BRIDGING PROGRAM

INCOMING 2nd YEAR- BS IN ENTREPRENEURSHIP

BATCH 2

Lecturer: Ms. Airen B. Abao, CPA, CTT, MBA Module 1 of 8

INTRODUCTION TO ACCOUNTING
Definition of Accounting

It is the process of identifying, measuring, and communicating economic information to permit informed judgments and
decisions by the users of information. - American Accounting Association (AAA)

It is the art of recording, classifying, and summarizing in a significant manner and in terms of money, transactions and
events which are in part at least of a financial character and interpreting the results thereof. - American Institute of Certified
Public Accountants (AICPA)

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 economic decision. - Accounting Standard Council (ASC).

Nature of Accounting

•Accounting is a process. - It performs the functions of identifying, recording and communicating economic events with
the end goal of providing information to internal and external parties.
•Accounting is an art. - It is an art of recording, classifying, summarizing and finalizing financial data. It is a combination
of techniques and its application requires applied skills and expertise.
•Accounting deals with financial information and transactions. - It deals only with quantifiable financial transactions.
Non-financial transactions are not the focus of accounting process but may be used to interpret and better estimate some
financial data.
•Accounting is a means and not an end. - It is a tool to achieve specific objectives.
•Accounting is an information system. - It is recognized and characterized as a storehouse of information. It also collects
processes and communicates financial information.

Functions of Accounting

•Keeping systematic record of business transactions. - The records should be systematic enough to enable easy
understanding of users.
•Protecting properties of business. - Accounting records serve as evidence that properties of a business do exist or how
much of a particular resource does a company have. The accounting system helps in preventing employee fraud and
misappropriation of company resources.
•Communicating results to various parties in or connected with the business. - Communication of the results of operations
of a company is essential for all concerned parties to enable them to take well-informed decisions.
•Meeting legal requirements. - It aims to protect the public by providing them the necessary information to make sound
decisions.

BUSINESS ORGANIZATIONS AND THEIR ACTIVITIES, AND USERS OF ACCOUNTING INFORMATION

Forms of Business Organizations

a. Sole or Single Proprietorship - Business is owned by only one person

b. Partnership - contract whereby two or more persons bind themselves to contribute money, property (other assets owned
by a person), or industry (skills and expertise) to a common fund, with the intention of dividing profits among themselves
and may also be formed for the exercise of a profession

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c. Corporation - artificial being created by the operation of law, having the right of succession and the powers, attributes
and properties expressly authorized by law or incident to its existence

Types of Business According to Activities

1. Service

Definition - generally use their employees to provide services to customers

Input - labor
Output - intangible; service
Advantages - absence of inventory; no production facilities
Disadvantages - inability to standardize services; maintaining human capital
Service revenue - primary source of revenue through performance of services

2. Merchandising

Definition - buy finished or almost finished goods from suppliers and resell the same to customers
Input - goods or merchandise bought from suppliers
Output - tangible; merchandise
Advantages - visible products; less conversion, time and effort
Disadvantage - managing inventory

3. Manufacturing (Manufacturers)
Definition - create their own products
Input - raw materials, labor, overhead
Output - tangible; manufactured products
Advantages - visible products; quality control
Disadvantages - generally need production facilities; high conversion costs; cost of quality control; managing inventory.

Users of Accounting Information

Activities in Business Organizations

• Financing Activities-

Organizations require financial resources to obtain other resources in financial markets are the methods an organization
uses to obtain financial resources from financial markets and how it manages these resources. (e.g., repaying creditors and
paying a return to the owners)

• Investing Activities

Involve the selection and management including disposal and replacement of long-term resources that will be used to
develop, produce and sell goods and services. (e.g. Buying land, equipment, buildings and other resources that are needed
in the operation of the business and selling theses resources when they are no longer needed.

•Operating Activities

Involve the use of resources to design, produce, distribute, and market goods and services. (e.g. research and development,
design and engineering, purchasing, human resources, production, distribution, marketing and selling and servicing.

The Basic Financial Statements and their definition

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1. Statement of Financial Position shows the financial condition or position of the organization at any given time.
2. Income Statement is the results of operating the business during a given time are reflected in the Income Statement.
3. Statement of Changes in Equity shows movements of owner's capital for a particular period.
4. Cash Flow Statement reflects the financing and investing activities of the business or the sources and applications of
funds during the period.
5. Notes to Financial Statements are supplied to achieve proper understanding of the financial statements.

Objective of Financial Statements

The objective of financial statements is to provide information about the financial position, performance and changes in
financial position of an entity that is useful to a wide range of users in making economic decisions.

Elements of Financial Statements

I. Statement of Financial Position elements

- Asset, Liabilities and equity Income

II. Statement elements

- Income and Expense

Basic Accounting Principles

1. Objectivity Principle- Accounting records and statements are based on the most reliable data available so that they will
be accurate and as useful as possible.
2. Historical Cost- states that acquired assets should be recorded at their actual cost and not at what management thinks
as at the reporting date.
3. Revenue recognition principle
4. Expense recognition principle
5. Full disclosure principle – Information communicated to users reflect a balance between detail and conciseness,
keeping in mind the cost-benefit principle.
6. Materiality Principle
7. Consistency Principle- Like transactions are accounted for in like manner from period to period.

The Accounting Equation and the Double Entry System (Part 1)

The Accounting Equation

Assets = Liabilities + Equity

A. Assets- are valuable resources owned by the entity

Characteristics of an asset:

1. Controlled by the enterprise- Control is the ability to obtain the economic benefits and to restrict the access of others.
2. Past events- The event must be past before an asset can arise.
3. Future economic benefits- these are evidenced by the prospective receipt of cash. This could be cash itself, an account
receivable or any item which may be sold.

Examples of assets:

Cash, Cash equivalents, notes receivable, accounts receivable, inventories, prepaid expenses, property, plant and
equipment, investments, intangible assets and other assets.

Classification of Assets

1. Current Assets- assets that are expected to be realized, sold or consumed within the enterprise’s normal operating cycle.

2. Non-Current Assets - All other assets which are not current and are expected to be realized in more than 12 months

Examples of Current assets

1. Cash - Most basic and familiar of all assets

- Also includes money in the form of bank deposits, cash equivalents and checks
- Most liquid
Money – everything composed of bills and coins, considered as legal tender or legal tenders of other nations

Cash Equivalents – short-term investments which are considered subject to negligible changes in fair value, and are
maturing within three months from the date of purchase

2. Accounts Receivable -Oral promises to the entity to receive cash at a later date and usually arise from the normal course
of business
Trade Receivables - arise from the normal course of business
Non-Trade Receivables – do not arise from the normal course of business (other receivables)

3. Short-Term Investments - Investments in low-risk, highly liquid assets such as bonds and stocks, which are expected to
be liquidated in less than a year. Most often, these are entered to make the most income out of its idle cash

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4. Notes Receivable - Written promises to the entity to receive cash at a later date and usually arise from the normal course
of business and sometimes called promissory notes

5. Inventories- Includes raw materials, work-in-process items, finished goods and supplies

Raw Materials – inputs for producing other materials

Work-In-Process Items – raw materials entered into production but awaiting completion
Supplies – do not serve as input for a product but are used in the production
Finished Goods – end products upon completing production

6. Prepayments- Paid in advance for goods or services anticipated to be received by the entity in the future

- Would only cease to be as such when they are finally used up

Examples of Non-Current assets

1. Investments- Most liquid of the noncurrent assets. Investments which are not expected to be realized within 1 year.

2. Fixed Assets- Most tangible, longest-serving assets. Expected to not be converted into cash immediately and regularly
placed as a means of production. Not usually consumable and are only used through utilization.

Depreciation – deterioration with the passage of time, through usage, normal wear-and-tear, and obsolescence (except
land)

3. Intangible Assets- Lack physical substance and yet are similarly realizable over long periods of time. Value and assets are
harder to measure and evaluate. Includes patents, copyrights, franchises, goodwill, trademarks and licenses. Often are
represented by written documents or certificates stating their description and ownership status.

4. Other Assets- All remaining assets which do not fall into any of the accounts mentioned. Catch-all for assets which are
usually very much unique or hard to classify.

B. Liabilities- are obligations of the entity to outside parties who have furnished resources

Characteristics of a Liability:

1. Obligations- may be legal or not.

2. Transfer economic benefits- this could be transfer of cash, or other property, the provision of a service or the refraining
from activities which would otherwise be profitable.
3. Past events
4. Complementary nature of assets and liabilities- as should be evident from the above, assets and liabilities are seen as
mirror images of each other.

Examples of Liabilities

Notes payable, accounts payable, accrued liabilities, unearned revenues, mortgage payable, bonds payable, and other debts
of the enterprise.

Classification of Liabilities

1. Current Liabilities - Expected to be settled or paid out within 12 months

Paying Out – not necessarily payment through cash, can also be conversion and/or refinancing

2. Noncurrent Liabilities- Form the residual portion of liabilities

Liabilities that are expected to be settled after more than a year, or have a legal or contractual capacity to defer payment
accordingly.

Examples of Current Liabilities

1. Accounts Payable- Opposite of accounts receivable. Contemplate only about borrowings involved in the production
process.
2. Notes Payable- Written promises of the entity to pay sum certain in a future determinable time. Can also arise from the
regular borrowings. Opposite of notes receivable. Pay interest regularly and may be paid in lump sum or installments.
3. Accrued Liabilities- All other accounts which the company should pay, arising from the normal course of business.
Company has already received benefits from certain events yet still been unable to pay for it.
4. Current Portion of Long-Term Debts- Portion of the remaining debt that is due many years from now.
5. Other Payables- All other due from the entity outside the normal course of the business. Catch-all classification.

Examples of Non-Current Liabilities

1.Long-term Notes Payable- written promises of the entity to pay sum certain in a future determinable time, it is payable
more than one year. Ex. Bank loan with 5 years maturity.

C. Equity- Residual interest of the owners in the assets of the business after considering all liabilities

Owner’s Capital – equity of sole proprietorship and partnerships

Stockholder’s Equity – equity of corporations

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Capital- this account is used to record the original and additional investments of the owner of the business entity.
Withdrawals- When the owner of the business entity withdraws cash or other assets, such as recorded in the drawing or
withdrawal account rather than directly reducing the owner’s equity account.

Increases in Equity
Revenues – amounts received by a business earned as a result of selling something or rendering a service
1. Operating Revenue – originate from main business operations
a. Sales Revenue – main source of revenue for businesses that sells products
b. Service Revenue - main source of revenue for businesses that render services
2. Non-Operating Revenue – result of some side activities
a. Interest Revenue –earned as a result of investment in debt securities or receivables from other entities
b. Dividend Revenue – earned as a result of dividend declaration of a company where in a business has invested
stocks
c. Contributions Revenue – earned by not-for-profit organizations usually in the form of donations by outside
parties
Gains – result of non-recurring activities or the increase in value of investments
Capital Contributions – result of transactions with owners and may be in the form of cash or non-cash assets for the use in
the business

Decreases in Equity- Result of expenses, losses and distribution to owners

Expenses – amounts consumed by the business to operate and the result of attempting to generate revenues
1. Cost of Goods Sold – incurred by the company to make the inventory sell or buy them
2. Utility Expense – water and electricity
3. Depreciation Expense – use of building and equipment
4. Office Supplies Expense – use of office supplies
5. Insurance Expense – insurance paid for, expiring over time
6. Salaries Expense – salaries and benefits of employees
7. Bad Debts Expense – estimate of how much accounts receivable the company will not be able to collect
8. Interest Expense – incurred as a result of borrowing money
9. Losses – direct opposite of gains
10. Distribution to Owners – assets given to owners, usually in cash
11. Liquidating Dividends – originate from some other equity account

The Expanded Accounting Equation

Assets = Liabilities + Equity + Income - Expenses

• INCOME – is increases in economic benefits during the period in the form of increases in assets, or decreases in liabilities,
that result in increases in equity, excluding those relating to investments by the business owner.
• EXPENSES – are decreases in economic benefits during the period in the form of decreases in assets, or increases in
liabilities, that result in decreases in equity, excluding those relating to distributions to the business owner.
• The difference between income and expenses represents profit or loss.

THE CHART OF ACCOUNTS

Chart of Accounts
A listing of all the accounts and their account numbers in the ledger is known as the chart of accounts. The chart is arranged
in the financial statement order, that is, assets first, followed by liabilities, owner’s equity, income, and expenses. The
accounts should be numbered in flexible manner to permit indexing and cross-referencing. The accountant refers to the
chart of accounts to identify the pertinent accounts to be increased or decreased when analyzing transactions. If an account
title is not listed in the chart, an additional account may be added.

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THE FINANCIAL STATEMENTS

1. The Statement of Financial Position

The statement of financial position
(SFP) shows the financial position or
condition of an entity by listing the
assets, liabilities, and owner’s equity
as at a specific date. The information
need are the net balances at the end of
the period, rather than the total for
the period as in the income statement.
This statement is also called as
balance sheet. The statement of
financial position is analyzed by users
to evaluate the entity’s liquidity,
financial flexibility, and its ability to
generate profits, and its solvency.
Liquidity refers to availability of cash
in the near future after considering of
the financial commitments over this
period. Financial flexibility is the
ability to take effective actions to alter
the amounts and timings of cash flows so that it can respond to unexpected needs and opportunities. This includes the
ability to raise new capital or tap in to unused lines of credit. Solvency refers to availability of cash over the longer term to
meet financial commitments as they fall due.

The balance sheet may be presented in two forms: account form and report form. In account form, assets are presented on
the left side while liabilities and capital are presented on the right. In report form, assets are presented first and then
followed by liabilities and capital. The example above is presented using the report form.

2. The Income Statement

Income statement is a formal statement showing the
performance of the entity for a given period of time. It
summarizes the revenues earned and expenses incurred
for the period of time. It is also referred to as Profit and
Loss (P&L) statement. Information about the
performance of the entity, in particular its profitability,
is required in order to assess potential changes in the
economic resources that is likely to control in the future.
It is also useful in predicting the capacity of the
enterprise to generate cashflows from its existing
resource base.

3. The Statement of Changes in Equity

Statement of changes in equity summarizes the changes that occurred in the owner’s equity. In the case of sole
proprietorship, changes arise from the following:

• Owner’s investments to the business

• Net income or net loss for the period
• Owner’s personal withdrawals
• Prior period adjustments

4. The Cash Flow Statement

Cash flow statement presents the information about the net changes in cash and cash equivalents during an accounting
period is provided by this statement. It classifies cash receipts (inflows) and cash payments (outflows) into operating,
investing, and financing activities. It also helps in projecting the future net cash flows of the entity.

• Cash Flows from Operating Activities. These are cash flows from the normal operating activities of the business. It may
be presented using either the direct or the indirect method. In direct method, the net cash provided by (used in) operating
activities is obtained by adding the individual operating cash inflows and then subtracting the individual operating cash

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outflows. Meanwhile, in indirect method, net cash is derived by adjusting the net income for income and expense items not
resulting from cash transactions.

• Cash Flows from Investing Activities. These include making and collecting loans, acquiring and disposing of investments
in debt or equity instruments, and obtaining and selling of property and equipment and other productive assets.

• Cash Flows from Financing Activities. These includes activities such as obtaining resources from owners and creditors
of the entity.

Operating Activities (i.e., sales revenue, expenses)

All these activities are reported in the I/S (income statement). However, I/S only provides the accrual-basis net income
(revenue –expense + gains – losses) which very often is not the change in cash. Therefore, we need to adjust from net income
flows to cash flows in order to report the net cash provided by (or used in) operating activities

There are two approaches to reconcile net income to net cash provided by (or used in) operating activities:

1. Indirect Method ==> Lump-Sum Adjustment

2. Direct Method ==> Individual Account Adjustment

Indirect Method

Adjust net income (the lump sum amount of all revenues and expenses) for all differences between income flows and cash
flows.

Direct Method

Adjust each revenue account to cash collection and adjust each expense account to cash payment. Subtract total cash
payments from total cash collections to derive net cash flows of the operation activities. Cash flows from operating activities

Cash Inflows:
1. Collections from customers including cash received from sales (or services) and collections of A/R.
2. Collections of other operating receipts (i.e., unearned revenue, rent revenue).

Cash Outflows:
1. Payments to suppliers.
2. Payments to employees.
3. Payments for interest expense.
4. Payments for income taxes.
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5. Payments for other expenses (i.e., Prepaid expenses; rent expenses).

Investing Activities
In addition, to generate cash from or use cash in the operating activities, companies can also generate cash from (or use
cash in) investing activities.

Cash Flows from Investing Activities

Transactions involving acquiring ( Investing (Cash outflows)) and selling ( Disinvesting (Cash inflows)):
a. Property, Plant, and Equipment.
b. Investments (current and non-current).
c. Notes Receivable (current and non-current), including:
Lending money (N/R , cash outflow);
Collecting of loan (N/R , cash inflow);
Selling of N/R (N/R, discounting N/R, cash inflow)

Financing Activities
Companies can also generate cash or use cash through financing activities:
Obtaining resources from owners and creditors (cash inflows) and repaying the amount borrowed (cash outflows).

Cash inflows:
Cash received from investment of an owner
Cash received from the issuance of bonds.
Cash received from the issuance of N/P (short-term or long term).

Cash Outflows:
Retirement of bonds. Payments of N/P.
Payment for bank loan

Operating Cash Flows

(Indirect Method; Reconciliation Method)
Net Income
+/- Adjustments
+ Any increase in current Liabilities (except for N/P)
+ Any decrease in current assets (except for cash and N/R)
- Any decrease in current liabilities (except for N/P)
- Any increase in current assets (except for cash and N/R)

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ACTIVITY NO. 1

Name: _________________________________________________ Section: ______________

Instruction: Read carefully the questions. Show your solution in good form. Submit this activity sheet to the lecturer-in-
charge. THIS IS A RECORDED ACTIVITY. Good luck!

I. Problem-solving
Get ¼ sheet of paper and answer the following:
Required: Compute the amount of the missing element of financial position.
Show your solution in good form.
a. Jimmy Delgado Pest Control has assets of P 600,000 and owner’s equity of P 450,000
b. Margie Clavano Realtors has liabilities of P 530,000 and owner’s equity of P 410,000
c. Marko Fuentes Plumbing Creator has assets of P 847,000 and owner’s equity of P 236,500.
d. Ryan Morales Acting Studio has liabilities of P 147,000 and owner’s equity of P 236,500.
e. Fely Monarca Dance has assets of P 624,000 and liabilities of P 237,000.

Required: In each of the preceding five situations, determine the amount of the
missing element of financial performance.
a. A small accounting firm has income of P 325,000 and expenses of P 237,000.

b. An advertising agency has expenses of P 163,000 and profit of P 42,000.

c. A computer-training outfit has expense of P 153,000 and loss of P 27,500.

d. A medical practitioner has income of P 737,000 and profit of P 168,000.

e. An environment consultant has income of P 362,000 and loss of P 20,000.

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II. Create a Chart of Accounts
Required: Arrange the following accounts on its proper place and classification.

Ref. Account Title Ref. Account Title

No. No.
Assets Revenues

Expenses
Liabilities

Owner’s Equity

100 Cash 131 Supplies

210 Accounts Payable 140 Prepaid rent
120 Accounts Receivable 121 Allowance for Bad Debts
300 MCkers, Capital 301 MCkers, Withdrawals
310 Income Summary 400 Service Revenue
501 Supplies Expense 500 Salaries Expense
151 AccumulatedDepreciation-Laundry Equipment 510 Utilities Expense
220 Unearned Revenues 150 Laundry Equipment
520 Rent Expense
515 Depreciation Expense

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