CHAPTER 2

ACCOUNTING ELEMENTS AND FINANCIAL STATEMENTS

ACCOUNTING ELEMENTS

The basic accounting elements or values are: assets, liabilities and capital. These accounts provide
information on the financial condition of the business. They are presented in the balance sheet and are thus called
balance sheet accounts. Balance sheet accounts are also termed real accounts because their usefulness continues
throughout the life of the business and that their year-end balances are forwarded to the next accounting period

The other accounting elements are revenues and expenses. These accounts provide information on the
changes in capital as the result of operation in the business. They are presented in the income statement and are
termed income statement accounts. They are also called nominal accounts because their usefulness is limited to the
year when they are incurred. The year-end balances are closed and not forwarded to the next accounting period.

ASSETS

Assets are resources controlled by the enterprise as a result of past transactions or events and from which
future economic benefits are expected to flow to the enterprise. The essential characteristics of an asset are:

a. The asset is controlled by the enterprise

b. The asset is the result of a past transaction or event

c. The asset provides future economic benefits and

d. The cost of the asset can be measured reliably.

Assets are classified into two: current assets and non-current asset (PAS No. 1).

1. Current Assets - normal trading cycle of accounting is 1 year.

The revised PAS 1 provides that an asset shall be classified as current when it satisfies any of the
following criteria:
a. It is a cash or a cash equivalent unless it is restricted from being exchanged or used to settle a
liability for at least twelve months after the balance sheet date.
b. It is held primarily for the purpose of being traded
c. It is expected to be realized within twelve months after the balance sheet date or
d. It is expected to be realized or intended for sale or consumption within the entity's normal
operating cycle.
 The operating cycle is the time between acquisition of assets for processing and their realization in cash or
cash equivalents. The operating cycle of a trading enterprise is the average period of time that it takes for an
enterprise to acquire the merchandise inventory, sell the inventory to customers and ultimately collect cash from
the sale. The operating cycle of a manufacturing company is the period of time that it takes to acquire receivables
and collect the receivables. When the entity's normal operating cycle is not materials, convert them into finished
goods, sell the finished goods, convert them into clearly identifiable, its duration is assumed to be twelve months.

Examples of current assets are:

Cash - includes currency or cash items on hand (such as items awaiting deposit and cash in working funds as well as
peso or foreign currency deposits in banks which are unrestricted and immediately available for use in the current
operations. Cash items include cash on hand, cash in bank, cash fund for current purposes like petty cash fund,
payroll fund, dividend fund and travel fund.

Cash equivalents - are short term highly liquid investments that are readily convertible to known amounts of cash
and so near their maturity that they present insignificant risk of changes in value because of changes in interest
rates. Only highly liquid investments that are acquired three months before maturity can qualify as cash equivalents.
Three-month BSP treasury bill, three-month deposit and three-month money market instruments are cash
equivalents.

Trading securities - investments which are readily marketable and represent temporary investment of funds
available for current operations and are intended to meet working capital requirements. These could include short-
term investment in stocks and bonds.

Accounts receivable - are open accounts or those that are not supported by promissory notes. Other names used
are charge accounts, customer's accounts or trade debtors

Allowance for doubtful accounts - a contra-asset account which is provided for possible losses from uncollected
accounts. This valuation allowance is actually not an asset. It is a deduction from the accounts receivable.

Notes receivables- amount collectible that are evidenced by a promissory note or a written promise to pay

Merchandise Inventory or merchandise - goods held for sale by trading concern

Finished goods, goods in process, raw materials and factory or manufacturing supplies - Inventories held by
manufacturing firms

Prepaid rent-rent paid in advance

Prepaid insurance - insurance paid in advance

Unused supplies- stationary and other supplies purchased for use and are still unused. Specific account titles such as
Office supplies unused or Store supplies unused may be used.
 2. Non-Current Assets

All other assets except current assets are non-current assets. These tangible, intangible, operating and financial
assets of a long-term nature.

a. Property, Plant or Equipment or Fixed Assets

These are tangible assets which are held by the enterprise in production or supply of goods or
services, for rental to others, or for administrative purposes, and are expected to be used during more than
one period (PAS No. 16)

The following are examples of Property, Plant and Equipment (use in the conduct “not 4 sale”)

Land - land used by the business

Building- building owned or controlled and used by the business

Office equipment-typewriters, adding machines, calculators

Store equipment - cash register, calculators

Delivery equipment - delivery truck or jeep used for transporting merchandise

Machineries - machines, motors

Furniture and fixtures - tables, chairs, showcases, counters

Accumulated depreciation - contra-account used to accumulate expired cost of fixed assets. It is a deduction
from property, plant and equipment.

b. Long Term Investments

Investments are assets held by an enterprise for the accretion of wealth through capital distribution, such as
interest, royalties, dividends and rentals, for capital appreciation or for other benefits to the investing enterprise
such as those obtained through trading relationship. (LAS No. 25). An investment may either be current or non-
current. A current investment is readily realizable and is intended to be held for not more than one year. A long-
term investment is intended to be held for more than one year.

Trade – 1year, 9months Non-trade – 1 year

Examples of long-term investments are Investment in bonds, Investment in subsidiaries, or Cash surrender value of
life insurance.
c. Intangibles

PAS 38 defines intangible assets as identifiable non-monetary assets without physical substance. The
intangible asset must be controlled by the enterprise as a result of past event and from which future economic
benefits are expected to flow to the enterprise. The following are examples of intangible assets.

Copyright - right granted to authors, composers, playwrights, artists, publishers or distributors to publish and
dispose of their works for a limited time.

Franchise-right granted to operate a utility or to manufacture or to market a product of another company within
a specified area

Patent - right granted to an inventor to manufacture or produce his inventions or products

Goodwill - is an intangible advantage that increases earnings over what is normal. It is the excess of agreed value
over contributed value.

Trademark or brand name - a symbol, sign, slogan or name used to mark a product or to distinguish it from
other products.

d. Other Non-Current Assets

Other non-current assets include assets that do not fit in into the definition of the above-mentioned non-
current assets. These include long-term advances to officers, or employees or abandoned property, and long-
term refundable deposits.

Land -

Inventory - CA

Investment - MSA

PPE - NCA
 LIABILITIES

Liabilities are the present obligations of an enterprise arising from past transactions or events, the
settlement of which is expected to result in an outflow from the enterprise of resources embodying economic
benefits. Liabilities are classified into current liabilities and non-current liabilities.

1. Current Liabilities
A liability shall be classified as current when it satisfies any of the following criteria:
a. It is expected to be settled in the entity's normal operating cycle
b. It is held primarily for the purpose of being traded
c. It is due to be settled within twelve months after the balance sheet date
d. The entity does not have an unconditional right to defer settlement of the liability for at
least twelve months after the balance sheet date.

Examples of liability accounts are:

Accounts payable - amounts due to suppliers for the purchase of goods or services on credit

Notes payable - amounts due to other parties when it is evidenced by a promissory

note - enforceable on court

Prepaid expense paid

Accrued expenses - expenses incurred but not yet paid such as salaries, rent, interest and taxes. Accounts like
salaries payable, rent payable, interest payable and taxes payable may be used

Accrued income - not received, but earmed.

Interest payable - unpaid interest on borrowings

Salaries payable - services rendered by employees but still unpaid

Bank loans payable - obligations due to banks for loans obtained (current portion)

Deferred revenue-income received but not yet earned.

SSS premium payable - amount due and payable by the enterprise to Social Security System

Philhealth premium payable - amount due and payable by the enterprise to Philippine Health Insurance Corporation

Withholding tax payable - amount due and payable by the enterprise to BIR for the tax withheld from employees
 2. Non-Current Liabilities

All liabilities that do not fit into the definition of current liabilities are classified as non-current liabilities.

Mortgage payable - economic obligations secured by collateral

Deferred revenue - income received in advance but not yet earned and which will be realized as income over a
period of more than one year or the normal operating cycle if it exceeds one year.

EQUITY

Equity represents residual interest in the assets of the enterprise after deducting all liabilities. It is equal to
total assets minus liabilities. It is otherwise known as net assets in a sole proprietorship, partners' equity or capital in
a partnership and stockholders' equity net worth. Terms used in reporting the equity of an enterprise are owner's
equity or or shareholders' equity in a corporation.

For a sole proprietorship, the capital accounts and withdrawal are presented as:

Owners' capital - This includes the capital contribution of the owner made at the formation of the business or
subsequent thereto.

Ex. Adoracion Grecia, Capital

Owner's Drawing - This is used for recording the withdrawal of capital by the owner.

Ex. Adoracion Grecia, Drawing

Revenues are gross inflow of economic benefits during the period arising in the course of ordinary activities
of an enterprise when those inflows result in increases in equity other than those relating to contributions from
owners. Revenues may be derived from sales of merchandise to customers, rendering of services, use of enterprise
resources and disposal of resources other than products

The income accounts in a service concern may be named as:

Service income-represents charges to clients or customers for services rendered.

Professional income - charges to clients by professionals for services rendered.

Ex. Legal fees income, accounting fees income or medical fees income

Rent income - represent charges for the use of assets like equipment and spaces in buildings

Repair income - represents charges to customers for repair services rendered.

Laundry income - represent charges to customers for laundry services rendered

Transportation income or fares earned - represents charges to passengers for transportation services rendered

Ticket sales - represent amount of tickets sold to watchers of games, shows or movies

Miscellaneous income - income earned by the business coming from other sources which is not the main line of
business and could not be clearly identified

For a merchandising firm, the account titles used are:

Sales-represent income from the sale of merchandise

Sales returns-represent deduction from sales due to merchandise returned by customers

Sales allowances-represent deductions from selling price of goods with defects or goods sent to customers
but not as ordered. The goods are retained by customers.

Sales discounts - deductions from the selling price due to payments of the customers within the discount
period.
 EXPENSES

Expenses are the gross outflow of economic benefits arising in the course of ordinary activities when those
outflows result in decreases in equity, other than those relating to distributions to owners.

Specifically expenses include the following: cost of sales, distributions or selling expenses, administrative expenses,
other operating expenses and income tax expense

Cost Accounts - these accounts represent the value of the goods sold. These include:

Purchases-represent the original acquisition price of the goods for resale

Purchase returns-represent the cost of goods purchased but returned to suppliers because they are either
damaged, defective or unacceptable

Purchase allowances - represent the reduction in the cost of defective or damaged goods bought but nor
returned to the supplier

Purchase returns and allowances - is usually used for the two accounts

Purchase discounts - represent the reduction in the amount to be paid to the supplier due to payment of
account within the discount period

Freight in-represent the cost of transporting goods purchased from the suppliers to the store or the
warehouse of the business
Other Expense Accounts:

Salaries and Wages - represents the value of services rendered by employees and laborers

Account titles like office salaries, sales salaries and the like may be used

Advertising expense - includes advertising or promotional expenses. This includes cost of publication in print media
and propaganda in radio and television

Rent expense - amount paid or incurred for the use of properties

Repairs and Maintenance - amount paid to maintain company assets in good working conditions

Transportation expense - amount paid for services of conveyance or means of transportation of goods to customers

Taxes and licenses - amount of taxes and other licenses paid to the government

Depreciation expense - is the portion of the cost of a fixed asset that is charged or allocated as expense for the
period

Insurance expense - premiums on insurance policies charged to expense

Supplies expense - amount of supplies used. Specifically termed as office supplies expense or store supplies expense

Utilities expense - cost of light and water consumed by the business. An account title Water and Electricity or Heat,
Light and Water may be used

Representation and Entertainment-represent value placed on activities that will promote goodwill and increase
customers' patronage.

Postage and Communications - amount paid for postage, telephone and other forms of communication

SSS Premiums- contributions of employer to the Social Security System

Miscellaneous expense-relatively small amount paid for items or services which do not fall under the above
accounts. Account titles like Miscellaneous selling expense or Miscellaneous office expense may be used