ch-1-accounting-in-business 2

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I. Accounting definition and purpose

   An information and measurement system that identifies, records, and communicates
    relevant, reliable and comparable information about an organization’s business activities.
   Language of business that helps users make better decisions

II. Users of Accounting Information
       a. External Information Users
            Not directly involved in running the organization
            Examples: shareholders, customers, suppliers, regulators, lenders, etc.
            Financial Accounting
                        • Serves external users
                        • Produces general purpose financial statements (i.e., balance sheet,
                            income statement, statement of cash flow)
                        • Complies with generally accepted accounting principles or GAAP

       b. Internal Information Users
           Directly involved in managing and operating an organization
           Examples: officers and employees
           Managerial accounting
                         • Serves the decision-making needs of internal users
                         • Generates reports specific to the needs of users
                         • Does not comply with GAAP

III. Generally Accepted Accounting Principles
      Govern the financial accounting practice
      Consist of basic assumptions, concepts, and guidelines for preparing financial statements

       a. Objectivity or reliability Principle – accounting information is supported by
          independent, unbiased evidence
              - Example: sales invoices, delivery receipts, physical counts as evidences of

       b. Cost Principle – accounting information is based on actual cost, which is measured
          on a cash or equal-to-cash basis

       c. Going-concern Principle – assumes that the business will continue to operate
          indefinitely unless there is evidence to the contrary
              - Example: recording of plant assets at acquisition cost instead of their current
          realizable value

       d. (Stable) Monetary Unit Principle – transactions and events can be expressed in
          monetary or money units. Record only facts that can be expressed in monetary units.
              - Example: Assuming that pesos today will buy as much as ten years ago.

       e. Time Period or Accounting Period – the life of the business is divided into short
          accounting periods of equal length (a year, a month, a quarter, etc.)
             - Example: Financial statements are prepared each year.

       f. Realization or Revenue Recognition Principle – revenue is recognized when earned
          – when the seller renders services or transfers ownership of products to the buyer

       g. Matching Principle – expenses of a period are associated with the respective
              - Example: record cost of goods sold in the same period that the sale was made;
          rent paid in advance is recorded as prepaid rent

       h. Business Entity Principle – a business is accounted for separately from its owner
          and other business entities
             - Example: Personal transactions of the proprietor are distinguished from
          business transactions

       i. Consistency principle – an accounting method, once adopted, will not be changed
          from period to period
              - Example: Adoption of the first-in, first-out inventory cost flow method means
          that it should be observed from period to period

       j. Disclosure principle – all material and relevant facts are communicated to users,
          either in the financial statements or in the notes to financial statements

       k. Materiality concept – trivial matters are disregarded. Important matters are
              - Example: All payments less than P1,000 are expensed as incurred.

       l. Conservatism – a guide in resolving uncertainties; recognize revenues when
          reasonably certain; recognize expenses when reasonably possible.

    Forms of business entities:

                                    Proprietorship Partnership Corporation

              Business entity             yes              yes            yes
              Legal entity                 no               no            yes
              Limited liability           no*              no*            yes
              Unlimited life               no               no            yes
              Business taxed               no               no            yes
              One owner allowed           yes               no            no

* Proprietorships and partnerships that are set up as limited liability companies (LLC’s) provide
limited liability.

IV. The Accounting Equation
           Assets       =        Liabilities       +         Equity
  What the company OWNS   What the company OWES to non-owners and owners

     • Resources owned or controlled by a company

     • Creditors’ claims on assets
     • Obligations to provide assets, products or services to others

    • Owners’ claim on assets
    • Net assets or residual equity
                  Equity        =          Assets          -         Liabilities

          Beginning capital
          - Owner, withdrawals
          + Revenues
          - Expenses
          = Ending capital

  Sample Transactions:

  J. Reyes started Candy Sweet Co., a new business that began operations on May 1. Candy
  Sweet Co. completed the following transactions during that first month:

  a.   J. Reyes, the owner, invested P60,000 cash in the business
  b.    Purchased P1,680 of supplies on credit
  c.   Sold candies to a customer and immediately collected P4,600 cash.
  d.    Sold P3,000 worth of candies for a customer on credit
  e.   Paid P1,680 cash for the supplies purchased on transaction b
  f.   Received P3,000 cash payment for the sale on transaction d
  g.    Paid P850 cash for an assistant’s salary
  h.    Paid P200 cash for this month’s telephone bill
  i.   J. Reyes withdrew P1,200 cash for personal use

Cash      +    AR      +   Supplies   =    AP       +   Reyes,   -     Reyes,      +   Revenue   -   Expense

                                                                   capital       drawings
A   60,000                                                          60,000
B                                       1,680         1,680
C    4,600                                                                                        4,600
D                    3,000                                                                        3,000
E   (1,680)                                          (1,680)
F     3,000        (3,000)
G     (850)                                                                                                        850
H     (200)                                                                                                        200
I   (1,200)                                                                           1,200
    63,670    +            0   +        1,680   =         0    +   60,000    -        1,200   +   7,600   -       1,050
                  65,350                        =                                    65,350

      V. Basic Financial Statements

                    a. Income statement – describes a company’s revenues and expenses along with the
                       resulting net income or loss over a period of time due to earnings activities.

                                                 The Simpson Company
                                                   Income Statement
                                           For the month ended May 31, 2006

                                   Service revenue                               $ 10,400
                                    Rent expense                    $ 3,200
                                    Utilities expense                     680
                                    Salary expense                      1,700
                                    Advertising expense                    60
                                    Miscellaneous expense                 800
                                    Total expenses                                    6,440
                                   Net income                                    $    3,960

          b. Statement of Owner’s Equity – explains changes in equity from net income (or
             loss) and from the owner investments and withdrawals over a period of time.

                                  The Simpson Company
                              Statement of Owner’s Equity
                            For the month ended May 31, 2006

                      Simpson, Capital, May 1     $ 60,000
                      Add: Net income                3,960
                      Deduct: Withdrawals                       (1,200)
                      Simpson, Capital, May 31               $ 62,760

          c. Balance Sheet – describes a company’s financial position (types and amounts of
             assets, liabilities, and equity) at a point in time

                                  The Simpson Company
                                      Balance Sheet
                                      May 31, 2006

                    ASSETS                               LIABILITIES
       Cash                      $ 61,140 Accounts payable                     $     60
       Office equipment             1,680  Total liabilities                         60

                                          Simpson, capital                       62,760
       Total assets              $ 62,820 Total liabilities and equity         $ 62,820

          d. Statement of cash flow – identifies cash inflows and outflows over a period of

VI. International Financial Reporting Standards
    • Harmonize accounting practices among various countries
    • Increase comparability of accounting reports in today’s global economy


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