Basic Accounting Review

ACCOUNTING, ITS THEORIES AND PRINCIPLES

Discussion Duration: 20 – 25 minutes

Definition
o 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.
o Accounting is the process of identifying, measuring and communicating economic information to permit
informed judgments and decisions by users of the information.
o 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 financial character and interpreting the results thereof.

Purpose of Accounting
o It handles financial operations of the business, and provides information and advice to other departments.
o To measure business transactions in terms of common financial denominator
o To record economic transactions to be useful in making decisions
o To summarize, interpret and/or analyze the liquidity, profitability and solvency of the business organization.
o To influence the decision-makers and users of the information.

Users of Information
a. Investors e. Customers
b. Employees f. Government and its Agencies
c. Lenders g. Public
d. Suppliers and Other Trade Creditors

Fundamental Concept
o Entity Concept – the transactions of different entity should not be accounted for together.
o Periodicity Concept – an entity’s life can be meaningfully subdivided into equal time periods for reporting.
o Stable Monetary Unit Concept – it allows the accountants to add and subtract peso amounts as though each
peso has the same purchasing power as any other peso at any time.

Basic Principles
o Objectivity Principle – reliable data are verifiable when they can be confirmed by independent observers.
Accounting records should not be based on whims and opinions.
o Historical Cost – assets should be recorded at their actual cost and not at what management thinks they are
worth as at reporting date.
o Revenue Recognition Principle – revenue is to be recognized in the accounting period when goods are delivered
or when service is rendered or performed.
o Expense Recognition Principle – expense is to be recognized in the accounting period when goods and services
are consumed and used up to produce revenue and not when the entity pays for those goods and services.
o Adequate Disclosure – requires that all relevant information that would affect the user’s understanding and
assessment of the accounting entity be disclosed in the financial statements.
o Materiality – financial reporting is only concerned with information that is significant enough to affect
evaluations and decisions.
o Consistency Principle – the entity should use the same accounting method from period to period to achieve
comparability over time within a single enterprise.

Accounting Standards
o Accounting Standards Council (ASC) – created by the Philippine Institute of Certified Public Accountants on
November 18, 1981 to establish and improve accounting standards in the Philippines. They issued Statement
of Financial Accounting Standards (SFAS), a counterpart of the International Accounting Standards (IAS). SFAS
was later renamed as Philippine Accounting Standards (PAS).
Basic Accounting Review
o Financial Reporting Standards Council (FRSC) – established through Republic Act No. 9298 or the Philippine
Accountancy Act of 2004 to be the new accounting standard setting body. They issued Philippine Financial
Reporting Standards (PFRS), a counterpart of the International Financial Reporting Standards (IFRS).

Role of Information Technology in the Accounting

o Manual Accounting Information System utilizes paper-based journals (general and special) and ledgers. Manual
systems rely on human processing so they are labor intensive and may be inefficient in today’s complex
business environment.
o Computer-based Accounting Information System replace paper records. A computer-based transaction system
maintains accounting data separately from other operating data. Examples are QuickBooks, Tally and
Peachtree.
o Database Accounting System embeds accounting data within the business event on which they are based. They
capture both financial and non-financial data. They reduce inefficiencies and redundancies that often exist in
transaction-based systems. Examples are SAP, Oracle and PeopleSoft.

SUGGESTED ACTIVITY: Give a short quiz about the things discussed (15 to 20 items).
Activity Duration: 10 – 15 minutes

ELEMENTS OF ACCOUNTING
Discussion Duration: 10 – 15 minutes

o Asset – any resource controlled or owned by an enterprise as a result of past events, and from which a future
economic benefits are expected to flow to the enterprise.
Example: Cash, Accounts Receivables, Inventories

o Liability – present obligation of the enterprise as a result of past events, the settlement of which is expected to
result in an outflow of resources with economic benefits from the enterprise.
Example: Accounts Payable, Loans Payable

o Owner’s Equity – the residual interest in the assets of an enterprise after deducting all liabilities.
Example: Capital Investments

o Income – increases in economic benefits during the accounting period in the form of inflows or enhancements
of assets or decreases of liabilities that result in increases in equity, other than those relating to contributions
from equity participants.
Example: Sales Revenue, Service Revenue, Gains

o Expenses – decreases in economic benefits during the accounting period in the form of outflows or depletions
of assets or incurrence of liabilities that result in decreases in equity, other than those relating to distributions
to equity participants.
Example: Salaries expense, depreciation expense, interest expense

SUGGESTED ACTIVITY: Let the students give examples of accounts of the element. Let them describe. Or, give a random
example accounts for element and let the students identify and classify the accounts.
Activity Duration: 10 – 15 minutes
Basic Accounting Review

ACCOUNTING EQUATION

ASSET = LIABILITIES + OWNER’S EQUITY

Extended version:

ASSET = LIABILITIES + [OWNER’S EQUITY + INCOME - EXPENSE]

The Double-Entry System and the Rules of Debits and Credits

The accounting equation may be translated into a T-account (double entry, meaning dual effect):

DEBIT CREDIT

Assets and Their normal Liabilities Their normal

Expenses balance is DEBIT. Owner’s Equity balance is CREDIT.
Income

Things to Remember 
o Every time an element (asset, liabilities, equity/capital, income and expense) is entered in their normal balance
(side), it will increase the amount of the element or account.
o If an element is on the opposite side of their normal balance, it will decrease the amount of the element or
account.

SUGGESTED ACTIVITY: Give a random account and asked the students about the normal balance of the accounts. Also,
to reinforce the previous topics, ask them to classify the accounts randomly given.
Activity Duration: 10 – 15 minutes

Application of the Accounting Equation

Example:
Juan invested cash of P 200,000 and a computer with a value of P 35,000 as a start capital for his business.

The effects of the above transaction will be:

ASSET = LIABILITIES + OWNER’S EQUITY

P 200,000 = P0 + P 235,000
P 35,000 =
P 235,000 = P0 + P 235,000

The asset is increased while the capital also increased. The above transaction may be simply journalized in books as:

Cash P 200,000
Debit
Computer P 35,000
Credit Juan, Capital P 235,000
Explanation or Memo To record the investment of Juan.

Always remember that a complete journal entry includes at least one debit and one credit, and a brief explanation.

Example:
Using the same given, assume that Juan obtained a loan of P 43,000 from ABC bank to secure more funds for his
business.
Basic Accounting Review
The effects of the above transaction will be:

ASSET = LIABILITIES + OWNER’S EQUITY

P 200,000 = P0 + P 235,000
P 35,000 =
P 235,000 = P0 + P 235,000
P 43,000 = P 43,000 + P 235,000
P 278,000 = P 43,000 + P 235,000

While the asset increased by P 43,000, the liabilities also increase by the same amount making the equation still in
balance. The above transaction may be simply journalized in books as:

Cash P 43,000
Loans Payable P 43,000
To record the loan obligation obtained
from ABC Bank.

Observe that the asset (cash) and the liability (loans payable) accounts are in their normal balance, as such they increase
both assets and liabilities.

Example:
Juan buys inventories amounting to P 75,000 from DAVAO Marketing. He paid P 45,000 cash, and issued a note payable
within 30 days for the remaining unpaid amount.

The effects of the above transaction will be:

ASSET = LIABILITIES + OWNER’S EQUITY

P 200,000 = P0 + P 235,000
P 35,000 =
P 235,000 = P0 + P 235,000
P 43,000 = P 43,000 + P 235,000
P 278,000 = P 43,000 + P 235,000
P 75,000 =
(P 45,000) = P 30,000 + P0
P 308,000 = P 73,000 + P 235,000

The asset both increased by P 75,000 (inventories purchased) and decreased by P 45,000 (cash paid), while the liabilities
increased by P 30,000 for the note issued. The above transaction may be simply journalized in books as:

Purchases P 75,000
Cash P 45,000
Notes Payable P 30,000
To record the inventories purchased thru
cash and issuance of notes.

SUGGESTED ACTIVITY: Continue the problem above. Explore the income and expense side. Let the students learn the
pattern by heart.
Activity Duration: 15 – 25 minutes
Basic Accounting Review
THE ACCOUNTING PROCESS
Discussion Duration: 20 – 25 minutes

An accounting cycle refers to a series of sequential steps or procedures performed to accomplish the accounting
process.
 Analysis of Documents – to gather and analyze information about transactions or events generally through
source documents such as Official Receipts.
 Journalizing – to record the economic impact of transactions on the firm in a journal, which is a form that
facilitates transfer to the accounts.
 Posting – to transfer the information from the journal to the ledger for classification.
 Trial Balance – to provide a listing to verify the equality of debits and credits in the ledger. This will summarize
all balances from different ledgers.
 Adjusting Entries – to record the accruals, expiration of deferrals, provision of estimates, and other events from
the worksheet.
a. Adjusting entries may be done to record assets or liabilities and expense or revenue which were not
previously recorded to adjust the account balances as of the end of the period.

Method Use Example

Purchase of supplies amounting to P 2,000. At the
end of the period, only P 500 worth of supplies were
on hand.

Original Entry:
Purchases or acquisitions are recorded initially Supplies P 2,000
Asset
as an ASSET. Cash P 2,000

Adjusting Entry:
Adjusting entry includes a debit in an Expense Supplies Expense P 1,500
and a credit in an Asset. Supplies P 1,500

Purchase of supplies amounting to P 2,000. At the

end of the period, only P 500 worth of supplies were
on hand.

Original Entry:
Purchases or acquisitions are recorded initially Supplies Expense P 2,000
Expense
as an EXPENSE. Cash P 2,000

Adjusting Entry:
Adjusting entry includes a debit in an Asset and Supplies P 500
a credit in an Expense. Supplies Expense P 500

On July 21, received P 5,000 cash for services to be

rendered on July 31. At the end of the month, only
P 4,000 worth of services was rendered.

Original Entry:
Cash P 5,000
Liability
Receipts of revenue in forms of cash are Unearned Revenue P 5,000
recorded as a LIABILITY.
Adjusting Entry:
Unearned Revenue P 4,000
Adjusting entry includes a debit in a Liability Service Revenue P 4,000
and a credit in an Income.
On July 21, received P 5,000 cash for services to be
rendered on July 31. At the end of the month, only
P 4,000 worth of services was rendered.

Original Entry:
Cash P 5,000
Receipts of revenue in forms of cash are Service Revenue P 5,000
Income recorded as an INCOME.
Adjusting Entry:
Service Revenue P 1,000
Adjusting entry includes a debit in an Income Unearned Revenue P 1,000
and a credit in a Liability.
Basic Accounting Review

 Financial Statements – to provide useful information to decision-makers.

a. Statement of Financial Position – Balance sheet
b. Statement of Comprehensive Income – profit or loss
c. Statement of Cash Flows – cash inflows and cash outflows arising from Operating, Investing and Financing
Activities
d. Statement of Changes in Equity
Beginning Capital Balance
+ Additional Investments
+ Profit for the Period
- Loss for the Period
- Withdrawals by Owners
Ending Capital Balance
e. Notes to Financial Statements – disclosures that were not presented in the above financial statements.

 Closing Journal Entries – to close temporary (income and expense) accounts and to transfer profit or loss to
owner’s equity.
 Post-Closing Trial Balance – to check the equality of debits and credits after the closing entries.
 Reversing Entries – to simplify the recording of certain regular transactions in the next accounting period. This
is an optional step. All adjusting entries under accruals, and adjusting entries under deferrals using income and
expense method

Points to Consider:

1. Do not over discuss the theories.

2. Give more example on journalizing, posting, and adjusting entries.
3. See Activity attached next page.