Module 1

Introduction to Accounting

Accounting is relevant in all walks of life and it is absolutely essential in the world of business.
Accounting is the system that measures business activities, processes that information into reports
and communicates the results to users. For this reason, accounting is called the language of
business.

The word account in everyday language is often used as a substitute for an explanation or a report
of certain actions or events wherein you need to report how the business is doing. In order to
explain or to report, of course you have to remember what you were doing or what happened. As
it is not always easy to remember, you need to keep written record. In effect, such records can be
said to form the basis of a rudimentary accounting (or reporting) system.

Accountants are the scorekeepers of business. Without accounting, a business couldn’t function
optimally, it wouldn’t know whether it’s making a profit, and it wouldn’t know its financial
situation. Also, a sound understanding of this language will bring about a better management of
the financial aspects of living. Personal financial planning, education expenses, car amortization,
business loans, income taxes and investments are based on the information system that we call
accounting.

Intended learning outcomes

At the end of the unit, you can:

1. Explain accounting and its role in business, how accounting is being processed.
2. State the nature, purpose and function of accounting in business organization.
3. Describe functions of accounting in business as to users’ need.

Topic Outline
Topic 1 – Definition of Accounting
Topic 2 – Three Important process in accounting
Topic 3 – Basic purpose of accounting
Topic 4 – Functions of accounting in business
Topic 5 – Forms of Business organization
Topic 6 – Types of Business according to activities

Topic 1
Accounting is a process of identifying, recording and communicating economic information that
is useful in making economic decisions.

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 (American Institute of Certified Public Accountants (AICPA).

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 Topic 2
Essential elements of the definition of accounting
1. Identifying – The accountant analyses each business transaction and identifies whether the
transaction is an “accountable event” or “non-accountable event.” This is because only
“accountable events” are recorded in the books of accounts. “Non-accountable events”
are not recorded in the book of accounts.

“Accountable events” (or ‘economic events’) are those that affect the assets,
liabilities, equity, income and expenses of a business. Sociological and psychological
matters are outside the scope of accounting.

2. Recording – The accountant recognizes (i.e. records) the “accountable events” he has
identified. This process is called “journalizing”.
After journalizing, the accountant then classifies the effects of the event on the
“accounts”. This process is called “posting”.
► Account is the basic storage of information in accounting
e.g., “cash,” “land,” “sales,” etc.

3. Communicating – At the end of each accounting period, the accountant summarizes the
information processed in the accounting system in order to produce meaningful reports.
This is important because information processed in the accounting system is useless unless
it is communicated to interested users. Accounting information is communicated to
interested users through accounting reports, the most common form of which is the
financial statements.
Topic 3
Nature of accounting
Accounting is a process and a service activity with the basic purpose of providing information
about economic activities intended to be useful in making economic decisions.

Information provided by accounting are (1) quantitative information expressed in numbers,

quantities, or units; (2) qualitative information expressed in words or descriptive form normally
found in the notes to financial statements as well as on the face of the other components of financial
statements; (3) financial information expressed in money which is also a quantitative information.

Accounting is an information system that measures, processes and communicates financial

information about and economic entity. A system is one that consists of an input, a process and an
output. In an accounting system, the inputs are the accountable events; the processes are recording,
classifying and summarizing; and the output is the accounting report that is communicated to users.

Accounting as a social science, is a body of knowledge which has been systematically gathered,
classified and organized and as a practical art, that requires the use of creative skills and
judgement.

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 Topic 4
Functions of Accounting in Business
Accounting is often referred to as “language of business” because it is fundamental to the
communication
Two broad functions of Accounting in a business
1. To provide external users with information that is useful in making, among others,
investment and credit decisions; and
2. To provide internal users with information that is useful in managing the business.

Users of Accounting Information

1. Internal users – those who are directly involved in managing the business.
Examples: (a) Business owners (b) Board of directors (c) Managerial personnel

2. External users – those who are not directly involved in managing the business
Examples: a. Existing and potential investors (e.g. stockholders who are not
directly involved
In managing the business.)
b. Lenders (e.g., banks) and Creditors (e.g. suppliers)
c. Government agencies (e.g. Bureau of Internal Revenue ‘BIR’, Securities
and Exchange Commission ‘SEC’)
d. Non-managerial employees
e. Customers
f. Public

Types of accounting information classified as to users’ needs

1. General purpose accounting information – is information designed to meet the common
needs of most statement users. It is provided by financial accounting and is prepared
primarily for external users.

2. Special purpose accounting information – is information designed to meet the specific

needs of particular statement users. It is provided by management accounting or other
branches of accounting and is prepared primarily for internal users.

Brief history of accounting

Accounting can be traced as far back as the prehistoric times. Since the dawn of civilization when
mankind began to engage in trade, methods of record keeping and accounting have been invented.
As early as 8500 B.C., accounting has already existed. Archaeologists have found clay
tokens as old as 8500 B.C. in Mesopotamia which were usually cones, disks, spheres and pellets.
These tokens correspond to commodities like sheep, clothing or bread. They were used in the
Middle West in keeping records. After some time, the tokens were replaced by wet clay tablets.
During such time, experts concluded this to be the start of the art of writing.
Other ancient civilizations keeping account records are Babylonia (4500 B.C.), Egypt
(2250 B.C.), China and Greece.

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 In the middle ages (13 th and 15th centuries), trade flourished in places such as Florence,
Venice and Genoa. This has brought advancement in account keeping methods. In 1211 A.D. , one
of the systems in accounting was kept by a Florentino banker. However, the system was primitive
as the concept of equality for entries was absent. Double entry records first came out during 1340
A.D. in Genoa.
In 1494, the first systematic record keeping dealing with the “double entry recording
system” was formulated by Fra Luca Pacioli, a Franciscan monk and mathematician. The “double
entry recording system was included in Pacioli’s book titled “Summa di Arithmetica Geometria
Proportioni and Proportionista” published on November 10, 1494 in Venice.
The concept of “double entry recording system” is being used to this day. Thus, Fra Luca
Pacioli is considered as the father of modern accounting.

Common branches of accounting

1. Financial accounting
2. Management accounting
3. Government accounting
4. Auditing
5. Tax accounting
6. Cost accounting
7. Accounting education
8. Accounting research

Financial accounting – is the branch of accounting that focuses on general purpose financial
statements -those that cater the common needs of a wide range of external users.
Financial accounting is governed by the Philippine Financial Reporting Standards
(PFRSs)

Financial accounting vs. Financial reporting

The terms “financial accounting” and “financial reporting” are often used
interchangeably. Although, both focus on general purpose financial statements, financial
reporting endeavors to promote principles that are also useful to “other financial
reporting”
“Other financial reporting” comprises information provided outside the financial
statements that assists in the interpretation of a complete set of financial statements or
improves users’ ability to make efficient economic decisions.

Financial Statements vs. Financial report

• Financial statements are the structured representation of an entity’s financial position and
results of its operations. They are the end product of the accounting process and the means
by which information gathered and processed are periodically communicated to users.

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 • A Financial report includes the financial statements plus other information provided
outside the financial statements that assist in the interpretation of a complete set of financial
statements or improves users’ ability to make efficient economic decisions.

Management accounting – involves the accumulation and communication of information for

use by internal users. An offshoot of management accounting is management advisory services
which includes services to clients on matters of accounting, finance, business policies,
organization procedures, product costs, distribution, and many other phases of business
conduct and operations.

Government accounting – refers to the accounting for the government and its instrumentalities,
focusing attention on the custody of public funds, the purpose or purposes to which those funds
are committed, and the responsibility and accountability of the individual entrusted with those
funds.

Auditing – involves the inspection of an entity’s financial statements or business processes to

ascertain their correspondence with an established criteria.

Tax accounting – it the preparation of tax returns and rendering of tax advice, such as the
determination of tax consequences of certain proposed business endeavors.

Cost accounting – is the systematic recording and analysis of the costs of materials, labor, and
overhead incident to the production of goods or rendering services.

Accounting education – refers to teaching accounting and accounting-related subjects in an

organized learning environment. It is a process of facilitating the acquisition of knowledge and
skills regarding one or more of the other branches of accounting.

Accounting research – pertains to the careful analysis of economic events and other variables
to understand their impact on decisions. Accounting research includes a broad range of topics,
which may be related to one or more of the other branches of accounting, the economy as a
whole, or the market environment.

Topic 5
Forms of Business Organizations
1. Sole or single proprietorship – is a business that is owned by only one individual called as
“sole proprietor registered with the Department of Trade and Industry (DTI).

2. Partnership – is a business that is owned by two or more individuals (partners) who entered
into contract to carry on the business and divide among themselves the earnings therefrom. A
partnership is registered with the Securities and Exchange Commission (SEC).

3. Corporation – a corporation is also owned by more than one individual. However, unlike a
partnership, a corporation is created by operation of law rather than a contract. Ownership in

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 a corporation is represented by shares of stocks, thus owners are called stockholders or
shareholders.
A corporation is an artificial being or a juridical person, meaning in the eyes of the law, a
corporation is like a person, separate from its owners. Therefore, a corporation can transact on
its own, have its own properties, incur its own obligations, and sue or be sued.

A partnership also has a juridical personality. However, unlike for corporations, the
partners are viewed as agents of the partnership. Meaning the partners transact on behalf of the
partnership.
The incorporators (i.e., founders) of a corporation shall not be less than 5 but not more than
15 individuals. However, a corporation can have as many stockholders as it authorized
capitalization permits.

4. Cooperative – a cooperative is also owned by more than one individual. However, a

cooperative is formed in accordance with the provisions of the Philippine Cooperative Code
of 2008. Owners of a cooperative are called members.
From the root word “cooperate,” a cooperative is an association of individuals who joined
together to contribute capital and cooperate in order to achieve certain goals.

Another concept of a cooperative is that members need to patronize the cooperative’s goods
or services. If the cooperative earns profit (net surplus), a member can recover his costs through
a patronage refunds. Patronage refund pertains to the profit that a cooperative return to its
owners. It should be noted that a member who has not patronized any of the services of the
cooperative for an unreasonable period of time may be removed from the cooperative upon the
majority vote of the board of directors. A cooperative also has juridical personality similar to
a corporation.
The founding members of a cooperative shall not be less than 15 individuals. However a
cooperative can have as many members as its by-laws permit.
A cooperative is registered with the Cooperative Development Authority (CDA).

Topic 6
Types of Business According to Activities
1. Service business
2. Merchandising (Trading)
3. Manufacturing

Service Business
A service business is one that offers services as its main product rather than physical goods. A
service business may offer professional skills, expertise, advice, lending service and similar
services.
Examples: Schools, Professionals (accounting firm, law firm, etc), hospitals, banks, hotels &
restaurant, transportation and travel, entertainment and events planners.

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 Merchandising business
A merchandising business (or trading business) is one that buys and sells goods without changing
their physical form. Examples: General merchandise resellers (grocery stores, department stores,
etc), Distributors and dealers (wholesalers).

Manufacturing business
A manufacturing business is one that buys raw materials and processes them into final products.
A manufacturing business changes the physical form of the goods it has purchased in a production
process. Examples: Car manufacturers, Technology companies, food processing companies,
factories.

Questions:
1. What are the important elements of accounting definition?
2. What are business transactions being identified; how recording is done; and what are the
things that being communicated in accounting?
3. Which one consist of financial information? Financial statements or financial report and
how does financial statements differ from financial report?
4. What are the forms of business organization and how they are formed?

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 Quiz 1
Introduction to Accounting
True or False:
1 Accounting is a process of identifying, recording and communicating economic
information that is useful in economic decisions.
2 Financial accounting focuses on the information need of internal user while management
accounting focuses on the information need of external user
3 Only accountable events are recorded in the books of accounts. Accountable events are
those that affect the accountant.
4 A school is most likely to be considered as manufacturing business - the raw materials are
the students and the finished products are responsible and competent business
professionals.
5 Accounting is considered a practical art since it requires the use of creative skills and
judgment.
6 General purpose financial statements are the end product of financial accounting process
and these are intended for external users.
7 Accounting as an information system, consists of an input, a process and an output.
8 Accounting information is expressed in numbers only.
9 A business transaction is considered accountable events if it affects the assets, liabilities,
equity, income or expenses of the business.
10 Accounting is the major facet of a business that is responsible in generating funds needed
to support the business operations.

Multiple Choice
1 Which of the following does not properly describe accounting?
a. It is a process by which useful information is generated.
b. It is a social science.
c. It requires the application of creative skills and judgment.
d. Accounting is often referred to as "language of the soul".
2 What type of information needs of users do general purpose financial statements cater to?
a. common needs
b. specific needs
c. a and b
d. caring needs
3 It is the basic storage of information in accounting.
a. Journal
b. Account
c. Memory card
d. USB
4 The terms record and recording are most synonymous with.
a. identifying
b. posting

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 c. journalizing
d. communicating
5 Without this branch of accounting there will be no accountants.
a. Tax accounting
b. Auditing
c. Accounting education
d. Accounting research

This is a 10 minutes quiz with a duration from September 12 to 13, 2020 and to be submitted
before 9 a.m. on September 14, 2020.

References:

Millan, Z. V. B. (2020). Financial Accounting and Reporting (Fundamentals) (2020th ed.).

Bandolin Enterprise.

Ballada, W. (2019). Accounting Fundamentals (Made Easy) (5th ed.). DomDane Publishers &
Made Easy Books.

Arganda, A.M. & Herrero, C.C. (2007). Accounting Principles 2 (4th ed.). National Book Store.

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 Module 2

Accounting concepts and principles; Equation, Major accounts

At the end of the unit, you can:

1. Apply concepts and use accounting equation in solving accounting problems.
2. Classify major accounts according to the financial statement report.

Topic Outline
Topic 1 – Basic accounting Concepts
Topic 2 – Accounting Equation
Topic 3 – Types of major accounts
Topic 4 – Chart of accounts (common account titles)

Questions:
1. What is accounting concepts and principles, and how each concept being applied in
accounting?
2. What are the elements of financial statement and how it is formulated?
3. What are the five major accounts; classification and nature of each account?
4. What is chart of accounts?

Accounting concepts and principles

Introduction

Accounting concepts and principles (assumptions or postulates) are a set of logical ideas and
procedures that guide the accountant in recording and communicating economic information. They
provide a general frame of reference by which accounting practice can be evaluated and they serve
as guide in the development of new practices and procedures.

Accounting concepts and principles provide reasonable assurance that information communicated
to users is prepared in a proper way.

Topic 1
Basic Accounting Concepts:

1. Separate business entity concept – under this concept, the business is viewed as a separate
person, distinct from its owner(s). Only the transactions of the business are recorded in the
books of accounts. The personal transactions of the business owner(s) are not recorded.

You will view your business as a separate person, therefore the money you invested in the
business is now owned by the business, it is not your personal money anymore. Also, the
business owns any money that it earns. If you take money from the business for your personal

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 use, it would be recorded in the books of accounts as a withdrawal of your investment from
the business. Your personal transactions must not be recorded in the books of accounts.

The application of the separate entity concept is necessary so that the financial position and
performance of a business can be measured properly. By applying the separate entity concept,
you can objectively know if the business is really earning profits, or if it has the ability to do
so.

2. Historical cost concept (Cost principle) – Under this concept, assets are initially recorded at
their acquisition cost.

3. Going concern assumption – Under this concept, the business is assumed to continue to exist
for an indefinite period of time. This is necessary for accounting measurements to be
meaningful. For example, measuring assets at historical cost (historical cost concept) is
appropriate only when the business is a going concern.
The opposite of going concern is liquidating concern. This is the case if the business
intends to end its operations.

4. Matching (or Association of cause and effect) – Under this concept, some costs are initially
recognized as assets and charged as expenses only when the related revenue is recognized.
Expenses incurred during a period be recorded in the same period when revenues are earned.

5. Accrual Basis of accounting – Under the accrual basis of accounting, economic events are
recorded in the period in which they occur rather that at the point in time when they affect
cash.

Thus, income is recorded in the period when it is earned rather than when it is collected,
while expense is recognized in the period when it is incurred rather than when it is paid.

6. Prudence (or Conservatism) – Under this concept, the accountant observes some degree of
caution when exercising judgements needed in making accounting estimates under conditions
of uncertainty. Such that, if the accountant needs to choose between a potentially unfavorable
outcome versus a potentially favorable outcome, the accountant chooses the unfavorable one.
This is necessary so that assets or income are not overstated and liabilities or expenses are not
understated.

7. Time Period (Periodicity or Accounting period concept) – Under this concept, the life of the
business is divided into series of reporting periods.
Users need timely periodic information on the results of operations for them to properly
perform their function and for making decisions.
For example, managers may need to know:
o Which products or services are selling well and which one are not?
o Is the business spending too much on expenses? Does the business need to cut down
costs?

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 External users may need to know:
o For creditors: Is the business generating enough cash needed to pay it liabilities?
o For investors: Is the business earning enough profits to ensure future growth?
Thus, instead of waiting until the life of the business ends before profit is determined, the
life of the business is divided into series of equal short periods called reporting periods (or
accounting periods).
A reporting period is usually 12 months, it can be longer or shorter. A 12-month accounting
period is either calendar year period or a fiscal year period. A calendar year starts on January
1 and ends on December 31 of the same year. A fiscal year period also covers 12 months but
starts on a date other than January 1. (e.g. July 1, 2017 to June 30, 2018).
An accounting period that is shorter than 12 months is called an “interim period”which
can be a month, quarter or semiannual

8. Stable monetary unit – Under this concept, assets, liabilities, equity, income and expenses are
stated in terms of a common unit of measure, which is the peso in the Philippines. Moreover,
the purchasing power of the peso is regarded as stable. Therefore, changes in the purchasing
power of the peso due to inflation are ignored.

9. Materiality concept – This concept guides the accountant when applying accounting
principles. Accounting principles are applicable only to material items.
An item is considered material if its omission or misstatement could influence economic
decisions. Materiality is a matter of professional judgement and is based on the size and nature
of an item being judged.
For example, material items are communicated to users in a more detailed manner as
compared to immaterial items.

10. Cost-benefit (Cost constraint) – Under this concept, the cost of processing and communicating
information should not exceed the benefits to be derived from it.

11. Full disclosure principle – This concept is related to both the concepts of materiality and cost-
benefit. Under the full disclosure principle, information communicated to users reflect a series
of judgmental trade-offs. The trade-offs strive for:

a. Sufficient detail to disclose matters that make a difference to users, yet

b. Sufficient condensation to make the information understandable, keeping in mind the costs
of preparing and using it.

12. Consistency concept – Under this concept, a business shall apply accounting policies
consistently, and present information consistently, from one period to another
Accounting policies used this year shall be the same accounting policies used last year.
This, however, does not mean that a business cannot change its accounting policies.
Accounting policies can be changed if it is required by a standard or a change would result
in more relevant and more reliable information. Any change in accounting policy must be
disclosed.

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 Accounting standards

Accounting concepts and principles are either explicit or implicit. Explicit concepts and
principles are those that are specifically mentioned in the Conceptual Framework for
Financial Reporting and in the Philippine Financial Reporting Standards (PFRSs).
Implicit concepts and principles are those that are not specifically mentioned in the
foregoing but are customarily used because of their general and longtime acceptance within
the accountancy profession.

The term “standards” is used to specifically refer to the Philippine Financial Reporting
Standards (PFRSs). Traditionally, accounting standards were referred to as the generally
accepted accounting principles (GAAP)
The Philippine Financial Reporting Standards (PFRSs) are standards and interpretations
adopted by the Financial Reporting Standards Council (FRSC) which is the official
accounting standard setting body in the Philippines.

Just like the basic accounting concepts, the standards serve as guide when recording and
communicating accounting information. The difference is that the standards provide a more
detailed application of concepts. They also provide which principle is most appropriate for
specific economic transactions. They also require certain information that should be
included in financial reports and how this information is presented.

We need to have uniform accounting standards because, for financial statements to be

useful, they must be prepared using the reporting standards that are generally acceptable
which means the standard has been established by an authoritative accounting standard
setting body or the principle has gained general acceptance due to practice and proven to
be most useful. Otherwise, each business would have to develop its own standards.

Relevant regulatory bodies

Other than FRSC, the following also affect the accounting policies:

1. Securities and Exchange Commission (SEC)

2. Bureau of Internal Revenue (BIR)
3. Bangko Sentral ng Pilipinas (BSP)
4. Cooperative Development Authority (CDA)

The Conceptual Framework for Financial Reporting

Just like the standards, the Conceptual Framework for Financial Reporting also prescribes
accounting concepts meant to guide the accountant in preparing and presenting the
financial statements. However, the Conceptual Framework is not a standard. Rather, it
serves as a general frame of reference in the application or development of standards.

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 Qualitative Characteristics of useful financial information
Among the concepts stated in the Conceptual Framework are the qualitative characteristics
of useful financial information.
Qualitative characteristics are the traits that make information useful to users.
Without these characteristics, information may be deemed useless. This characteristic
identify the types of information that are likely to be more useful in making decisions about
the reporting entity on the basis of information in its financial report.

Qualitative Characteristics are broadly classified into two:

1. Fundamental qualitative characteristics – these refer to the essential characteristics that
information must have before it can be included in the financial statements:
a. Relevance
b. Faithful presentation ReFa

2. Enhancing qualitative characteristics – these characteristics support the fundamental

characteristics. They enhance the usefulness of information. As such, they must be
maximized. Enhancing qualitative characteristics consist of:
a. Comparability
b. Verifiability CoVeTiUn
c. Timeliness
d. Understandability

Relevance
Information is considered relevant if it has the ability to affect the decision making of the
users.

Elements of relevance:
a. Predictive value – Information has a predictive value if users can use it as an input in
making predictions or forecasts of outcomes of events.

b. Confirmatory value (or Feedback value) – This is related to predictive value, information
has a confirmatory value if users can use it to confirm their past predictions.

c. Materiality – is and ‘entity-specific’ aspect of relevance, meaning it depends on the facts

and circumstances surrounding a specific entity. Information is material if omitting ir or
misstating it could influence the decision making of the users.

Faithful presentation
Information is faithfully represented if it is factual, it represents the actual effects of events
that have taken place.

Elements of faithful presentation:

a. Completeness – Information must be presented with sufficient detail necessary for users to
understand them. Important information must not be omitted.

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 b. Neutrality – Information are selected or presented without bias. Information must not be
manipulated to increase the probability that it will be received favorably or unfavorably by
the users.

c. Free form error – Means information presented in the financial statements must not be
materially misstated. Means there are no errors in the description and in the process by
which the information is selected and applied.

Enhancing qualitative characteristics

Comparability
Information has this characteristic if it enables users to make comparisons to identify and
understand the similarities in, and the differences among items. A comparison requires at
least two items.

Verifiability
Information is verifiable if it enables different and independent users to reach a general
agreement about what the information intends to depict.

Timeliness
Information must be provided to users on time to be capable of influencing their decisions.

Understandability
Information must be presented clearly and concisely in order for users to understand them.

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 Topic 2
Accounting Equation

The Basic Accounting Equation

All the process in an accounting system must observe the equality of the accounting equation:

Assets = Liabilities + Equity

ASSETS – are the resources you control that have resulted from past events and can provide with
future economic benefits.

Essential elements in the definition of asset

a. Control – you control the economic benefits from the resource, means you have the
exclusive right to enjoy those benefits or you can prevent others from enjoying those
benefits.
b. Past events – the control over a resource have resulted from a past event or transaction.
Therefore, resources for which control is yet to be obtained in the future do not qualify as
assets in the present.
c. Future economic benefits – means the resource is expected to provide economic benefits
over more than one accounting period. If it provides economic benefits only in one
accounting period, it is not an asset but an expense.

LIABILITIES – are your present obligations that have resulted from past events and can require
you to give up resources when settling them.

Essential elements in the definition of liability

a. Present obligation – means that right now, you have a responsibility to pay someone
because of an obligating event that has already transpired. An obligating event is an event
that creates either (a) a legal obligation arises from a contract, a law or other operation of
law or (b) a constructive obligation that arises from your past business practices or
published policies that have created a valid expectation on the part of others that you will
pay them.
b. Giving up resources (or Outflow of economic benefits) – means that settling an obligation
necessarily would require you to pay cash, to transfer other non-cash assets or to render a
service.

EQUITY – is simply assets minus liabilities. Other term or known as “capital,” “net assets,” and
“net worth”.

The Expanded Accounting Equation

Assets = Liabilities + Equity + Income - Expenses

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 Income is added because it increases equity while expenses are deducted because it decreases
equity.

INCOME - is increases in economic benefits during the period in the form of inflows or
enhancements of assets or decreases of liabilities that result in increases in equity,
excluding those relating to investments by business owners.

EXPENSES – are decreases in economic benefits during the period in the form of outflows
or depletions of assets or increases of liabilities that result in decreases in equity, excluding
those relating to distributions to the business owners.

The difference between income and expenses represents profit or loss.

We can make another variation to the equation:

Assets = Liabilities + Equity + Profit / - Loss

Regardless of its form or variation, the accounting equation (basic or expanded) remains balanced.

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 Topic 3
Types of major account

Account is the basic storage of information in accounting. It is a record of the increases and
decreases in a specific item of asset, liability, equity, income or expense.

The Five Major Accounts – also called the elements of the financial statements are the items in
the expanded accounting equation as discussed earlier.

1. ASSETS
2. LIABILITIES
3. EQUITY
4. INCOME (includes both revenue & gains)
Revenue – arises in the course of the ordinary activities of a business
Gains – other items that meet the definition of income and may or may not arise in the
ordinary activities of an entity.
5. EXPENSES

Classification of the Five Major Accounts

According to the financial statement where they appear:

INCOME
BALANCE SHEET
STATEMENT
ACCOUNTS
ACCOUNTS
1. ASSETS 1. INCOME
2. LIABILITIES 2. EXPENSES
3. EQUITY

► The balance sheet (or the statement of financial position) is one of the components of a
complete set of financial statements where it shows the financial position of a business.
► The income statement (or the statement of profit or loss) is a sub-component of the
statement of comprehensive income, which is also one of the components of a complete
set of financial statements where it shows the profit or loss of a business.

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 Topic 4
Chart of Accounts
A chart of accounts is a list of all the accounts used by a business.

Example of basic chart of accounts as follows:

Chart of Accounts
BALANCE SHEET ACCOUNTS INCOME STATEMENT ACCOUNT
Account Account
No. No.
ASSETS INCOME
110 Cash 410 Service fees
120 Accounts receivable 420 Sales
125 Allowance for bad debts 430 Interest income
130 Notes receivable 440 Gains
140 Inventory
150 Prepaid supplies EXPENSES
155 Prepaid rent 510 Cost of sales
160 Prepaid Insurance 515 Freight-out
170 Land 520 Salaries expense
180 Building 525 Rent expense
185 Accumulated depreciation-Bldg. 530 Utilities expense
190 Equipment 535 Supplies expense
Accumulated depreciation-
195 Equipment 540 Bad debt expense
545 Depreciation expense
550 Advertising expense
LIABILITIES 555 Insurance Expense
210 Accounts payable 560 Taxes and licenses
Transportation and travel
220 Notes payable 565 expense
230 Interest payable 570 Interest expense
240 Salaries payable 575 Miscellaneous expense
250 Utilities payable 580 Losses
260 Unearned income

EQUITY
310 Owner's capital
320 Owner's drawings

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 Account numbers are assigned to the accounts to facilitate recording, cross-referencing, and
retrieval of information. Although there is no standard way of assigning account numbers, it should
be assigned in a manner that the accounts are categorized logically.

The account titles in the chart of accounts shown above are numbered in the following manner:
1. The first digit in the 3-digit numbering refers to the major types of accounts:

Major types of Assigned

accounts number
ASSETS 1
LIABILITIES 2
EQUITY 3
INCOME 4
EXPENSES 5

2. The second digit in the 3-digit numbering refers to the account titles and the sequence on
how they are listed in the chart of accounts.
Thus, in the chart of accounts, the second digit in the 3-digit numbering of “Cash”
is 1 because it is the first asset account listed in the chart; the second digit in the 3-digit
numbering of “Accounts receivable” is 2 because it is the second asset account listed in the
chart; etc.

3. The third digit in the 3-digit numbering, if not zero, signifies that the account is a contra
account or an adjunct account to a related account.
180 Building
185 Accumulated depreciation-Bldg.

The third digit signifies that this account is a contra-account to the

‘Building’ account

Common Account Titles

BALANCE SHEET ACCOUNTS:

ASSETS
• Cash – includes money or its equivalent that is readily available for unrestricted use. e.g.
cash on hand and cash in bank.

• Accounts receivable – receivables supported by oral or informal promises to pay.

• Allowance for bad debts – the aggregate amount of estimated losses from uncollectible
accounts receivable. Also known as “allowance for doubtful accounts.”

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 • Notes receivable – receivables supported by written or formal promises to pay in the form
of promissory notes.

• Inventory – represents the goods that are held for sale by a business. For a manufacturing
business, inventory also includes goods undergoing the process of production and raw
materials that will be consumed in the production process.

• Prepaid supplies – represents the cost of unused office and other supplies

• Prepaid rent – rent paid in advance

• Prepaid insurance – cost of insurance paid in advance

• Land – the lot on which the building of the business has been constructed or a vacant lot
which is to be used as future plant site. Land is not depreciable.

• Building – the structure owned by a business for use in its operations.

• Accumulated depreciation – building – the total amount of depreciation expense

recognized since the building was acquired and made available for use.

• Equipment – consists of various assets such as:

a. Machineries and other factory equipment
b. Transportation equipment
c. Office equipment
d. Computer equipment
e. Furniture and fixtures

• Accumulated depreciation – equipment – the total amount of depreciation expenses

recognized since the equipment was acquired and made available for use.

Land, buildin.g and equipment are collectively referred to as “Property, plant and
equipment”, “Capital assets,” or “Fixed assets”.

LIABILITIES
• Accounts payable – obligations supported by oral or informal promises to pay by the
debtor.
• Notes payable – obligations supported by written or formal promises to pay by the debtor
in the form of promissory notes.
• Interest payable – interest incurred but not yet paid. Interest payable arises from interest-
bearing liabilities. Ex. Interest on bank loan
• Salaries payable – salaries already earned by employees but not yet paid by the business.
• Utilities payable – utilities already used but not yet paid (e.g. electricity, water, telephone,
etc.)

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 • Unearned income – items related to income that were collected in advance before they are
earned. After the earning process is completed, these items are transferred to income.

EQUITY (Capital, Net Assets or Net worth)

• Owner’s capital (or Owner’s equity) – the residual amount after deducting liabilities
from assets.

INCOME STATEMENT ACCOUNTS

INCOME
 Service fees – revenue earned from rendering services
 Sales – revenues earned from the sale of goods
 Interest income – revenues from the issuance of interest-bearing receivables.
 Gains – income earned from the sale of assets (except inventory) or from enhancements of
assets or decreases in liabilities that are not classified as revenue.

EXPENSES
 Cost of sales or (Cost of goods sold) – represents the value of inventories that have been
sold during the accounting period.
 Freight out – represents the sellers’ costs of delivering goods to customers. Other term for
freight-out are “delivery expense,” “transportation-out” and “carriage outwards”.
 Salaries expense
 Rent expense
 Utilities expense
 Supplies expense
 Bad debt expense
 Depreciation expense
 Advertising expense
 Insurance expense
 Taxes & licenses
 Transportation and travel expenses
 Interest Expense
 Miscellaneous expense
 Losses

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 Exercise
Indicate the classifications of each accounts listed below as Asset, Liability, Equity,
Income or Expense account, either under column A Balance Sheet, or under Column B
Income Statement.
Account Title COLUMN A COLUMN B
Balance Sheet Income Statement
Accounts payable
Accounts receivable
Advertising expense
Bad debt expense
Building
Cash
Cost of sales
Depreciation expense
Freight-out
Gains
Income tax payable
Insurance Expense
Interest expense
Interest income
Interest payable
Inventory
Land
Losses
Miscellaneous expense
Notes payable
Notes receivable
Office Equipment
Owner's capital
Owner's drawings
Prepaid rent
Prepaid supplies
Rent expense
Salaries expense
Salaries payable
Sales
Service fees
Supplies expense
Taxes and licenses
Transportation and travel expense
Unearned income
Utilities expense
Utilities payable

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 Quiz 2
Accounting Concepts & Principles
Multiple Choice

Which of the following are the guidelines that accountants follow when recording and
1 communicating accounting information?
a. Accounting principles
b. Accounting memos and guidelines
c. Accounting concepts and principles
d. Accounting laws and regulations

2 This concept requires the preparation of financial statements at least annually.

a. Accrual basis
b. Reporting period
c. Materiality
d. Historical cost

3 What concept justifies the use of the accrual basis and historical cost concept?
a. Going concern
b. Materiality
c. Accrual basis
d. Full disclosure

4 Under the accrual basis of accounting, a business records a sale

a. when the sale occurs
b. when the sale price is collected
c. at the point in time when (a) and (b) above are satisfied
d. a or b, as an accounting policy choice

Information has this qualitative characteristic if two different users could reach a general
5 agreement as to what the information intends to represent
a. Relevance
b. Faithful representation
c. Comparability
d. Verifiability

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 Accounting Equation
Problem solving:
Entity Z's beginning equity was 40M. If during the year, entity Z earned total income of
1 5M and total expenses of 9M, how much is Entity Z's ending equity?
Entity A earned a total income of 30M and reported a profit of 8M, how much is entity
2 A's expenses?
3 Entity B total assets is 50M and total liabilities is 30M, how much is entity B's net worth?
At the end of the year, Entity C's total assets and total liabilities are P90M and 35M
respectively. Entity C had a beginning equity of 30M and there were no contributions
from or distribution to the owner during the period, how much profit (loss) did entity C
4 earned (incurred) during the year?
Entity D had total assets of P50M and total liabilities of P30M at the beginning of the
period. If at the end of the period, total assets increased by 20M while total liabilities
5 increased by 5M, how much is entity D's total equity at the end of the period?

Major Accounts

1 What are balance sheet accounts?

2 What are income statement accounts?
3 What are the three parts of "T" account
4 The unused portion of an insurance paid in advance is called.
5 The amount of estimated losses from uncollectible accounts receivable during the period
is called.

This is a 15 minutes quiz with a duration from September 19 to 20, 2020 and to be submitted
before 9 a.m. on September 21, 2020.

Reference:

Millan, Z. V. B. (2020). Financial Accounting and Reporting (Fundamentals) (2020th ed.).

Bandolin Enterprise.

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DISTRIBUTION, UPLOADING, OR POSTING ONLINE IN ANY FORM OR BY ANY MEANS WITHOUT THE WRITTEN PERMISSION OF
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25