ACTBAS1 Reviewer

Definitions of Accounting Accounting 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. 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 decisions. *Board of Accountancy (BOA) prepares and administers the CPA licensure examination *Professional Regulation Commission (PRC) issues licenses to successful examinees of the CPA licensure examination *Financial Reporting Standards Council (FRSC) body that formulates the Accounting standards (we now adopt the International Accounting Standards and International Financial Reporting Standards) 4 Functions of Accounting Work: Recording Classifying Basic Accounting Principles Entity -It is assumed that the business is separate from the owners, managers and employees who constitute the firm. The transactions of the enterprise should not be merged with the transactions of the owners. Going Concern -It is assumed that in the absence of evidence to the contrary, the business will continue to operate indefinitely to carry out its existing contracts and commitments. Cost Principle -This principle requires that the assets should be recorded initially at original acquisition cost. Objectivity/Reliability -This principle requires that the quality of information assumes users that the information is free from bias and error and represents what it claims to represent. Revenue Recognition -This principle states that revenue is recognized when earned regardless of when cash is received. Point of sale is the point of revenue recognition. Accrual Concept -This principle means that income is recognized when earned regardless of when received and expense is recognized when incurred regardless of when paid. Matching -This principle states that all costs and expenses incurred in earning a revenue should be reported in the same period. (*It is possible that an expense is not yet incurred even if you have already paid) Time Period/Accounting Period Assumption Summarizing Interpreting

-This assumption requires that the indefinite life of an enterprise is subdivided into time periods or accounting periods which are usually of equal length to ensure reports at regular intervals -There are 3 kinds of accounting period namely: Calendar year(Jan1-Dec31), Fiscal year(any 12 months), and Natural Business year(any 12 months but the end of the period is during a slack season) Monetary Unit -This principle requires that money is used as the unit of measure Disclosure -This principle means that all significant and relevant information leading to the preparation of financial statements should be clearly reported so as not to make the financial statements misleading Materiality -Also known as the Doctrine of Convenience -This principle is a practical rule in accounting which dictates that strict adherence to the Generally Accepted Accounting Principles(GAAP) is not required especially when the items are not significant enough to affect the fairness of the financial statements. Consistency -This Principle requires that the accounting methods and practices should be applied on a uniform basis from period to period. Conservatism -This principle resolves uncertainties in accounting. When alternatives exist, the alternative which has the least favorable effect on owners equity should be chosen. -This principle is synonymous with Prudence, which is the desire to exercise care and caution in dealing with the uncertainties in the measurement process such that assets or income are not overstated and liabilities and expenses are not understated. Financial Statements Financial statements are the means by which the information accumulated and processed in financial accounting is periodically communicated to the users. Four financial statements are prepared from the summarized accounting data. Each statement provides management, owners and other interested parties with relevant financial information. 5 Major Accounts 1. 2. 3. Assets Liabilities Owners Equity 4. 5. Income Expenses

*** Assets, Liabilities and Owners Equity are also known as Balance Sheet Accounts, Real Accounts or Permanent Accounts *** Income and Expenses are also known as Income Statement Accounts, Nominal Accounts or Temporary Accounts 1. Statement of Financial Position -A formal statement showing the financial condition of an entity as of a particular date by summarizing its assets, liabilities and owners equity. Assets -are resources controlled by the entity as a result of past transactions and events and from which future economic benefits are expected to flow to the entity.

-Characteristics of Assets: Controlled by the entity Result of a past transaction or event Provides future economic benefits Its cost can be measured -An asset shall be classified as CURRENT when it satisfies any of the following criteria: It is cash It is held primarily for the purpose of being traded It is expected to be realized within 12 months after date of statement of financial position It is expected to be realized or intended for sale or consumed within the entitys normal operating cycle *operating cycle average time period to convert cash back to cash -The caption NON-CURRENT assets is a residual definition. All other assets not classified as current. Current Asset Accounts Cash includes coins, currency, chekcs Investment in Trading Securities debt ad equity securities purchased with the intention of selling them in the near future in order to generate short term gains or profits Notes Receivable claims from customers evidenced by formal promises to pay usually in the form of notes Accounts Receivable claims from customers arising from sale of goods/services in the ordinary course of business Accrued Income income already earned but not yet collected Advances to Employees cash advance given to employee Prepaid Expenses expenses already paid but not yet incurred Non-Current Asset Account Property, Plant and Equipment includes land, building, office equipment, furniture & fixtures, transportation equipment, tools, machineries *Properties of Non-Current Assets include physical existence, more or less permanent in nature, not for sale, used in business operations, and must undergo depreciation except land Liabilities -are defined as present obligations of an entity arising from past transactions and events, the settlement of which is expected to result in an outflow from the entity of resources embodying economic benefits. -Characteristics of Liabilities: A present obligation of a particular entity Arises from past transactions or events Its settlement requires an outflow of resources embodying economic benefits -A liability shall be classified as CURRENT when it satisfies any of the following assumptions: It is expected to be settled in the entitys operating cycle It is held primarily for the purpose of being traded It is due to be settled within 12 months after the date of the statement of financial position -The term NON-CURRENT liabilities is also a residual definition.

Current Liability Accounts Notes payable amount owed to creditors evidenced by a written promise to pay Accounts Payable amount owed to creditors Accrued Expenses expenses already incurred but not yet paid (eg. Salaries payable, interest payable, rent payable, utilities payable) Unearned Revenue revenue already received but not yet earned Non-Current Liability Accounts Mortgage Payable long term debt of the business for which the business has pledged certain assets as security to the creditor. sangla Bonds payable bonds issued to lenders to finance the acquisition of equipment and other needed assets Equity -The term equity is the residual interest in the assets of the entity after deducting all its liabilities. (* Equity= NET ASSETS or Equity = Total Assets Total Liabilities) -Is increased by revenue and contributions(investments) of owners -Is decreased by expenses and drawings by owners Equity Accounts Owners Capital a traditional accounting term to refer to the resources invested by the owner Owners Drawing used to record temporary withdrawal of cash or non-cash assets made by the owner 2. Income Statement A formal statement showing the financial performance of the entity for a given period of time. The performance of the entity is primarily measured in terms of the level of income earned by the entity through the effective and efficient use of its resources. Two Forms: Natural Form - nature of expense method - Formerly known as the single step form - Expenses are aggregated according to their nature and not allocated among the various functions within the entity Functional Form - cost of sales method - Formerly known as the multiple step form - Expenses are classified according to their function as cost of sales, selling activities, administrative activities and other activities Income -increase in economic benefit during the accounting period in the flow of inflow or increase in asset or decrease in liability that results in increase in equity rather than contribution from owners

-Sources of Income: Sale of merchandise to customers Rendering of services Use of entity resources Disposal of resources other than products Expense -decrease in economic benefit during the accounting period in the form of outflow or decrease in asset or increase in liability that results in decrease in equity other than withdrawals by the owners -Expenses include: Cost of sales Distribution costs/selling expenses General administrative expenses ( salary, utilities, rent, taxes, transportation, supplies, repairs & maintenance, depreciation, etc) Other expenses Finance cost

3. Statement of Cash Flow -is a basic component of the financial statements summarizing the operating, investing and financing activities of an enterprise -provides information about the cash receipts and cash payments of an enterprise during a period - Purpose of Statement of Cash Flow: To provide relevant information about cash receipts and cash payments of an enterprise during a period To provide information that enables users to evaluate the changes in net assets of an enterprise, its financial structure, liquidity and solvency To assess the ability of the enterprise to generate cash and equivalents To enhance the comparability of operating performance by different enterprises Classification of Cash Flows Operating Activities (***accounts under Current Assets and Current Liabilities) -are the cash derived primarily from the principal revenue producing activities of the enterprise -generally result from transactions and other events that enter into the determination of net income or loss -Examples of Cash Flows from Operating Activities: Cash receipts from sale of goods and rendering of services Cash receipts from royalties, rental, fees, commissions and other revenue Cash payments to suppliers for goods and services Cash payments for selling, administrative and other expenses Cash receipts and payments for securities held for dealing or trading purposes Investing Activities (***non-current asset account) -are the cash flows derived from the acquisition and disposal of long-term assets and other investments not included in cash equivalent -include cash flows from transactions involving non-operating assets

-Examples of Cash Flows from Investing Activities: Cash payments to acquire property, plant and equipment, intangibles and long-term assets Cash receipts from sale of property, plant and equipment, intangibles and other long-term assets Cash payments to acquire equity or debt instruments of other enterprises Cash receipts from sale of equity or debt instruments Financing Activities -are the cash flows derived from the equity capital and borrowings of the enterprise -in other words, these are the cash flows that result from transactions between the enterprise and its owners and between the enterprise and its creditors -include the cash flows from transactions involving nontrade liabilities and equity of enterprise -Examples of Cash Flows from Financing Activities: Cash receipts from contributions by owners Cash withdrawals by owners Cash receipts from issuing notes, bonds, mortgages and other short or long term borrowings Cash payments for amounts borrowed ***Note: cash payments to settle such obligations as trade accounts and notes payable, accrued expenses and similar items are operating activities, not financing activities) T-account Left side or Debit side -When an amount is entered on the left side, it is called a Debit entry. Rules on Debit and Credit for Assets, Liabilities and Capital Debit -Increase in Asset -Decrease in Liabilities -Decrease in Capital Rules on Debit and Credit for Revenues and Expenses Debit -Increase in Expense ***General Journal book of original entry ***Accounting cycle series of repetitive steps performed during an accounting period to accomplish the accounting process Credit -Increase in Revenue Credit -Decrease in Asset -Increase in Liabilities -Increase in Capital Right side or Credit side -When an amount is entered on the right side, it is called a Credit entry.

Payroll Accounting Gross Pay total earnings of an employee for a payroll period before taxes and other deductions which comprise of salaries, wages, commissions, bonuses, cost of living allowance and fringe benefits are deducted Employee Benefits The Social Security System (SSS) administers two programs namely: the Social Security Program and the Employees Compensation Program. SSS benefits provide for a replacement of income to members and covers the ff: sickness benefits, maternity benefits, disability benefits, retirement benefits, death benefits. The Employees Compensation (EC) Program aims to assist employees who suffer work related sickness or injury resulting in disability or death. The benefits under this program are as follows: Medical services and supplies, Rehabilitation services, Income cash benefits for temporary total disability or sickness, permanent total or partial disability and death.

The National Health Insurance Program (formerly known as Medicare) is a health insurance program for SSS members and their dependents who may find themselves in need of financial assistance when they get hospitalized. The PAG-IBIG Fund offers its members the ff benefits: Savings, Short term loans, Access to housing programs. Net Pay gross pay less the payroll deductions (SSS, Philhealth, PAG-IBIG contributions, withholding taxes and other deductions). Also known as take-home pay. The employer is mandated by the law to collect contributions of members through payroll deductions and is required to remit the employees contributions along with his counterpart contributions and remitted to respective agencies.

Accounting for Promissory Notes Payee Notes Receivable I. Receipt of Work a. Rendering of Services Notes Receivable xxx Service Revenue xxx b. Lending of Money Notes Receivable xxx Cash c. Settlement of an Account Notes Receivable xxx Accounts Receivable Maker Notes Payable I. Issuance of Note a. Purchase of asset Asset Notes Payable b. Borrowing of Money Cash Notes Payable c. Settlement of an Account Accounts Payable Notes Payable

xxx xxx xxx xxx

xxx

xxx xxx

xxx

***Example: On July 1, Company B received a 36000 pesos 90-day 6% note from customer A on account. July 1 Notes Receivable 36000 Accounts Receivable II. a. 36000 Payment of Note Non-interest Bearing Sept 29 Notes Payable 36000 Cash b. Interest Bearing Sept 29 Notes Payable 36000 Interest Expense 540 Cash

II. Collection of Note a. Non-interest Bearing Sept 29 Cash 36000 Notes Receivable 36000 b. Interest Bearing Sept 29 Cash 36540 Notes Receivable 36000 Interest Income 540 (*36000 x 0.06 x 90/360 = 540) III. Dishonor of Note a. Non-interest Bearing Sept 29 Accounts Receivable 36000 Notes Receivable 36000 b. Interest Bearing Sept 29 Accounts Receivable 36540 Notes Receivable 36000 Interest Income 540 Renewal of Note a. Non-interest Bearing Sept 29 Notes Receivable(new) 36000 Notes Receivable(old) 36000 b. Interest Bearing Sept 29 Notes Receivable(new) 36540 Notes Receivable(old) 36000 Interest Income 540

36000

36540

III. Dishonor of Note a. Non-interest Bearing Sept 29 Notes Payable 36000 Accounts Payable 36000 b. Interest Bearing Sept 29 Notes Payable 36000 Interest Expense 540 Accounts Payable 36540 IV. Renewal of Note a. Non-interest Bearing Sept 29 Notes Payable(old) 36000 Notes Payable(new) 36000 b. Interest Bearing Sept 29 Notes Payable(old) 36000 Interest Expense 540 Notes Payable(new) 36540

IV.

***Example: On Aug 18, 2010, Company B discounted Customer As note on Back C at 9%. Computation: Face Value P36000 Add: Interest for full term 540 Maturity Value P36540 Less: Bank Discount (36540 x 0.09 x 42/360) 383.67 Net Cash Proceeds P36156.33

V.

Discounting of Customers Note - payee Aug 18 Cash 36156.33 Interest Expense 383.67 Liability on Notes Receivable Discounted 36000 Interest Income 540 a. Discounted Customers Note honored at maturity date Sept 29 Liability on Notes Receivable Discounted 36000 Notes Receivable 36000 b. Discounted Customers Note dishonored at maturity date Sept 29 Accounts Receivable(MV+protest fee, if any) 37040 Cash 37040 Liability on Notes Receivable Discounted Notes Receivable 36000 36000

V.

Date of Discounting maker NO ENTRY. The maker of the note will only be notified about the discounting.

VI.

Discounting of own note ***Example: On August 1, 2010, the company discounted its own 90-day 6% note for P24000. On October 30, 2010, the company paid the note that has matured. Computation: Face Value P24000 Less: Discount on Notes Payable (24000 x 0.06 x 90/360) 360 Cash Proceeds P23640 Journal Entry: Aug 1 Cash Discount on Notes Payable Notes Payable Notes Payable Cash Interest Expense 360 Discount on Notes Payable 23640 360 24000 24000 24000 360

Oct 30

***Discount on Notes Payable is recorded on the Statement of Financial Position (Balance Sheet) as seen below: Note # - Trade and Other Payables Accounts Payable Pxxxxxxx Notes Payable P24000 Less: Discount on Notes Payable 360 23640 Accrued Expense xxxxxxxx Total xxxxxxxx Trial Balance -to prove the equality of DRs and CRs -not a proof that transactions are recorded properly -not a proof of accuracy The Trial Balance will remain In balance even if: The transaction is recorded with a wrong account The transaction is recorded with a wrong amount The transaction is not recorded Errors and Their Location If the difference of error is 1, 10, 100 or 1000, the error may be cause of wrong addition If the difference is a figure exactly divisible by 2, error may be due to: Wrong placement in Trial Balance Omitted from the Trial Balance If the difference is exactly divisible by 9, error may be due to: Transposition (amount is 801 but 810 was recorded) Transplacement (incorrect placement of decimal point amount is 825.00 but 82.50 was recorded) Correcting Entries Wrong Entry 1. 2. Salaries Expense 12000 Cash 12000 Cash 1600 Accounts Payable 1600 Required Entry Ang, Drawing Cash 12000 12000 Correcting Entry Ang, Drawing 12000 Salaries Expense 12000 Office Supplies Cash 1600 1600

Office Supplies 1600 Accounts Payable 1600 Cash 850 Accounts Receivable 850

3. Accounts Payable 850 Cash 850

Cash 1700 Accounts Payable 850 Accounts Receivable 850

Adjusting Entries When: At the end of the Accounting period Why: To update the books of accounts What: Accrued Expense, Accrued Revenue, Prepaid Expense, Unearned Revenue, Depreciation and Allowance for Doubtful Accounts Accrued Expense an expense already incurred but not yet paid, eg. taxes, salaries, interest, rent Accrued Revenue revenue already earned but not yet collected, eg. service rendered on account, rent(landlord), interest(payee), commission

***Example: On December 1, 2008 received/issued a 90-day 6% note for money borrowed. PAYEE Dec 1 Notes Receivable 36000 Cash Dec 31 Interest Receivable 180 Interest Revenue 180 2009 Mar 1 Cash 36540 Notes Receivable 36000 Interest Income 360 Interest Receivable 180 MAKER Cash 36000 Notes Payable Interest Expense 180 Interest Payable Notes Payable Interest Expense 360 Interest Payable 180 Cash 36000 36540

36000

36000 180

Prepayments/Deferrals Prepaid Expense expense already paid but not yet incurred ***Example: On January 1, 2010 paid a 3-year insurance premium for 36000. ASSET METHOD Jan 1 Prepaid Insurance Cash 36000 36000 EXPENSE METHOD Jan 1 Insurance Expense Cash 36000 36000

Dec 31 Insurance Expense 12000 Prepaid insurance 12000 Unearned Revenue already received but not yet earned

Dec 31 Prepaid Insurance 24000 Insurance Expense 24000

***Example: On November 1, 2010 received a 60000 from a tenant representing rental for 5 months. LIABILITY METHOD Nov 1 Cash 60000 Unearned Rent 60000 Dec 31 Unearned Rent 24000 Rent Income 24000 INCOME METHOD Nov 1 Cash Rent Income 60000 60000

Dec 31 Rent Income 36000 Unearned Rent 36000

Depreciation is the systematic allocation of the cost of an asset over the accounting period making up its useful life. The formula to be used in computing the annual depreciation is: Where: C = Cost of the asset S = Salvage value/ Scrap value/ Residual value n = estimated useful life of the asset *note that the amount that you will get from using this equation is the annual depreciation. If the asset was bought in the middle of the year, and you want to solve for the depreciation expense of the asset in that year,

you should divide the annual depreciation amount by 12 and multiply it by the number of months that the asset was used. ***Example: On Jan 1, 2010, a building is acquired at a cost of 220000 pesos with an estimated useful life of 10 yrs and estimated scrap value of 20000 pesos. Solution: Adjusting Journal Entry: Dec 31 Depreciation Expense Building 20000 Accumulated Depreciation Building Doubtful Accounts / Bad Debts There are 2 methods of accounting for doubtful accounts/bad debts: 1. Direct Write-off method (used in tax acctg) 2. Allowance method (used in financial acctg) *Allowance method will be used in Actbas1 Example: Assume the following account balances at year end. DR CR Accounts Receivable 10000 Allowance for Doubtful Accounts 300 The company estimates that 1% of outstanding Accounts Receivable may not be collected. Solution: Required allowance for doubtful accounts(1% x 100000) Less: Existing balance in Allowance for Doubtful Accounts Required increase in Allowance for Doubtful Accounts Adjusting Journal Entry: Dec 31 Doubtful Accounts Expense 700 Allowance for Doubtful Accounts 700 Closing Entries When: At the end of the Accounting period Why: To prepare the nominal accounts for the next accounting period What: Only nominal accounts are closed at the end of the period How: 1. Debit all revenue accounts then credit Income Summary account 2. Debit Income Summary then credit all expense account 3. DR/CR Income Summary then DR/CR owners drawing account (CR Income Summary if expenses are greater than revenues, and vice versa) 4. DR/CR Owners drawing account then DR/CR Owners capital account Reversing Entries When: At the beginning of the next accounting period Why: for convenience and for consistency What: AJE(Adjusted Journal Entries) for 1. Accrued Expense, 2. Accrued Revenue, 3. Prepaid Expense (expense method only) and 4. Unearned Revenue (income method only) P1000 300 P 700

20000

Example: Dec 1 Cash

Notes Payable

36000

36000

Dec 31 Interest Expense 180 Interest Payable 180 Adjusting Journal Entry Jan 1 Interest Payable 180 Interest Expense Reversing Entry 36000 36540 180

(Maturity Date) Mar 1 Notes Payable Interest Expense 540 Cash

* This reviewer was based from the lectures of Ms. Elsie Velasco.

Prepared By: The Academics Committee Economics Organization