BASIC ACCOUNTING (adapted)

I.Introduction to Accounting

Definition of Accounting

1. Accounting Standards Council (ASC) - Accounting is a service activity. Its function is to provide
quantitative information primarily financial in nature, about economic activities, that is intended to be
useful in making economic decisions.
2. AICPA – Accounting is the art of recording, classifying and summarizing in a significant manner and in
terms of money, transaction and events which are in part, at least of a financial character and interpreting
the results thereof.
3. AAA – The process of identifying, measuring and communicating economic information to permit
informed judgements and decisions by users of the information.

Phases of Accounting

1. Recording (journalizing)
- Recording of all transactions that occurred in a given time in a systematic and chronological manner
in the journal books like general journal, sales journal, purchases journal, cash receipts journal and
cash disbursement journal.
- Transactions to be recorded are based on source documents such as receipts and cash vouchers.

2. Classifying (posting)
- All about sorting and grouping all individual accounts
- Transactions from the journals are transferred or posted to the ledgers.

3. Summarizing
- Summarizing data through the preparation of financial statements, charts or graphs to interpret data
easily and effectively.
- Done after an accounting period like monthly, quarterly, yearly, etc.

4. Interpreting
- The final stage where users of financial information interpret data for decision making, interpreting
the financial position of a company and the results of its operations.

Objectives of Accounting

1. To provide general purpose financial statements about a reporting entity that is useful to the financial
users involved to assist them in making economic decisions.
2. To determine the results of the business operation in a given period.
3. To determine the financial position (asset, liability and equity) of an entity.
4. To implement and maintain internal controls over assets.
5. To help management in planning, decision making and performance evaluation.
6. To provide financial and/or legal information to government agencies.
Users of Accounting Information

1. Internal Users
a. Owners like proprietor, partners, BOD/BOT
b. Management
2. External Users
a. Investors and potential investors
b. Lenders and financing institutions
c. Suppliers and trade creditors
d. Employees and labor unions
e. Customers
f. Government agencies, regulatory agencies and taxing authorities
g. General public

History

8500 BC – use of “bulla” or “bullae” for commercial and legal documentation. These hollow ball-like clay envelopes
were also used to identify the quantity and types of goods being recorded.

3600 BC – “The clay of Mesopotamia” containing commercial transactions including accounts receivables and
payables.

2286 – “Code of Hammurabi” required merchants to give buyers a sealed memorandum containing the agreed
price of goods

1000 BC – Phoenicians created an alphabet with accounting to trade with ancient Egyptians

500 BC - Egyptian Accounting records and the invention of Bead and Wire Abacus

63 BC – “Res Gestae Divi Augusti” or The Deeds of the Divine Augustus containing the expenditures of the
emperor, including distributions to people

10 AD – Emperor Wang Mang of Xin Dynasty implemented the first income tax of 10% of profits.

1299 – Giovanni Farolfi & Company a firm of Florentine Merchants that used the earliest evidence of full double
entry bookkeeping that appeared in the “Farolfi Ledger”

1299 to 1300 – Amatino Manucci kept the ledger accounts of Giovanni Farolfi & Company

1300 - “Statute of Westminster” showed historical records of accountants

1340 – “Massari Ledgers of Commune of Genoa” displayed the perfect double-entry form of double entry
bookkeeping that shows different pages for debit and credit

1458 – Benedetto Contrugli an economist who wrote the first bookkeeping manuscript called “Della mercatura e
del mercante perfetto” but his work was only published in 1573. Pacioli credited Cotrugli for the origination of the
double entry bookkeeping system.

1494 – Luca Pacioli the father of modern accounting who published the first ever book with detailed capter of
double entry bookkeeping known as the “Summa de Arithmetica, Geometria, Proportioni et Proportionalita”.
1675 - Jacques Savary published his book “The Perfect Merchant” with chapters describing accounting.

1798 - income tax was implemented in Britain

1804 – “Code of Napoleon” a civil law that was enforced containing regulations on commercial transactions.

1861 – income tax was implemented in America

1896 – First CPA examination in the State of New York

1898 – Eugen Schmalenbach-quoted price level accounting

1913 – income tax was implemented in the Philippines

1915 – Vicente F. Fabella became the first Filipino CPA. He took the exam at Wisconsin USA.

1932 – First CPA Exam in the Philippines.

Accounting as a Profession

1. Practice in Public Accountancy – accountants who offer their professional services to clients for a fee
including partners and staff members of an accounting or auditing firm.
2. Practice in Commerce and Industry – accountants employed in a private company or a nonprofit
organization.
3. Practice in Academe – accountants teaching accounting subjects like schools and review centers.
4. Practice in the Government – accountants working in a government body like BIR, COA, DBM, etc.

II. Accounting Cycle

1. Identify and Analyze Transaction

a. Understanding Transactions – transactions is a transfer of resources (asset) and obligations (liability).
A business can be involved in many affairs and activities – when it pays electricity, hire employees,
incur debts and even receiving investments from investors a transaction occurs.
b. Examples of common financial transactions:
1. Owner invested money in the business
2. Purchase of office furniture and supplies
3. Purchase of a fire insurance for office building
4. Hiring and training employees
5. Purchasing inventories
6. Purchasing supplies on credit
7. Getting a loan from the bank
8. Paying bills and loan interest
9. Depreciation of factory machine
10. Paying government taxes

In a transaction there is a value received and a value parted with.

 Example:

When a business pays the salary of an employee, the business gives cash in exchange of services from
the employee. So the value received by the business is the service provided by the employee and the
cash is the value parted with.

Examples of Analyses of transactions:

Transaction(s) Value Received (Debit) Value Parted With (Credit)

Investment of the Owner Cash Obligation of the business to
hold and make use of
investment
Purchase of office supplies Office Supplies Cash
Purchase of Machine on Machine Obligation to pay(accounts
account payable)
Loan from the bank Cash Obligation to pay
Payment of Loan No more obligation to pay Cash
Payment of Salaries Services from employees Cash

c. The Basic Accounting Elements

The 5 types of accounting elements to understand a transaction:
1. Asset – all resources of the business
a. Current asset – are assets that can be realized by the business within its normal operating
cycle usually 12 months and can be easily converted to cash.
b. Noncurrent assets – all other assets that are not current (realized in more than a year).
2. Liability – all obligations/debts of the business
a. Current Liability – a liability expected to be settled within the normal operating cycle of the
business, usually 12 months
b. Noncurrent liability – all liabilities that are not current (payable -more than a year).
3. Equity/capital – refers to the investment of the owner
4. Revenue/income – all earnings/profits of the business from its day to day operations
5. Expenses – all cash outflows and costs incurred by the business.

Examples:

Asset Liability Capital Revenue Expenses

Cash Accounts Payable Owner’s Equity Service Income Supplies Expense
Office Supplies Notes Payable Partner’s Capital Sales Insurance
Expense
Furniture and Loans Payable Share Capital Interest Income Salaries Expense
Fixtures
Land Interest Payable Owner, Rent Income Interest Expense
Withdrawal
Building Mortgage Payable Taxes and
Licenses
 d. Normal Balance
An account balance has 2 sides, the debit (right side) and the credit (left side) side. The normal
balance of an account is the side where the account increases. (ALPInE)

Account Normal Balance

Asset Debit
Liability Credit
Proprietorship, Capital, Equity Credit
Income, Revenue Credit
Expense Debit

Example:

Cash
Debit (Dr) Credit (Cr)
Beginning balance 10,000 520,000 Ending balance
Cash from Income 500,000 20,000 Payment for expenses
Cash from Rent Income 30,000
Total 540,000 540,000 Total

NOTE: The normal balance of cash which is an asset is Debit, so every time the business receives cash
the debit side increases and when it pays expenses the cash decreases on the credit side – both sides
should always be equal!

e. Accounting Equation

ASSET = LIABILITY + EQUITY

ASSET = LIABILITY + EQUITY + REVENUE - EXPENSES

2. Journalizing
Double entry bookkeeping – a method used in journalizing transactions where there is always a value
received and a value parted with, hence a debit and credit side.

Chart of accounts
A list of accounts that a business use in journalizing transactions, the industry uses standard names for
common accounts; however, a business may opt to adopt its own.

Let us try journalizing below transactions:

1. Princess invested 1 million to open a restaurant; the money was deposited in a savings account.

Dr Cr
Cash in Bank 1,000,000
Princess, Capital 1,000,000
To record initial capital

2. She paid P100,000 to rent a space in a building.

 Dr Cr
Rent Expense 100,000
Cash in Bank 100,000
To record a month’s rent

3. Purchased kitchen equipment amounting to P250,000.

Dr Cr
Equipment 250,000
Cash in Bank 250,000
To record purchase of equipment

4. She acquired a loan of half a million from the bank.

Dr Cr
Cash in Bank 500,000
Loans Payable 500,000
To record loan from the bank

5. She paid her employees P50,000.

Dr Cr
Salaries Expense 50,000
Cash in Bank 50,000
To record salaries expense paid

6. Paid utilities for the office P20,000.

Dr Cr
Utilities Expense 20,000
Cash on Hand 20,000
To record utilities paid

7. Earned P50,000 for the first week of operations.

Dr Cr
Cash in Bank 50,000
Income 50,000
To record income earned

NOTE: Remember that in journalizing, a transaction must occur; there should always be a value
received and a value parted with. Otherwise, there will have NO journal entry on your book of
accounts.

3. Posting
T-accounts – has 3 main parts
1. Account Title
2. Debit (left side)
3. Credit (right side)
 Cash (account title)
Debit (Dr) Credit (Cr)
100 2,000
200 150
5,000
Let us do this!

Journalizing and Posting Activity:

1. Princess invested 1 million to open a restaurant; the money was deposited in a savings account.

Dr Cr
Cash in Bank 1,000,000
Princess, Capital 1,000,000
To record initial capital

Cash in Bank
Debit (Dr) Credit (Cr)
1,000,000

Princess, Capital
Debit (Dr) Credit (Cr)
1,000,000

2. She paid P100,000 to rent a space in a building.

Dr Cr
Rent Expense 100,000
Cash in Bank 100,000
To record a month’s rent

Rent Expense
Debit (Dr) Credit (Cr)
100,000

Cash in Bank
Debit (Dr) Credit (Cr)
1,000,000 100,000
3. Purchased kitchen equipment amounting to P250,000.

Dr Cr
Equipment 250,000
Cash in Bank 250,000
To record purchase of equipment

Equipment
Debit (Dr) Credit (Cr)
250,000

Cash in Bank
Debit (Dr) Credit (Cr)
1,000,000 100,000
250,000

4. She acquired a loan of half a million from the bank.

Dr Cr
Cash in Bank 500,000
Loans Payable 500,000
To record loan from the bank

Cash in Bank
Debit (Dr) Credit (Cr)
1,000,000 100,000
500,000 250,000

Loans Payable
Debit (Dr) Credit (Cr)
500,000

5. She paid her employees P50,000.

Dr Cr
Salaries Expense 50,000
Cash in Bank 50,000
To record salaries expense paid
 Salaries Expense
Debit (Dr) Credit (Cr)
50,000

Cash in Bank
Debit (Dr) Credit (Cr)
1,000,000 100,000
500,000 250,000
50,000

6. Paid utilities for the office P20,000.

Dr Cr
Utilities Expense 20,000
Cash in Bank 20,000
To record utilities paid

Utilities Expense
Debit (Dr) Credit (Cr)
20,000

Cash in Bank
Debit (Dr) Credit (Cr)
1,000,000 100,000
500,000 250,000
50,000
20,000

7. Earned P50,000 for the first week of operations.

Dr Cr
Cash in Bank 50,000
Income 50,000
To record income earned

Cash in Bank
Debit (Dr) Credit (Cr)
1,000,000 100,000
500,000 250,000
50,000 50,000
20,000
 Income
Debit (Dr) Credit (Cr)
50,000

NOTE: Same accounts from the journal entry will be posted in just one account. This is done in order to
monitor the amounts of a specific account. Remember that if the journal entry is on the debit side then it will also
be posted on the debit side of the T-account, same with the credit sides.

Totaling your Ledger Accounts

After posting the journal entries to the T-accounts/ledger accounts, the next step is to total the amounts. In doing
this, identify if the account is open or closed:

Closed account: equal amounts in both debit and credit side

Cash on Hand
Debit (Dr) Credit (Cr)
50,000 50,000

Both sides are equal

Open account: amount in both sides are unequal

Cash in Bank
Debit (Dr) Credit (Cr)
1,000,000 100,000
500,000 250,000
50,000 50,000
-_______ 20,000____
1,550,000 ≠ 420,000

Not Equal

1,550,000 – 420,000 = 1,130,000

On this example Cash in Bank has a debit balance of 1,130,000

For illustration:

Sample of a General Ledger (manual):

GENERAL LEDGER
Account: Cash
Account No. 101
Date Item PR Debit Date Item PR Credit
01/01/19 Initial investment 24,000 01/01/19 Office Supplies 5,000
01/02/19 income 12,000 01/02/19 Telephone 2,000
Expenses
01/03/19 Other income 6,000 01/03/19 Drawing 10,000
01/03/19 Office Supplies 3,000
Total Debit: 42,000 Total Credit: 20,000
Dr Balance 22,000
42,000 42,000

(Computerized)

Cash – 101
Date Particulars F Debit Credit Balance
(2019)
Jan. 01 Initial investment 24,000 24,000
Office supplies bought 5,000 19,000
02 Income 12,000 31,000
Telephone expenses 2,000 29,000
03 Other income 6,000 35,000
Drawing 10,000 25,000
Office Supplies bought 3,000 22,000

4. Trial Balance
Trial Balance – a statement created to test the equality of the debit and the credit side. A correct trial
balance is proof of accuracy in posting and journalizing transactions.

Let’s do this!

Let us try the previous transactions:

Princess, Capital
Debit (Dr) Credit (Cr)
1,000,000

Rent Expense
Debit (Dr) Credit (Cr)
100,000

Equipment
Debit (Dr) Credit (Cr)
250,000
 Loans Payable
Debit (Dr) Credit (Cr)
500,000

Salaries Expense
Debit (Dr) Credit (Cr)
50,000

Utilities Expense
Debit (Dr) Credit (Cr)
20,000

Income
Debit (Dr) Credit (Cr)
50,000

Cash in Bank
Debit (Dr) Credit (Cr)
1,000,000 100,000
500,000 250,000
50,000 50,000
-_______ 20,000____
1,550,000 420,000

1,550,000 – 420,000 = 1,130,000

The amounts of the accounts should be posted on their normal side:

ABC Company
Trial Balance
December 31, 2020
Account Debit Credit
Cash in Bank 1, 130,000
Equipment 250,000
Loans Payable 500,000
Princess, Capital 1,000,000
Income 50,000
Rent Expense 100,000
Salaries Expense 50,000
Utilities Expense 20,000
Total 1,550,000 1,550,000
NOTE: Both Sides should always be equal. IF NOT, check the journal entries and T-accounts, you might have missed
something, recorded a wrong amount, totaled incorrectly, posted to a wrong account, etc.

5. Adjusting Entries
- Updating the balances of certain accounts which is necessary before preparing the financial
statements, usually at the end of the accounting period
- Supports the matching principle and also to avoid overstatement and understatement
- These entries should also be posted
1. Accruals
a. Accrued Revenue

Date Account Title Debit Credit

12/31/19 Accounts Receivable 24,000
Service Revenue 24,000
To record unbilled service
12/31/19 Interest Receivable 24,000
Interest Income 24,000
To record interest income

b. Accrued Expense

Date Account Title Debit Credit

12/31/19 Salaries Expense 24,000
Salaries Payable 24,000
To record salaries payable
12/31/19 Interest Expense 24,000
Interest Payable 24,000
To record interest payable

2. Prepayments/Prepaid Expense

ASSET METHOD
Initial Transaction Adjusting Entry
Date Account Title Debit Credit Date Account Title Debit Credit
01/01/19 Prepaid Expense 24,000 12/31/19 Expense 12,000
Cash 24,00 Prepaid 12,000
0 Expense

EXPENSE METHOD
Initial Transaction Adjusting Entry
Date Account Title Debit Credit Date Account Title Debit Credit
01/01/19 Expense 24,000 12/31/19 Prepaid Expense 12,000
Cash 24,00 Expense 12,000
0
3. Precollections/Unearned Revenue/Deferred Revenue

LIABILITY METHOD
Initial Transaction Adjusting Entry
Date Account Title Debit Credit Date Account Title Debit Credit
01/01/19 Cash 24,000 12/31/19 Unearned 12,000
Income
Unearned 24,000 Income 12,000
Income

REVENUE METHOD
Initial Transaction Adjusting Entry
Date Account Title Debit Credit Date Account Title Debit Credit
01/01/19 Cash 24,000 12/31/19 Income 12,000
Income 24,000 Unearned 12,000
Income

4. Bad debts/Uncollectible accounts

a. Percentage from sales = bad debts expense

Date Account Title Debit Credit

12/31/19 Bad Debts Expense 24,000
Allowance for Bad Debts 24,000

b. Percentage from Accounts Receivable = Allowance ending

Date Account Title Debit Credit

12/31/19 Bad Debts Expense 24,000
Allowance for Bad Debts 24,000

Allowance for Bad Debts

Beg. Balance
Write-off Bad Debts
Ending balance Recovery
Total Total

5. Depreciation and Amortization

Depreciation Expense = Cost – Salvage Value

Estimated Useful Life in Years

Date Account Title Debit Credit

12/31/19 Depreciation Expense 24,000
Accumulated Depreciation 24,000
FINAL COVERAGE

6. Worksheet
7. Financial Statements
8. Closing Entries
9. Post-closing Trial Balance
10. Reversing Entries
11. Post-Reversing Trial Balance
12. Correcting Entries

MERCHANDISING CONCEPTS

Freight Terms

Buyer Seller
Ownership FOB Shipping Point FOB destination
Who should pay? Freight Collect Freight Prepaid

Credit Terms

Cash discount – 5, 8, 15, 2/10, 3/15, 10/20, EOM, n/30 (journalized)

2 Methods:

1. Gross Method – cash discount is not yet deducted

2. Net Method – Cash discount is already deducted

Trade discount – 5, 8, 15, 2/10, 3/15, 10/20, EOM, n/30 (not journalized)

EOM – (end of month) – start counting from the first day of the next month

List Price – before discounts

Invoice Price - after discounts, what you can see on the receipt

Periodic Inventory System vs. Perpetual Inventory System

Periodic – no continuous record of inventory

Perpetual – continuous record of inventory and cost of goods sold

Periodic Inventory System Perpetual Inventory System

 Account Title Debit Credit Account Title Debit Credit
Purchases 500 Merchandise Inventory 500
Cash/AP 500 Cash/AP 500
# #
Freight-in 100 Merchandise Inventory 100
Cash 100 Cash 100
# #
Accounts Payable 150 Accounts Payable 150
Purchase Ret & Allow 150 Merchandise Inventory 150
# #
Accounts Receivable 600 Accounts Receivable 600
Sales 600 Sales 600
# #
Cost of Goods Sold 400
Merchandise Inventory 400
#
Sales Returns and Allowances 100 Sales Returns and Allow 100
Accounts Receivable 100 Accounts Receivable 100
# #
Merchandise Inventory 50
Cost of Goods Sold 50
#

COSTING METHODS

Specific Identification – the cost of units is identified as coming from specific purchase (units on hand multiplied by
the actual unit cost)

FIFO – first merchandise acquired is the first merchandise sold

Illustration: the following data pertain to an inventory item:

Units Unit cost Total cost Sales (in units)

Jan 1 Beginning balance 800 P200 P160,000
8 Sale 500
18 Purchase 700 210 147,000
22 Sale 800
31 Purchase 500 220 110,000

The ending inventory is 700 units (800-500+700-800+500)

Units Unit Cost Total Cost

From Jan. 18 Purchase 200 P210 P 42,000
From Jan. 31 Purchase 500 220 110,000
Ending Inventory 700 P152,000

Moving Average – an average unit price is computed each time a purchase is made. The average unit price is used
to determine the cost of items sold until another purchase is made (for perpetual inventory system)
Weighted Average – the average unit cost is computed by dividing the total cost of goods available for sale by the
total number of goods available for sale (for periodic inventory system)

Illustration: the following data pertain to an inventory item:

Units Unit cost Total cost

Jan 1 Beginning balance 800 P200 P160,000
18 Purchase 700 210 147,000
31 Purchase 500 220 110,000
Total GAS 2,000 P417,000

Weighted average cost (P417,000/ 2,000) P 208.50

Inventory Cost (700 x P208.50) 145,950