital account

Another variation of the expanded equation is: DEBIT Assets + Drawings + Expenses = Liabilities + Equity + Income CREDIT Note: Always observe the Duality Principle

Income - Expenses = Net Profit

I. JOURNALIZING

Business Transactions and their Analysis

1. The Accounting Cycle refers to the steps or procedures performed to accomplish the accounting process

2. Basic Steps in Analyzing Transaction

Identify the transactions from source documents Indicate the accounts - A, L, OE, I, E affected by the transaction Ascertain whether each account is increased or decreased by the transaction Using the rules of debit and credit, determine whether to debit or credit the amount to record its increase or decrease 3. Types of Source Documents (Business Documents)

1. Official Receipt acknowledgment for payment of money

2. Check an order to the bank to disburse the amount

3. Delivery Receipt evidence confirmation of delivery goods

4. Sales Invoice/Billing a request for payment for amounts due indicated therein this is the basis of recording billings

5. Purchase Order a request to a supplier for the delivery of goods

6. Sales Order a request from a customer for the business to deliver goods

7. Bank Deposit Slip an acknowledgment of the bank for receipt of money from the depositor for deposits or payments to suppliers

8. Payroll evidence showing expense in terms of salaries

9. Voucher an acknowledgment of disbursements

10. Recording Business Transactions in the recording of business transactions, the bases are the business documents However, not all transactions are qualified for recording. Thus, accounting only identifies qualified transactions. the recording phase of accounting is called journalizing as it involves the chronological recording of transactions the act of recording a transaction is known as accounting recognition while the maintenance of the records up to journalizing of transactions is called bookkeeping

11. Procedures in Recording Business Transactions Identify accountable transactions and events (an accountable transaction is an activity or event that can be measured by money and which affects the financial position or operations of a business) also involves two parties such as the seller and buyer; creditor and debtor e.g. purchase of supplies, payment of salaries, sales of good on cash or on account, loss due to theft, payment of liabilities or debt, withdrawal of cash by the owner

12. Basic Rules in Recording Accountable Transactions and Events

The general rule: one journal = one accountable transaction or event

7. Recording of Simultaneous Transactions

May use either of the following types of journal entry:

Simple Entry Composed of one debit and credit Compound Entry Composed of one or more debits or credit

Debit = what is received Credit = what is given away