FINANCIAL ACCOUNTING AND 5.

Notes - comprising significant accounting

REPORTING: AN OVERVIEW policies and other explanatory information;
Statement of financial position as at the
beginning of the preceding period
FINANCIAL STATEMENTS 6. Statement of financial position as at the
beginning of the preceding period - when
- All companies produce them
an entity applies an accounting policy
- quantitative financial information and other
retrospectively or makes a retrospective
relevant information are communicated to
restatement of items in its financial
the interested users
statements, or when it reclassifies items in
- General purpose: to meet the needs of the
its financial statements.
users who are not in the position to require
 must be presented with equal prominence in a
an entity to prepare reports tailored to their
complete set of financial statements
needs
- A company communicates its financial GENERALLY ACCEPTED ACCOUNTING
information to those who have no direct PRINCIPLES (GAAP) AND STANDARD-
access to the company’s records SETTING PROCESS
- provide information about the entity’s
 Generally Accepted Accounting Principles
financial position as of the end of the period
(GAAP)
- comprehensive income, cash flows, changes
- sets of practices developed and constantly
in equity, note disclosures *(at the end of the
reviewed to provide guidelines for financial
period
accounting and reporting
Set of Financial Statements - comprises the principles, standards,
conventions, and assumptions used in the
1. Statement of financial position as at the
preparation and presentation of financial
end of the period - presents the resources
statements.
controlled and the liabilities owed by the
 International Accounting Standards
entity, and the equity of the owners over the
Committee (IASC)
business.
- formed in 1973
2. Statement of profit or loss and other
- developed accounting standards called
comprehensive income for the period -
International Accounting Standards (IASs);
provides information about how the entity
earned worldwide acceptance and
performed during a period, by showing the
observance
income earned and expenses incurred.
- World Bank, International Monetary Fund,
Income - expenses = profit or loss.
International
3. Statement of changes in equity for the
- Organization of Securities Commission and
period - shows the changes of owner’s
Organization for Economic Cooperation and
interest in the business. Capital +
Development urged the public to adopt these
Contributions and Income – Withdrawals
set of global accounting standards.
and Losses
 International Accounting Standards Board
4. Statement of cash flows for the period -
(IASB)
shows the movements of cash during a
- Under the governance of the IFRS
period. Movements means inflow and
Foundation, replaced IASC in 2001
outflow of cash which may be classified as
- Develops International Financial Reporting
operating, financing, and investing.
Standards (IFRSs)
- IFRS is a collective terminology to refer to establishing financial reporting standards in
standards developed by both IASC and the Philippines
IASB including interpretations by Standing  Formulation of accounting standards is a
Interpretations Committee (SIC)  social process
International Financial Reporting  Rapid changes in the accounting profession
Interpretations Committee (IFRIC) affects the financial reporting environment
 Standards are constantly assessed and
evaluated to determine necessary revisions
The Qualitative Characteristics of Useful
Financial Information
- Identify the types of information that are
likely to be most useful to the existing and
potential investors, lenders, and other
-
creditors for making decisions about the
*In the Philippines: reporting entity based on information in its
financial report (financial information).
Accounting Standard Council (ASC)
1. Fundamental
 1981 - Organized by the Philippine Institute  Relevance - ability of the information to
of Certified Public Accountants or PICPA influence a decision; capable of making
 tasked to formulate accounting standards a difference in a decision if it has
composed of eight members from PICPA, predictive value, confirmatory value, or
SEC, BSP, BOA, and FINEX. both.
 Prior to 1997 – PH considered the issuances o Financial information has
of US Financial Accounting Standards predictive value if it can be used
Board which are called Statement of as an input to processes
Financial Accounting Standards (SFAS) employed by users to predict
 1997 - ASC moved to adopt IAS in the outcomes; does not need to be a
Philippines and published its version of the prediction or forecast
standard as Philippine Accounting Standard o Financial information has
 2005 - ASC decided for the full adoption of confirmatory value if it provides
existing IASs by the IASC. feedback (confirms or changes)
 2006 - Financial Reporting Standards about previous evaluations
Council (FRSC) which was created by the  Faithful representation - should be
Philippine Regulation Commission upon the complete, neutral, and free from error.
recommendation of the Board of o Complete depiction - includes all
Accountancy, replaced ASC information necessary for a use to
 FRSC’s Main Task - establish GAAP understand the phenomenon being
although it carried on the resolution of ASC depicted, including all necessary
to converge Philippine accounting standards descriptions and explanations.
with international accounting standards. o Neutral depiction - without bias in
 Philippine Financial Reporting (PFRS) – the selection or presentation of
FRSC’s approved statement financial information; not slanted,
 Philippines Interpretation Committee – weighted, emphasized, de-
created by FRSC to assist the latter in emphasized, or otherwise
 manipulated to increase the 2. Liability - a present obligation of the entity
probability that financial arising from past events, the settlement of
information will be received which is expected to result in an outflow
favorably or unfavorably by users. from the entity of resources embodying
o Free from error - there are no errors economic benefits.
or omissions in the description of 3. Owner’s claim or equity - the residual
the phenomenon, and the process interest in the assets of the entity after
used to produce the reported deducting all its liabilities
information has been selected and 4. Income - increase in economic benefits
applied with no errors in the process during the accounting period in the form of
2. Enhancing – should be maximized to the inflows or enhancements of assets or
extent possible; however, cannot make decreases of liabilities that result in
information useful if the information is increases in equity, other than those relating
irrelevant or not faithfully represented to contributions from equity participants.
 Verifiability - different knowledgeable 5. Expense - decrease in economic benefits
and independent observers could reach during the accounting period in the form of
consensus outflows or depletions of assets or
 Comparability - enables users to identify incurrences of liabilities that result in
and understand similarities in, and decreases in equity, other than those relating
differences among, items. to distributions to equity participants.
 Understandability - Classifying,
The Accounting Equation and Double Entry System
characterizing, and presenting
information clearly and concisely Accounting Equation
 Timeliness - having information
- Assets = Liabilities + Equity
available to decision-makers in time to
- Must always be equal or in balance all
be capable of influencing their decisions;
throughout the accounting process
updated
- Creditor’s claim and owner’s claim
The Definition, Recognition and Measurement of
the Elements from which Financial Statements
are Constructed
- FSs portray the financial effects of
transactions and other events by grouping
them into broad classes according to their
economic characteristics/elements of Examples of Assets:
financial statements
- assets, liability, equity, income, and 1. Cash - comprises cash on hand and demand
expenses deposits
- ALEq = measurement of financial positions 2. Cash equivalents - short-term, highly liquid
- IEx = measurement of performance in the investments that are readily convertible to
Comprehensive Income Statement known amounts of cash and which are
1. Asset - resource controlled by the entity subject to an insignificant risk of changes in
arising from past transactions or events and value.
from which future economic benefits are
expected to flow to the entity.
 3. Accounts receivable - open accounts from a fixed determinable date, a sum certain in
the sale of goods or services in the ordinary money.
course of business. 6. Bonds payable - a liability arising from a
4. Notes receivable - receivables supported by formal unconditional promise of a debtor,
a promissory note. made under seal, to pay a specified sum of
5. Inventories - assets held for sale in the money at a determinable future date, and to
ordinary course of business; in the process make periodic interest at a stated rate until
of production for such sale; or in the form of the principal sum is paid.
materials or supplies to be consumed in the 7. Mortgage payable - a liability of an owner of
production process or in the rendering of property to pay a loan that is secured by a
services. property.
6. Prepaid expense - future expense that are
Examples of Equity:
already paid in advance.
7. Property, plant, and equipment - tangible 1. Dela Cruz, Capital - the equity or capital
items that are held for use in the production account of an owner over an enterprise
or supply of goods or services, for rental to 2. Retained Earnings - the accumulated profits
others, or for administrative purposes, and and losses of an enterprise from the time it
are expected to be used for more than one started operations up to the current period.
accounting period.
Examples of Income:
8. Equity securities - represent ownership in a
company or rights to acquire ownership 1. Service income - income earned after
interests at an agreed-upon or determinable providing services to the clients or
price. customers.
9. Debt securities - instruments representing 2. Interest income - income earned from
creditor relationship with an enterprise. lending of money, computed using a
10. Intangible asset - an identifiable, non- stated interest rate.
monetary asset without physical substance. 3. Rent income - income arising from the use
of property.
Examples of Liabilities:
4. Sales / Revenue, income arising from sale of
1. Accounts payable or trade accounts - are goods in the normal course of business.
liabilities arising from the purchase of 5. Gain on sale or gain on disposal, the excess
goods, materials or supplies on an open- of the net selling price over the carrying
charge account basis. value of the asset disposed.
2. Interest payable, refers to the obligation of a
Example of Expense:
company for interest already incurred but
not yet paid. 1. Advertising expense - amount incurred in
3. Provision - liabilities of uncertain timing or marketing or advertising a product or service.
amount.
2. Cost of sales - the cost of services or products
4. Unearned rent - amount received in advance
sold during the current period.
from lessee for the use of the asset in the
future. 3. Loss on sale - occurs when the carrying value of
5. Note payable - an obligation arising from an the asset disposed exceed the net selling price.
unconditional promise in writing by a debtor
4. Warranty expense - expense arising from the
to another, engaging to pay on demand or at
estimate of the repair or service costs during a
specified period if the products sold are defective.
5. Salary expense - amount incurred to pay for the - Mirror images of Asset
salaries of employees during a specific period. - current and non-current liabilities
o Current – expected to realize in its
Transaction Analysis normal operating cycle (12 months after
Accounting Cycle the reporting period

- Refers to the series of sequential steps or Current Liabilities Non-Current

procedures performed to accomplish the Liabilities
accounting process  Accounts  Mortgage
Payable Payable
Step 1: Identifying and Analyzing Business  Notes Payable  Bonds Payable
Transactions  Accrued
Liabilities
- to gather information about transactions or  Unearned
events generally through source documents revenues
- to identify and analyze the accounts affected  Current Portion
and the amounts to be recorded of long term-
debt
Accounting Equation
- Basic tool of accounting
- A=L+E Owner’s Equity
Assets - Capital Account
- Withdrawal Account
- Controlled by Enterprise - Income Summary Account
- Result of past events - Expense Accounts
- Future Economic Benefit - Income Accounts
- current and non-current assets
o Current Assets – realizes in its normal Income Expenses
operating cycle (12 months after the  Service Income  Cost of Sales
 Sales  Salaries or Wages
reporting period)
Expense
o These are cash or cash equivalents, the
 Utilities Expense
rest are non-current assets  Rent Expense
 Supplies Expense
 Insurance Expense
Current Assets Non-Current Assets  Depreciation
 Cash  Property, Plant Expense
 Cash Equivalents and Equipment  Interest Expense
 Notes Receivable (PPE)  Bad Debts
 Accounts  Accumulated Expense
Receivable Depreciation
 Inventories  Intangible Assets
 Prepaid
Expenses Normal Balance of an Account

Liabilities
- OBLIGATION
- Transfer economic benefits
- Results from past transaction or events
 - Date
- Account Title and Explanation
- P.R. (Posting Reference)
- Debit
- Credit
Rules of Double Entry System
 Two or more accounts area affected by each
transaction
Transaction Analysis  Sum of debits = sum of the credits
 Equality of accounting equation is
1. Identify the transaction from source
ALWAYS maintained
documents
1. Simple Entry – 2 accounts are affected by
- Ex: The company bought an Equipment
the transaction
costing P10,000 on account
2. Compound Entry – 3 or more accounts are
2. Indicate the Accounts affected by the
affected by the transaction
transaction
- Ex: Equipment is an Asset, and Step 3: Posting to the Ledger
Accounts Payable (Liability) account is
affected by the transaction - To transfer the information from the journal
3. Indicate whether each account is increased to the ledger for classification
or decreased by the transaction o Ledger – a collection of accounts
- Ex: Assets are increased because of the that shows the changes made to each
acquisition of new equipment and account because of past transactions,
Liabilities are increased because a new and their current balances
obligation arises o Posting – transferring the amounts
4. Determine whether to debit or credit the from the journal to the ledger
account to record its increased or Sample format of the Ledger
decreased
- Ex: Increase in assets is debit; Increase  Account Name
in Liabilities is credits  Account No.
 Date
Step 2: Recording in the Journals  Explanation
- To record economic impact of transactions  J.R. (Journal reference)
on the firm in a journal, which is a form that  Debit
facilitates the transfer to accounts  Credit
o Journal – Books of Original Entry.
A book: paper or electronic, where Ledger Accounts after Posting
transactions are recorded
o Journalizing – process of recording a Footing – each account balance is determined by
transaction adding ALL debits and credits

Journal Step 4: Unadjusted Trial Balance

- Chronological record of the entity’s - To verify the equality of the debits and
transaction credits
- General Journal – Simplest Journal - Trial Balance – prepared to test the equality
of the debits and credits
Format of Journal
Procedures
 1. List the account title in numerical order  Allowance for Uncollectible Accounts
2. Obtain the account balance of each
Step 6: Financial Statements
account from the ledger and enter the
balances 1. Statement of Comprehensive Income
3. Add the debit and credit columns
 An entity shall present income and expense
recognized during a period
 Single – statement of comprehensive income
 Two statement of comprehensive income –
displays components of profit or loss
(separate income statement) and a second
statement beginning with profit and loss
(statement of comprehensive income)
Step 5: Worksheet including Adjusting Entries 2. Statement of Changes in Equity
- To aid in preparation of the financial - summarizes the changes that occurred in
statements owner’s equity
 Worksheet – simplifies the adjusting and
- changes in an enterprise’s equity between two
closing entries
balance sheet dates reflect the increase or
Adjusting Entries decrease in its net assets during the period
 Deferred Expense 3. Statement of Financial Position
- an expense already paid but not yet
- statement that shows the financial condition of
incurred
an entity by listing the assets, liabilities, and
- allocating the assets to reflect expenses
owner’s equity as at a specific date
incurred during the accounting period
 Deferred Income - the information needed here is the net balances
- Revenue already collected but not yet at the end of the period
earned
- Allocating revenues received in advance to - aka balance sheet
revenue to reflect revenues earned during 4. Statement of Cash Flow
the accounting period
 Accrued Expense - provides information about the cash receipts
- Expense already incurred but unpaid and cash payment of an entity during the period
- Accruing expense to reflect expense
incurred during the accounting period that
are unpaid and unrecorded
- Step 7: Adjustments are Journalized and Posted
 Accrued Income/Revenues
- Revenues already earned but uncollected - The adjustment process is a key element of
- Accruing revenues to reflect revenues accrual basis accounting
earned during the accounting period that are - The worksheet helps in the identification of
unpaid and unrecorded the accounts that need adjustment
 Depreciation
Step 8: Closing Entries are Journalized and
- Straight line method – allocating the cost of
Posted
asset over the estimated usefulness of that
asset - Income, Expense, and Withdrawal Accounts
Depreciation Expense¿ ¿ ¿ are temporary accounts
- ^^ they accumulate information related to
specific accounting period
1. Close the income accounts
2. Close the expense account
3. Close the income summary account
4. Close the withdrawal account
Step 9: Preparation of a Post-Closing Trial
Balance
- The post – closing trial balance verifies that
all debits equal the credits in the trial
balance

Step 10: Reversing Entries

- a journal entry that is exact opposite of a
related adjusting entry made at the end of
the period
- to simplify the accounting record upon
occurrence of the adjusting entries on the
next period
- technically reversal is done for those
adjustments that increases assets and
increases liabilities

Adjusting Entries
- converts from cash basis of accounting to
the accrual basis of accounting
  Accrual Basis of Accounting – recognition
of revenues when earned and recognition of
expenses when incurred
 Revenues are earned when the services are
already rendered, or products have been sold
to the customer
 Expenses are incurred when there is
consumption or enjoyment that will benefit
you in a certain period

Account Titles Used in Adjusting Entries

Prepaid Expenses
 Expenses paid for but not yet used by the
company
 ex: prepaid rent, prepaid insurance, prepaid
supplies
 two methods: the asset and expense method
Step by Step process in Prepaid Expenses
1. Assess if it is accounted under asset method
or expense method
Asset Method
 Cash payments are recorded as assets
 Adjustment will be made for the
expired/used portion of the asset
 Dr. Prepaid Asset/Expense
Cr. Cash
 Dr. Expenses
Cr. Asset/Prepaid Asset

Expense Method
 Cash payments are recorded as expenses
 Adjustments will be made for the
UNEXPIRED/UNUSED portion of the
expense