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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

Summarizing
Interpreting

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

-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.

Right side or Credit side


-When an amount is entered on the right
side, it is called a Credit entry.

Rules on Debit and Credit for Assets, Liabilities and Capital


Debit
-Increase in Asset
-Decrease in Liabilities
-Decrease in Capital

Credit
-Decrease in Asset
-Increase in Liabilities
-Increase in Capital

Rules on Debit and Credit for Revenues and Expenses


Debit
-Increase in Expense

Credit
-Increase in Revenue

***General Journal book of original entry


***Accounting cycle series of repetitive steps performed during an accounting period to accomplish the accounting process

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.

Maker Notes Payable

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

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. 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)
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

II.

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
a.

36000

36540

III.

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.

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

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

***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

Oct 30

Cash
Discount on Notes Payable
Notes Payable

23640
360

Notes Payable
Cash

24000

Interest Expense
360
Discount on Notes Payable

24000
24000
360

***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

Required Entry

Correcting Entry

1.

Salaries Expense 12000


Cash
12000

Ang, Drawing
Cash

12000
12000

Ang, Drawing
12000
Salaries Expense 12000

2.

Cash
1600
Accounts Payable 1600

Office Supplies 1600


Accounts Payable 1600

Office Supplies
Cash

3. Accounts Payable 850


Cash
850

Cash
850
Accounts Receivable 850

Cash
1700
Accounts Payable
850
Accounts Receivable
850

1600

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

1600

***Example: On December 1, 2008 received/issued a 90-day 6% note


for money borrowed.
PAYEE
Dec 1 Notes Receivable 36000
Cash

36000

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

36000

Interest Expense
180
Interest Payable

180

Notes Payable
Interest Expense 360
Interest Payable 180
Cash

36000
36540

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

EXPENSE METHOD

Prepaid Insurance
Cash

36000

Jan 1
36000

Dec 31 Insurance Expense


12000
Prepaid insurance
12000

Insurance Expense
Cash

36000
36000

Dec 31 Prepaid Insurance


24000
Insurance Expense
24000

Unearned Revenue already received but not yet earned


***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

INCOME METHOD
Nov 1 Cash
Rent Income
24000

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

20000

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

P1000
300
P 700

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)

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

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

180

36000
36540

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

Prepared By:
The Academics Committee
Economics Organization