INTRODUCTION TO ACCOUNTING AND USERS information sought by its users which are recorded and

OF ACCOUNTING INFORMATION classified.

DEFINITION OF ACCOUNTING Accounting is an information system. Accounting is a

According to Accounting Standards Council, accounting storehouse of information as it collects processes and
is a service activity in which function is to provide communicates financial information of any entity.
quantitative information, primarily financial in nature,
about economic entities, that is intended to useful in Business transactions are analyzed, recorded, classified and
making economic decisions. summarized to be able to prepare the financial statements
for decision making. Source documents are important
The American Institute of Certified Public Accountants because these are the evidence of transactions. Analysis of
defines accounting as art of recording, classifying and business transactions can be done through the accounting
summarizing in a significant manner and in terms of equation.
money,
transactions and events which are in part at least of a HISTORY OF ACCOUNTING
financial character and interpreting the results thereof.
The Cradle of Civilization-Around 3600 B.C., record-
 Recording involves keeping a chronological order keeping was already common from Mesopotamia, China and
of transactions in journal and ledger. India to Central and South America. The oldest evidence of
 Classifying is the process of categorizing the this practice was the “clay tablet” of Mesopotamia which
accounts in leger and financial statements. dealt with commercial transactions at the time such as listing
 Summarizing is summing up the financial data in of accounts receivable and accounts payable.
each accounting period.
14th Century - Double-Entry Bookkeeping-The most
The American Accounting Association stated that important event in accounting history is generally
accounting is the process of identifying (analytical considered to be the dissemination of double entry
component), measuring (technical component) and bookkeeping by Luca Pacioli (The Father of Accounting) in
communicating (formal component) economic information 14th century Italy. The Italians of the 14th to 16th centuries
to permit informed judgment and decision by user of the were the first to commonly use Arabic numerals, rather than
information. Roman, for tracking business accounts. Luca Pacioli wrote
Summa de Arithmetica, the first book published that
 Identifying is the recognition or non recognition of contained a detailed chapter on double- entry bookkeeping.
business activities.
 Measuring is the process of assigning of per French Revolution (1700s)-The thorough study of
amount. accounting and development of accounting theory began
 Communicating deals with preparing and during this period. Social upheavals affecting government,
distributing accounting reports to its users. finances, laws, customs and business had greatly influenced
the development of accounting.
NATURE OF ACCOUNTING
The Industrial Revolution (1760-1830)-Mass production
Accounting is a service activity. Accounting provides and the great importance of fixed assets were given attention
assistance to decision makers by providing them financial during this period.
reports that will guide them in coming up with sound 19th Century – The Beginnings of Modern Accounting in
decisions. Europe and America-The modern, formal accounting
profession emerged in Scotland in 1854 when Queen
Accounting is a process. A process refers to the method of Victoria granted a Royal Charter to the Institute of
performing any specific job step by step according to the Accountants in Glasgow, creating the profession of the
objectives or targets. Accounting is as a process as it Chartered Accountant (CA). The first national U.S.
performs the specific task of collecting, processing and accounting society was set up in 1887. Rapid changes in
communicating financial information. In doing so, it follows accounting practice and reports were made in this period.
some definite steps like the collection, recording,
classification, summarization, finalization, and reporting of
financial data.

Accounting is both an art and a discipline. Accounting is

the art, which refers to the way something is performed, of The Present - The Development of Modern Accounting
recording, classifying, summarizing and finalizing financial Standards and Commerce- The accounting profession in
data. It involves creativity and skill to help us attain some the 20th century developed around state requirements for
specific objectives. financial statement audits. Beyond the industry's self-
Accounting is a systematic method as it follows certain regulation, the government also sets accounting standards,
standards and professional ethics, it is also a discipline. through laws and agencies such as the Securities and
Accounting deals with financial information and Exchange Commission (SEC). As economies worldwide
transactions. Accounting involves recording of financial continued to globalize, accounting regulatory bodies
transactions and data which are classified and finalized in a required accounting practitioners to observe International
given specified period of time. It deals with financial Accounting Standards. This is to assure transparency and
reliability, and to obtain greater confidence on accounting business or accounting entity will continue its
information used by global investors. operation indefinitely.

THE USERS OF FINANCIAL INFORMATION It is the foundation of the cost principle where
assets are initially recorded at
The users of accounting information are classified into cost or purchased price.
internal and external users.
Example: The person who prepares financial statements
1. Internal Users. These are people within a business should assume that the entity will continue indefinitely.
organization who use financial information. They
are directly involved in management and 2. Business Entity Principle says that entity is
operation of business. separate and distinct from the owners, managers,
and employees who constitute the entity.
Examples:
 Management for planning and controlling the Example: If a person has driving business, the cash from
operation of the business. services rendered should be reported separately from
 Owner/s of the firm need to know if the personal cash.
business is operating at a profit or loss.
 Employees are interested in information 3. Time Period Principle states that preparation of
regarding the profitability and stability of an financial statements should be divided into
enterprise so they can assess their employment accounting periods which are usually of equal
status, and whether the company has the ability intervals. Accounting period may be a calendar year
to provide better remuneration and additional or a natural business year.
benefits.
Example: Jollibee should report financial statements
2. External Users. These are individuals outside a quarterly.
business organization who use financial information.
They are not directly involved in management 4. Monetary Unit Principle explains that amounts are
and operation of business. reported into a single monetary unit.
3.
Examples: Example: McDo should report financial statements in peso
 Creditors and suppliers in order to evaluate a even they have branches in other countries that have
borrower’s ability to pay and I deciding whether to different currencies.
extend credit to a debtor.
 Investors to determine if their investment is 5. Materiality Principle dictates that strict compliance
profitable and safe and in deciding whether to invest with GAAP is not required as long as the items are
or not, or whether they should buy, hold or sell their immaterial or insignificant to affect the decision
shares of stocks. making or fairness of the financial statements.
 Government and their Agencies. In order to regulate
the activities of the enterprise, determine taxation Example: An error in the financial statement of
policies and as basis for national income statistics. multinational company may be immaterial but not in startup
Examples of such agencies are Bureau of Internal businesses
Revenue (BIR), Securities and Exchange
Commission (SEC) and Department of Trade and
Industry (DTI).
 Customers use financial statements as basis for 6. Conservatism Principle or Concept of Prudence
evaluating the possibility of price changes and means that “in case of doubt”, record any loss and
identifying other sources of cheaper services and do not record any gain.
commodities.
Example: In case of doubt, expenses should be reported at a
 Trade Associations use financial data to report
higher amount which results in decrease of revenue.
industry statistics; industry comparisons and
analysis in order to that firms belonging to the same
7. Disclosure Principle states that all relevant and
industry can make relevant economic decisions.
material information should be disclosed or
reported.
Other users of financial information include financial
analysts and advisors, lawyer, media or press and the
Example: ABC Company should report all relevant
general public.
information and if needed, include on notes to financial
statements.
ACCOUNTING CONCEPTS AND PRINCIPLES
ACCOUNTING EQUATION
8. Accrual Basis implies that revenue should be
recognized when performed regardless of when cash
ACCOUNTING CONCEPTS AND PRINCIPLES
is received, while expenses should be recognized
when incurred regardless of when it was paid. On
1. Going Concern or Continuity Principle- means
the other hand, Cash Basis recognizes revenue
that in the absence of evidence of its ceasation, the
 when cash is received and recognizes expenses Accounts Affected Effect
when cash is paid. Office Supplies - Decrease
Cash - Increase
Example: XYZ received Php 20,000 for payment of
services on January but performed the services next month. The return of office supplies will decrease the office
Under the accrual basis, revenue is recognized on February; supplies of the company. The refund will increase the Cash
however, under the cash basis income should be reported on Account.
the date of collection or on January.
4. Purchased office equipment worth Php 20,000 on credit.
9. Matching Principle states that revenue should be
matched on expenses. Accounts Affected Effect
Office Equipment - Increase
Example: When you provide services, there were costs Accounts Payable - Increase
incurred directly and should be reported for that period.
The effect of purchasing office equipment will increase its
THE ACCOUNTING EQUATION account. Since office equipment was purchased on credit (on
account), the Accounts Payable which is a liability account
Business transactions are analyzed, recorded, classified and also increases.
summarized to be able to prepare the financial statements
for decision making. Source documents are important 5. Issued check in payment of the office equipment
because these are the evidence of transactions. Analysis of purchased on July 4.
business transactions can be done through the accounting
equation: Accounts Affected Effect
Accounts Payable - Decrease
Assets = Liabilities + Owner’s Equity Cash - Decrease
The left side of the equation shows the assets while the right The liability account was decrease due to the payment;
side shows who provide the funds or resources needed by likewise, the Cash Account will decrease because it was
the business. Equity means right to properties and liabilities paid.
is placed before equity because creditors have preferential
rights on the assets of the entity.
TIPS IN ANALYSING BUSINESS TRANSACTIONS:
 There are always two or more accounts affected
or involved in every transaction. 6. Paid office rent amounting to Php 15,000 for the month
 The effect of transactions on the accounts of July.
involved an increase or a decrease.
 Transactions are analyzed in the point of view of Accounts Affected Effect
the business Rent Expense - Increase
Cash - Decrease

Illustration of business transaction that affect the accounting The payment was for office rental, so it charged to Rent
equation: Expense Account. Every time expense is paid, particular
expense account increases while cash decreases.
1. Mr. Ricardo Miranda invested Php 400,000.
7. The owner withdrew Php 15,000 for personal use.
Accounts Affected Effect
Cash - Increase Accounts Affected Effect
Miranda, Capital - Increase Miranda, Drawing - Increase
Cash - Decrease
The business received cash which increases the Cash
Account. The amount received represents investment so
it will also increase Capital Account. In proprietorship, the owner is the one managing using
his/her efforts, time and resources in running the business.
2. Acquired office supplies amounting to Php 10,000 The owner can sometimes withdraw cash and/or non-cash
items for personal use. Such withdrawals are charged to
Accounts Affected Effect Withdrawal Account which decreases Cash Account.
Office Supplies - Increase
Cash - Decrease 8. Received cash payment for services rendered worth Php
45,000.
Office supplies were acquired by the firm so it will Accounts Affected Effect
increase its Office Supplies Account. The payment of Cash - Increase
cash decreases the Cash Account of the business. Service Revenue - Increase

3. Received refund for defective office supplies worth Php A service business earned its revenue/income from
5,000 performing services to customers or clients. Once services
have been done or rendered whether cash or on account, statement accounts. So, effectively, there are five major
Revenue Account increases because it is considered earned accounts.
or recognized.
 Assets – A resource controlled by the entity as
9. Rendered services to customers on account amounting a result of past events. An economic resource
to Php 50,000. is a right that has the potential to produce
economic benefits.
Accounts Affected Effect  Liability – A present obligation of the entity to
Accounts Receivable - Increase transfer an economic resource as a result of
Service Revenue - Increase past events. An obligation is a duty of
responsibility that the entity has no practical
The company will have receivables or collectibles from the ability to avoid.
customer whom services were rendered on account. This  Owner’s Equity – The residual interest in the
transaction both increases the Accounts Receivable and assets of the enterprise after deducting all its
Service Revenue Account. liabilities.
 Income – Increases in assets or decreases in
10. Collected the payment of services rendered on July 9. liabilities, that result in increases in equity,
other than those relating to contributions from
Accounts Affected Effect holders of equity claims.
Cash - Increase  Expenses – Decreases in assets or increases in
Accounts Receivable - Decrease liabilities, that result in decreases in equity.

The Cash Account will increase as the company

collected its receivable; however, will decrease the
latter account. POINTERS TO REMEMBER

Accounts Normal Increase Decrease

SUMMARY OF BUSINESS TRANSACTIONS: Balance through through
Assets Debit Debit Credit
Liabilities Credit Credit Debit
ASSETS = LIABILITIES + OWNER’S Owner's Credit Credit Debit
EQUITY equity
Income Credit Credit Debit
Expenses Debit Debit Credit

A journal is a detailed record of all the transactions done by

a business. Whenever an event occurs or a transaction
happens, it records in a journal. Journal can be of two types
– general journal and a special journal.

WHAT IS GENERAL JOURNAL?

The general journal is the book of original entry. It is where

the company initially records all the business transactions
that affects assets, liabilities or equity of a company. For
example, recording depreciation, expense, income and etc.

It also provides the chronological order of all non-

specialized activities, and the recording of these events must
follow the accounting equation which specifies that assets
must be equal to liabilities plus shareholders' equity.
THE FIVE MAJOR ACCOUNTS:
Note: Not all business events are recorded in journal. Only
1. Assets accountable events that affects the account balances of a
2. Liability company's financial statements.
3. Owner’s Equity
4. Income GENERAL JOURNAL FORMAT EXAMPLE
5. Expenses

POINTERS TO REMEMBER

There are five major accounts in accounting, namely: assets,

liabilities, owner's equity, revenues and expenses. Though
revenues and expenses are under owner's equity account,
they are shown separately because they are main income
 account balances, and it is where total balances of each
account are located. Furthermore, transaction data is
segregated by type into assets, liabilities, owners' equity,
revenues, and expenses accounts.

FORMATS OF GENERAL LEDGER

Notice that it usually has date of transaction, short

description/memo, debit amount, credit amount, and a
reference number (referencing to journal ledger as an easy
indicator).
Note: You can choose any of these formats unless the
problem states so.
Notice that both formats have account title, date and account
balance.

WHAT IS SUBSIDIARY LEDGER?

A subsidiary ledger is a group of similar accounts whose

WHAT IS SPECIAL JOURNAL? combined balances equal the balance in a specific general
ledger account.
A special journal is used to record the most frequently
occurring transactions of a business. It records specific types For example, an accounts receivable subsidiary ledger
of high-volume information that would otherwise be (customers' subsidiary ledger) includes a separate account
recorded in and overwhelm the general ledger. for each customer who makes credit purchases. The
There are mainly four kinds of specialty journals – Sales combined balance of every account in this subsidiary ledger
journal, Cash receipts journal, Purchases journal, and Cash equals the balance of accounts receivable in the general
disbursements journal. The total amounts in these journals ledger. Posting
are periodically transferred to the general ledger in summary a debit or credit to a subsidiary ledger account and also to a
form. Moreover, the company can have more special general ledger control account does not violate the rule that
journals depending on its needs and type of transactions. total debit and credit entries must balance because
subsidiary ledger accounts are not part of the general ledger;
SPECIAL JOURNAL EXAMPLE they are supplemental accounts that provide the detail to
support the balance in a control account.

SPECIAL LEDGER EXAMPLE

A ledger is the book of final entry. It summarizes the

transactions of a business and aggregate the amount of each
account being debited and credited in the journal. It has
individual accounts that record assets, liabilities, equity,
revenue, expenses, gains, and losses.

WHAT IS GENERAL LEDGER? PREPARATION OF FINANCIAL STATEMENTS

General ledger is an accounting document that holds Key Terms:

accounting information needed to prepare the company's a. Worksheet – a device used to simplify the adjusting and
financial statements. It summarizes a subsidiary ledger's closing process (this is not a financial statement).
b. Statement of Financial Position – or the balance sheet
provides the assets, liabilities, and equity of an entity at a
specific date. All accounts found on this financial statement
are real
accounts.

c. Statement of Financial Performance – or the Income

Statement (also, Statement of Comprehensive Income)
provides the summary of revenues and expenses of an entity
of a specific period. All accounts found on this financial
statement are nominal accounts.

d. Statement of Changes in Owner’s Equity – FS

providing the movement of the equity account of an entity.
Additional information:
e. Statement of Cash Flows – FS providing the movement
a. Prepaid rent covers the rent for January 2020.
(inflows and outflows) of cash of an entity of a certain
b. Supplies on hand, P5,000.
period.
c. The furniture and fixtures were bought on April 1, 2020,
with no salvage value and an estimated useful life of three
f. Cross-footing – the process of combining of unadjusted
years.
balances with the adjustments such that:
d. The office equipment was bought on July 30, 2019.
e. Unearned Service Revenues include P250,000 rendered
Debit + Debit – Credit = Adjusted Balance
services.
Or
Credit + Credit - Debit = Adjusted Balance
Requirement: Prepare the worksheet for Valencia
Accounting Firm. Use the worksheet on the following page.
SAMPLE WORKSHEET

THE FINANCIAL STATEMENTS

Using the worksheet is easy. The figures for the unadjusted A. Statement of Financial Performance/Income
balance will be the inputs for the Trial Balance columns of Statement/Statement of Comprehensive Income
the worksheet. The Adjustments columns’ input will be - This financial statement presents the summary of all
copied from the revenue and expense items of the entity for the given period
adjusting entries. The adjusted trial balance figures will be of time.
from the cross-footing process. - Information regarding the performance (profitability) of
the enterprise is required to assess potential changes in
The income statement columns will be copied from the economic resources to control in the future. In this reason,
adjusted Revenues and Expenses accounts. The same will be the expenses are arranged from the highest to lowest
done with the balance sheet columns, but Assets, Liabilities, amounts (except for Miscellaneous Expenses, which will
and Equity accounts will be copied. The financial statements always be the last regardless of the amount).
should always be balanced in the end.

Illustrative Exercise 1:
 *Note that if there is no additional investment or profit, do
not include it anymore. It is presented onthe example for
illustrative purposes.

D. Statement of Cash Flows

- This financial statement presents inflows and outflows of
B. Statement of Financial Position/Balance Sheet cash. Remember that this FS revolve only to CASH. Any
- This financial statement presents the financial non-cash items should be removed.
position/condition of entity.
- This financial statement enlists all assets, liabilities and CLASSIFICATIONS OF CASH FLOWS
equity of an entity in net amount at a given point in time.
- This FS is used to evaluate an entity’s liquidity (for short 1. Operating Activities
term obligations), solvency (for long term obligations), - Items that primarily affects the determination of profit and
financial flexibility, and the ability to generate profits. loss. This mainly comes from the normal operations of the
- Items in this FS are arranged by decreasing liquidity (likely entity.
to be converted to cash in short period of time).
2. Investing Activities
- Items including making and collecting loans, acquiring and
disposing of property plant and equipment, and other
productive assets, investments in debt and equity
instruments.

3. Financing Activities
- Items from obtaining or distributing resources from/to the
owners and creditors.

*Note that after the preparation of the Statement of Cash

Flows, the net balance of cash should be equal to the cash
balance found in your SFP.

JOURNALIZE CLOSING JOURNAL ENTRIES

The nominal accounts are the only items closed in the books
of an entity. They are also called temporary accounts. These
accounts accumulate all the transactions of only one
accounting period. In the end of the accounting period, they
will be closed to the owner’s capital account. In summary,
*Note that the net figures of the non-current assets presents all nominal accounts should be transferred to the capital
the net amounts. Meaning, Cost less the accumulated account leaving no (0) balance.
depreciation.
STEPS IN JOURNALIZING CLOSING ENTRIES
*Note that the Capital account is already adjusted
(Beginning Balance less withdrawals and loss). This amount 1. Close the Revenues and Expenses Accounts
will be seen in the Statement of Changes in Owner’s Equity. The revenue and expenses are closed to a summary account
called “Income Summary”.
*Note that the prepaid rent is not presented because it has
no balance on the account anymore. No need to present an
item if it has no balance. PRO FORMAT CLOSING JOURNAL ENTRIES

C. Statement of Changes in Owner’s Equity

- This financial statement presents the movement of the
equity account. This account is affected by withdrawals,
profit (loss), and additional capital.
*Note that the revenue has a normal balance of credit;
therefore, it should be debited to zero out the balance. Our
main goal is to make the balances of temporary accounts 0.

* Note that the expenses have normal balances of debit;

therefore, it should be credited to zero out the balance. The
expenses should be listed one-by-one because they have
their own separate ledgers.

2. Close the Income Summary Account

After closing the revenue and expenses account, the balance
of income summary (debit balance signifies profit and credit
balance signifies loss) will be closed to the capital account.

PRO FORMAT CLOSING JOURNAL ENTRIES

Income Summary xx
Capital xx
To close the income summary account.

*This entry is used if the entity gains a profit. If loss, the

capital account should be debited and the income summary
should be credited.

3. Close the Withdrawal account

PRO FORMAT CLOSING JOURNAL ENTRIES

Capital xx
Withdrawals xx

Once the closing journal entries have been entered into the
general journal, the information should be posted to the
general ledger. All of the nominal accounts in the general
ledger should
have zero balances. To double check on this, another trial
balance (called Post Closing trial balance) will be prepared
based on the new balances in the general ledger.