BSA Qualifying Exam Reviewer

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QUALIFYING EXAM REVIEWER

THEORIES FROM

FINANCIAL ACCOUNTING

BY WEYGANDT ET AL Prepared by:

Laron Yvette Vicente de Ocampo

ACTBAS1

I. Introduction to Accounting 1.1 Financial Statements

Financial Statements provide management, owners and other interested parties with relevant financial data. These are:

Statement of Comprehensive Income – presents income and expenses and resulting profit or loss for a specific period of time. As permitted by the International Accounting Standards, an entity may present all items of income and expense recognized in a period in either a single statement of

comprehensive income or in two statements:

a. a separate Income Statement/Profit of Loss Statement – displays income and expenses resulting in a profit or loss

- revenue is listed first followed by expenses before determining profit (or loss) for the period

- expenses are listed in order or magnitude

b. a Statement of Comprehensive Income – displays components of other comprehensive income which comprises other income and expenses that are not recognized in profit or loss

Statement of Changes in Equity – summarizes the changes in owner’s equity for a specific period of time

- time period is the same as that covered by the income statement

- information in this statement indicated the reasons why owner’s equity has increased or decreased

a. owner’s additional investments – assets that the owner puts into the business

b. profits (or loss) – gross increase (decrease) in owner’s equity which is equal to the difference of revenue – arises

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in the course of the ordinary activities of the business – and gains – include gains on disposal of non-current asses and unrealized gains on revaluing assets – (expenses) over the expenses – the cost of assets consumes or services used in the process of earning income (revenue and gains)

c. owner’s drawings – withdraw cash or other assets for personal use

Statement of Financial Position – reports the assets, liabilities and owner’s equity at a specific date or point in time

- assets are listed at the top, followed by liabilities and owner’s equity - total assets must equal total liabilities and owner’s equity (capital) - snapshot of business’ financial condition at a specific moment in time

usually month-end or year-end

Statement of Cash Flows – summarizes information about the cash inflows (receipts) and outflows (payments) for a specific period of time

- reports the cash effect of the following activities of an entity during a period:

a. operating activities – include transactions that create income and expenses

b. investing activities – include (a) acquiring and disposing of investments and plant, property and equipment and (b) lending money and collecting loans

c. financing transactions – include (a) obtaining cash from issuing debt and repaying the amounts borrowed and (b) obtaining cash from shareholders and providing them with a return on their investment

- reports the net increase or decrease in cash and the cash amount at the end of the period

- this report is useful of investors and creditors because they would want to know what is happening to the company’s most liquid resource

- answers the following questions:

a. Where did cash come from? b. What was the cash used for?

c. What was the change in the cash balance?

Notes to Financial Statements – include summary of significant accounting policies used to prepare financial statements, and other explanatory notes and supporting schedules

1.2 Definition, Nature and Scope of Accounting

Accounting – is an information system that identifies, records and communicates the economic events of an entity to interested users

Identifying – selecting the economic activities/transactions relevant to a particular entity

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Recording – provide a history of the entity’s financial activities - consists of keeping a systematic, chronological diary of events - classifies and summarizes economic events

Communicating –through accounting reports of which the most common are the financial statements, financial information is communicated to interested users:

a. Internal – managers who plan, organize and run a business 1. Marketing Managers

2. Production Supervisors 3. Chief Financial Officers 4. Other Employees

b. External – there are types of external users and these are: 1. Investors (Owners) – use accounting information to

make decisions to buy, hold or sell shares 2. Creditors (such as Supplier and Bankers) – use

accounting information to evaluate risks of granting credit or lending money

3. Tax Authorities - want to know whether the company complies with the tax laws

4. Regulatory Agencies – want to know whether the entity is operating within the prescribed rules 5. Customers – interested in whether an entity will

continue to honor product warranties and support its product lines

6. Employees and Labor Unions – want to know whether the entity can pay increased wages and benefits

7. Economists – use accounting information to forecast economic activity

Analyzing- involves the use of ratios, percentages, graphs and charts to highlight significant financial trends and relationships

Interpreting – involves explaining the uses, meaning and limitations of reported data

- often referred to as the “language of business” – means of communication as it provides information that assist users to understand where the entity has been by looking at its past performance, to understand where it is now by looking at its current financial position, and to provide insight into what is likely future prospects are

- its purpose is to assist people, whether internal or external to an entity, to make decisions about the allocation of scarce resources

- means of measuring business activity and processing this information into reports to communicate results to decision makers

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- may be divided into:

a. Financial Accounting – provides economic and financial information for external users

b. Management Accounting – provides economic and financial information for internal users

- has three major fields:

a. Public Accounting – would offer expert services to the general public

- involves the following major area/work:

1. Auditing – public accountants such as Certified Public Accountant (CPA) or Chartered Accountant (CA) examine the financial statements of entities and express on opinion as to the fairness/reliability of presentation

2. Taxation – includes tax advice and planning, preparing tax returns and representing clients before government agencies

3. Management Consulting – ranges from installing of basic accounting systems to helping entities

determine whether they should use the space shuttle for high-tech research and development projects

- also include activities such as developing business financial plans and outsourcing requirements for clients

b. Private (or Management) Accounting – includes the following activities:

1. General Accounting – recording daily transactions and preparing financial statements and related information

2. Cost Accounting – determining the cost of producing specific products

3. Budgeting – assisting management in quantifying goals concerning revenue, costs of goods sold and operating expenses

4. Accounting Information Systems - designing both manual and computerized data processing systems 5. Tax Accounting – preparing tax returns and doing

tax planning for the business

6. Internal Auditing – reviewing the business operations to see if they comply with the

management policies and evaluating the efficiency of operations

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c. Not-for-Profit Accounting – non-profit entities also need sound financial reporting and control because donors to such entities would want information about how well the entity has met its financial objectives and whether continued support is justified

- entities must also make decisions about allocating funds - one area of Not-for-Profit Accounting is Government

Accounting 1.3 Brief History of Accounting

The origins of accounting are generally attributed to the work of Luca Pacioli, an Italian renaissance mathematician. In his 1494 text Summa de arithmetica, geometria, proportione et proportionalite, he described a system to ensure that financial information was recorded efficiently and accurately.

The advent of the industrial age in the 19th century and later, the emergence of large entities, a separation of the owners from the managers of business took place. As a result, the need to report the financial status of the entity became more important, to ensure that the managers acted in accord with the owner’s wishes. Also, transactions between entities became more complex, making necessary improved approaches for reporting financial information

Our economy has now evolved into a post-industrial age – the information age – in which many “products” are information services. The computer had been the driver of this age

1.3.1 Double-Entry Bookkeeping

Double-Entry Bookkeeping – suggests that for every credit entered into a ledger, there must be corresponding debit.

- one of the most beautiful discoveries of the human spirit 1.3.2 Harmonization of Accounting Reports

Generally Accepted Accounting Principles (GAAP) – set of standards and rules for financial reporting

- these principles, since they are ‘Generally Accepted’, have a substantial authoritative support from…

1.3.3 International Accounting Standards

International Accounting Standards Board (IASB) – national accounting standard-setting bodies and/or regulatory and enforcement agencies 1.4 Relationship of Accounting to Other Fields of Discipline

“How will the study of accounting help me?”

General Management – make wise business decisions Marketing – develops strategies to help the sales Finance – examine and analyze statements

Real Estate – agents must understand the numbers involved 1.5 Forms of Business Organization as to Ownership and Activity

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- owner is often the manager/operator of the business, which is usually a small service-type one

- only relatively small amount of money is necessary

- owner receives any profits, suffers any losses and is personally liable for all debts of the business

- although there is no legal distinction between the business and the owner, accounting records of the business activities are still kept separate from the personal records of the owner

Partnership – business owned by two or more persons

- like a proprietorship in most cases expect that there are more than one owner involve

- partnership agreement which may either be oral or in writing sets forth terms such as initial investment, duties of each partner, division of profit (or loss) and

settlement to be made upon death or withdrawal of a partner

- each partner has unlimited personal liability for the debts of the partnership - partnership affairs must be kept separate from the personal activities of the

partners

- often used to organize retail and service-type business, including professional practices

Company/Corporation – business organized as a separate legal entity under the corporation law and having ownership divided into transferable shares

- shareholders enjoy limited liability or they are not personally liable for the debts of the company

- shareholders may transfer all or part of their shares to other investors at any time - ease with ownership

- has unlimited life since the ownership may be transferred without dissolving the company

1.6 Basic Professional Values and Business Ethics

Ethics – standards of conduct which encompasses principles such as: a. acting in the public interest

b. acting with integrity (i.e. with honesty, fairness and sincerity) c. avoiding conflicts of interest

d. independence

e. respect for confidentiality

f. maintaining technical competence g. acting with due care

h. behaving ethically II. Measuring and Reporting Financial Position

2.1 Nature and Forms of Statement of Financial Position Statement of Financial Position presents:

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Current Assets – cash and other resources that are reasonably expected to be realized in cash or sold or consumed in the business within 1 year of the reporting date or the business operating cycle - is the average time that is required to go from cash to cash in producing revenue – whichever is longer

- Important in assessing the business’s short-term dept-paying ability

Financial Assets – cash and accounts receivables are example of these. Financial Assets may also be:

a. Current

b. Non-Current – are long-term assets and are given meaningful descriptions, such as:

1. Property, Plant and Equipment – tangible resources of a relatively permanent nature that are used in the business and not intended for sale

2. Intangible Assets – are non-current resources that do not have physical substance and are recorded at cost which is expensed over the useful life of the intangible asset 3. Investment Property – investment of non-current assets

other than financial assets

Current Liabilities – are liabilities that are (1) expected to be settled in the business’ operating cycle, (2) held primarily for the purpose of trading, (3) due and to be settled within 12 month after the end of the reporting period. Liabilities are also current when the entity does not have an unconditional right to defer settlement of the liability for at least 12 months after the reporting period

Non-Current Liabilities – obligations expected to be paid after 1 year or after an operating cycle

Owner’s Equity/Capital – this varies with the form of business entity. a. Proprietorship: one capital account

b. Partnership: capital for each partner

c. Company: divided into three accounts which when combined comprise the shareholders’ equity

1. Share Capital – investment of assets

2. Reserves – increases in equity from sources other than contributed capital from the owners and retained earnings

3. Retained Earnings – profit retained for the use in the company

Presentation of Financial Statements, as prescribed by the IAS that must at least include the following line items: (a) property, plant and equipment, (b) investment property, (c) intangible assets, (d) financial assets, (e) investments accounted for using equity

method, (f) biological assets, (g) inventories, (h) trade and other receivables, (i) cash and cash equivalents, (j) the total assets classified as held for sale, and assets included in disposal groups classified as held for sale, (k) trade and other payables, (l) provisions,

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(m) financial liabilities, (n) liabilities and assets for current tax, (o) deferred tax liabilities and deferred tax assets, (p) liabilities included in disposal groups classified as held for sale, (q) minority interest, presented within the equity and (r) issued capital and reserves attributable to owners of the parent may be presented in either:

2.1.1 Report Form – assets are presented above the liabilities and equity 2.1.2 Account Form – assets and liabilities and equity are presented side by side

with assets at the left and liabilities and equity at the right 2.2 Related Accounting Concepts/Principles

2.2.1 Entity – activities of the company be kept separate and distinct from the activities of the owner

2.2.2 Monetary – only transaction data that can be expressed in terms of money may be included in the accounting records

2.2.3 Cost – assets should be recorded at cost – the value exchange at the time something is acquired

Market (or Fair) Value – value determined by the market at the time 2.2.4 Objectivity or Reliability - information is free of error and bias

2.2.5 Going Concern – assumes that the entity will continue in operation long enough to carry out its existing objectives

2.2.6 Materiality – relates to an item’s impact on an entity’s overall financial condition and operations

- an item is said to be material when it is likely to influence user’s decisions

2.2.7 Disclosure – circumstances and events that make a difference to financial statement users be disclosed

2.3 Accounting Equation

The two basic elements of a business are what it owns and what it owes. Assets – resources controlled by an entity

Liabilities – claims against assets or existing debts and obligations Owner’s Equity – ownership claim on total assets

At all times, Assets of the entity MUST equal to its Liabilities and Owner’s Equity (Capital) – A=L+C

2.4 Transactional Analysis: Assets, Liabilities and Owner’s Equity

Transactions – are the economic events of an entity that are recorded, which may be identified as external – entity and some outside entity, or internal – within one entity 2.5 Preparation of Statement of Financial Position

III. Measuring and Reporting Financial Performance 3.1 Nature and Forms of Income Statement

3.1.1 Natural Form – format where expenses are classified according to the nature of expense

3.1.2 Functional Form – expenses are subdivided into:

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d. Administrative Expenses (General Expenses) – general operating activities

e. Finance Cost – associated with the financing of the business’ operations and debt collection

f. Other Expense 3.2 Related Accounting Concepts/Principles

3.2.1 Time Period – division of economic life of a business into artificial time periods

d. Interim Periods – monthly and quarterly time periods e. Annual Basis

1. Financial (or Fiscal) Year – starts months between January and December

2. Calendar Year – starts January

3.2.2 Income Recognition – revenue be recognized in the accounting period when an increase in future economic benefits has occurred

3.2.3 Matching or Expense Recognition – expenses be recognized in the accounting period when a decrease in future economic benefits has occurred

3.2.4 Accrual – determine profits means recognizing revenue when earned rather when cash is received and recognizing expenses when incurred rather than when paid

3.2.5 Consistency – entity uses the same accounting principles

3.2.6 Conservatism (Prudence) – not overstating assets and income and understating liabilities and expenses

3.2.7 Disclosure

3.3 Expanded Accounting Equation

Assets = Liabilities + Owner’s Capital - Owner’s Drawings + Revenue - Expenses 3.4 Transactional Analysis: Revenues and Expenses

3.5 Preparation of Natural Form Income Statement IV. Measuring and Reporting Changes in Equity

4.1 Nature and Form of Statement of Changes in Owner’s Equity 4.2 Transaction Analysis: Investments, Withdrawals, Net Income (Loss) 4.3 Preparation of Statement of Changes in Owner’s Equity

V. Measuring and Reporting Cash Flows

5.1 Nature and Forms of Statement of Cash Flows

Statement of Cash Flows – which helps creditors and investors to assess (a) the entity’s ability to generate future cash flows, (b) ability to pay dividends and meet obligations, (c) the reasons for the difference between profit and net cash provided (used) by operating activities and (d) the cash investing and financing transaction during the period may be presented using two methods:

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5.1.1 Direct Method – provides major classes of gross cash receipts and gross cash payments which are determined from the accounting records of the entity or by adjusting sales, cost of sales and other items in the income statement for:

a. changes during the period in inventories and operating receivables and payables

b. other non-cash items, and

c. other items for which the cash effects are investing or financing cash flows

5.1.2 Indirect Method – net cash from operating activities is determined by adjusting profit for the effect of:

a. changes during the period in inventories and operating receivables and payables

b. non-cash items such as depreciation, provisions, deferred taxes, unrealized foreign currency gains and losses, undistributed profits of associates, and minority interest, and

c. all other items for which the cash effects are investing and financing cash flows

5.2 Components of Statement of Cash Flows 5.2.1 Operating Activities

5.2.2 Investing Activities 5.2.3 Financing Activities

5.3 Preparation of Statement of Cash Flows – Direct Method VI. The Accounting Cycle

6.1 Accounting Cycle and Business Documents Used

Documents – provide evidence that transactions and events have occurred. Examples are:

a. Official Receipts b. Sales Invoice c. Shipping Document d. Check Butt

e. Cash Register Tape

6.2 Analyzing Business Transactions in Terms of Debits and Credits

Account – an individual accounting record of increases and decreases in a specific asset, liability and owner’s equity item.

T-Account – standard shorthand in accounting that helps make clear the effects of transactions on individual accounts.

Debit – indicates left Credit – indicate right

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6.3 Recording of Business Transactions in the Journal

Journal – referred to as book of original entry on which transactions are recorded in chronological order

6.3.1 Rendering of Service, with Output VAT

6.3.2 Purchase of Supplies and Equipment, with Input VAT 6.3.3 Remittance of VAT

6.4 Accounting for Payroll

6.4.1 Definition of Payroll Terms Payroll – pertains to both:

a. Salaries – are paid managerial, administrative and sales personnel b. Wages – are based on a rate per hour or on a piecework basis paid

to sales assistants, factory employees and manual laborers

Bonus – agreements for management personnel and employees which may be based on such factors as increased sales or profit

- may be paid in cash and/or by granting executives and employees to acquire company shares at favorable prices called share option plans 6.4.2 Calculation of Net Pay or Take Home Pay

Net Pay – determined by subtracting payroll deductions from gross earnings – is total remuneration earned by an employee

6.4.3 Payment with Deductions (SSS, Philhealth, PAG-Ibig, Withholding Tax, Advances to Employees)

6.4.4 Subsequent Remittance to Government Agencies of Amount Withheld from Salaries and Corresponding Employer’s Contribution

6.5 Accounting for Promissory Notes

Promissory Note – is a written promise to pay a specified amount of money on demand or at a definite time.

- may be used (a) when individuals and businesses lend or borrow money, (b) when the amount of the transaction and the credit period exceed normal limits or (c) settlement of accounts receivable

- may be transferred to another party by endorsement Issuer – party making the promise to pay

Payee – party to whom payment is made Basic issues in accounting for notes are:

a. recognizing notes b. valuing notes c. selling notes

Honored Note – paid in full at its maturity date

Dishonored Note – not paid in full at maturity and is no longer negotiable

6.5.1 Determination of Maturity Date, Interest, Maturity Value, Discounts and Cash Proceeds

6.5.2 Recording of Transactions Involving Promissory Notes 6.5.2.1 Receipts and Issuance

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6.5.2.2 Collection and Payment at Maturity 6.5.2.3 Dishonor by the Maker

6.5.2.4 Renewal of Note

6.5.2.5 Discounting of Notes Receivable with Recourse (Separate Recording of Interest Expense and Income)

6.5.2.5.1 Honor or Dishonor of Discounted Note 6.5.2.6 Discounting Own Note

6.5.2.6.1 Honor or Dishonor of Discounted Own Note

6.5.2.6.2 Amortization of Discount on Note Payable (Straight-Line Method)

6.6 Posting to the General Ledger (T-Account Form of Ledger)

Ledger – keeps in one place all the information about the changes in specific account balances

Chart of Accounts – lists the accounts and the account numbers that identify their location in the ledger

6.7 Preparing the Trial Balance

Trial Balance – list of accounts and their balances at a given time which is prepared at the end of the accounting period.

6.7.1 Use and Limitations of a Trial Balance Purposes:

a. primary purpose is to prove (check) that the debits and credits are equal after posting

b. may be used to correct errors in journalizing and posting c. useful in preparation of financial statements

Limitations:

a. does not guarantee freedom from recording errors

b. does not prove that all transactions have been recorded or that the ledger is correct

6.7.2 Locating Errors in the Trial Balance Correcting Errors

a. If the error is 1, 10, 100, 1000… re-add and recalculate

b. If the error is divisible by 2, scan trial balance to see whether a balance equal to half the error has been recorded in the wrong column

c. If the error is divisible by 9, retrace the account balances to see whether they have been correctly copied to the ledger. Usually occurs when there’s transposition error – reversing order of numbers

d. If the error is not divisible by 2 or 9…scan everything 6.7.3 Preparing Correcting Entries

Errors should be corrected as soon as they are discovered through correcting entries

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6.7.4 Preparing Corrected Trial Balance

6.8 Journalizing and Posting Year-End Adjustments (Accrual Basis)

Adjusting Entries – are needed to ensure that the revenue and expense recognition principles are followed

6.8.1 Accrued Expenses (Expenses Payable) – expenses incurred but not yet paid 6.8.2 Accrued Income (Receivables) – revenue earned but the yet received in

cash

6.8.3 Prepaid Expenses – expenses paid in cash and recorded as assets before they are used or consumed

6.8.4 Amortization of Discounts of Notes Payable (Straight-Line Method)

6.8.5 Unearned Income – cash received and recorded as liabilities before revenue is earned

6.8.6 Depreciation (Straight-Line Method) – allocation of the cost of an asset to expense over its useful life in a rational and systematic manner and represents the future economic benefit that has been used in the period 6.8.7 Doubtful Accounts (Allowance Method) – estimating receivables not

expected to be collectible at the end of each period

6.8.8 Direct Write-Off Method – when a particular account is determined to be uncollectible and the loss is charged to Bad Debts Expense and the carrying amount of Accounts Receivable is reduced in the Statement of Financial Position

6.8.8.1 Balance Sheet Approach

6.8.8.1.1 Percentage of Accounts Receivable – management estimates what percentage of receivables will result to losses from uncollectible accounts

6.8.8.1.2 Percentage of Sales Method – management estimate what percentage of credit sales will be uncollectible 6.8.8.1.3 Aging of Accounts Receivable – customer balances are

classified by length of time they have been unpaid 6.9 Preparing Financial Statements

6.9.1 Statement of Comprehensive Income 6.9.1.1 Income Statement

6.9.2 Statement of Financial Position 6.9.3 Statement of Changes in Equity 6.9.4 Statement of Cash Flows 6.9.5 Notes to Financial Statements 6.10 Closing the Books

Closing the Books – accounts are made ready for the next period

Temporary or Nominal Accounts – are the accounts that are closed which relate to only given accounting period and they include all income statement and drawing accounts

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Permanent or Real Accounts – relate to one or more future accounting periods and they consist of all statement of financial position accounts which are not closed but rather forwarded to the next accounting period

6.10.1 Journalizing Closing Entries 6.10.2 Posting Closing Entries

6.10.3 Ruling Nominal Accounts and Balancing Real Accounts 6.10.4 Preparing and Post-Closing Trial Balance

Post-Closing Trial Balance – lists of permanent accounts and their balances after closing entries have been journalized and posted

6.11 Journalizing and Posting Reversing Entries

Reversing Entries – made at the beginning of the next accounting period which is the exact opposite of the adjusting entry made in the previous accounting period

ACTBAS2

I. Introduction to Merchandising Business 1.1 Nature and Operating Cycle

Operating cycle of a merchandising business is ordinarily longer than that of a service business

1.2 Business Documents Used

Purchase Invoice – documents that indicates the total purchase price and other relevant information

Sales Invoice – provides support for a credit sale II. Accounting Cycle of a Merchandising Business

2.1 Recording Purchase and Sale of Merchandise in General Journal

2.1.1 Perpetual Inventory System (Gross Method Only) – detailed records of the cost of each inventory purchase and sale are maintained and continually shows the inventory that should be on hand

- cost of sales is determined each time a sale occurs

2.1.2 Periodic Inventory System (Gross Method Only) – detailed inventory records of the goods on hand are not kept throughout the period and the cost of sales is only determined at the end of the accounting period - cost of goods on hand are determined through physical count

- in determining cost of sales (1)determine inventory beginning, (2) add the cost of goods purchased and (3) subtract inventory end

2.1.3 Freight Terms

Freight Cost – cost of delivering goods

Freight-In – considered part of the cost or purchasing inventory Freight-Out – delivery expense

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FOB Shipping Point – goods are placed free on board the carrier by the seller, and the buyer pays the freight cost

FOB Destination – goods are placed free on board to the buyer’s place of business and the seller pays the freight

Collect – the buyer pays Prepaid – the seller pays

2.1.3.1 FOB Shipping Point, Collect – buyer pays

2.1.3.2 FOB Shipping Point, Prepaid – buyer has to pay but the seller pays 2.1.3.3 FOB Destination Point, Collect – seller has to pay but the buyer

pays

2.1.3.4 FOB Destination Point, Prepaid – seller pays 2.1.4 With Value-Added Tax

2.2 Recording Purchase and Disposal of Property, Plant and Equipment

PPE Assets/Fixed Assets – are resources that (1) have physical substance, (2) are used in the operations of the business and (3) are not intended for sale to customers

- are expected to provide services to the entity for a number or years

- with exception of land, PPE Assets decline in service potential over their useful lives Cost – consists of all expenditures necessary to acquire the asset and make it ready for its intended use, including import duties and non-refundable taxes after deducting trade discounts and rebates

Useful Life/Service Life – is an estimate of the assets expected productive life which may be expressed in terms of (1) time period over which the asset is expected to be available for use or (2) the number of units of production or the output expected to be obtained from the asset

Residual Value – the current estimate of the asset’s disposal value, net of disposal costs, if the asset is already of the age and in the condition expected at the end of its useful life

Carrying Amount – cost of the PPE less its accumulated depreciation Depreciable Cost – is the cost of the asset less its residual value

Depreciation – is the allocation of the depreciable amount of PPE to expense over its useful life which may be calculated using the following methods:

a. Straight-line Method – depreciation is the same for each year of the asset’s useful life and is measured solely by the passage of time b. Units-of-Activity or Production Method – useful life is expressed in

terms of total units of production or expected from asset, rather than as time period

c. Reducing-Balance/Accelerated-Depreciation Method – produces a decreasing annual depreciation expense over the asset’s useful life 2.2.1 Revenue vs. Capital Expenditures

Capital Expenditures – addition and improvements incurred to increase the operating efficiency, productive capacity or useful life of a PPE which are usually material in amount and occur infrequently

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Revenue Expenditures – are expenditures during useful life or the costs incur for ordinary repairs, additions or improvements with the purpose of maintaining the operating efficiency and productive life of the PPE Asset 2.2.2 Journal Entries Related to Purchase (Net Method)

2.2.3 Disposal of Property, Plant and Equipment through Sale

In a disposal by sale, the carrying amount of the asset is compared with the net proceeds received from the sale

Gain on Disposal – occurs if the net proceeds of the sale exceed the carrying amount of the PPE and is reported as income on the income statement Loss on Disposal – occurs if the net proceeds of the sale are less than the carrying amount of the PPE and is reported on the income statement among expense items

2.3 Preparing Functional-Form Income Statement (Including Computation of Missing Amounts)

Income Statement begins by presenting Sales Revenue. The contra revenue accounts Sales Returns and Allowances and Sales Discounts are deducted from Sales to arrive at Net Sales

Gross Profit – the difference of sales over cost of sales which represents the inventory profit of a business

Other Income – revenue items other than sales revenue

Other Expenses – are the third component in measuring profit for a retailer 2.4 Recording of Business Transactions using Special Journals and the General Journal

Special Journal – is used to record similar types of transactions

2.4.1 Sales Journal – used to record sales of inventory on account Steps:

a. journalizing credit sales b. posting the sales journal c. proving the ledgers

1. the total of the general ledger debit balances must equal the total of the general ledger credit balances

2. the sum of the subsidiary ledger balances must equal the balance in the control account Advantages include:

a. one-line entry for each sales transaction saves time because it is not necessary to write out the four account titles for each transaction

b. only totals, rather than individual entries, are posted to the general ledger which saves posting

c. division of labor because one individual can takes responsibility for the sales journal

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Steps:

a. journalizing cash receipts transactions b. posting the cash receipts journal c. proving the ledgers

2.4.3 Purchase Journal – used to record all purchases on inventory on account Steps:

a. journalizing credit purchases of inventory b. posting the purchase journal

c. expanding the purchases journal

2.4.4 Cash Payments Journal – used to record all payments of cash Steps:

a. journalizing cash payments transactions b. posting the cash payments journal

2.4.5 General Journal - is used if a transaction cannot be recorded in a special journal

- includes credit sales of assets other than inventory and other types of purchases on account

- may be used to record such transactions as granting credit to a customers for a sales return or allowance, granting or to record such transactions as granting credit to a customers for a sales return or allowance, granting of credit from a supplier for purchases returned, acceptance of note receivable from a customer and purchase of equipment by issuing note payable

- also used for correcting, adjusting and closing entries

2.5 Posting from the General and Special Journals to the General and Subsidiary Ledgers Subsidiary Ledger – is a group of accounts with a common characteristics

Advantages:

a. show transactions affecting one customer or one creditor in a single

account, thus providing up-to-date information on specific account balances b. free the general ledger of excessive details resulting to the trial balance of

the general ledger to not contain vast numbers of individual account balances

c. help locate errors in individual accounts by reducing the number of accounts in one ledger and by using control accounts

d. make possible a division of labor in posting

2.5.1 Accounts Receivable/Customer Subsidiary Ledger – which collects transaction data of individual customers

2.5.2 Accounts Payable/Creditor Subsidiary Ledger – which collects transaction data of individual creditors

2.5.3 General Leger/Control Account – summarizes the subsidiary ledger 2.6 Preparing Scheduled of Accounts Receivable and Payable

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2.8 Completion of the Accounting Cycle

2.8.1 Journalizing and Posting Year-End Adjustments (Accrual Basis) 2.8.1.1 Review: Accrued Expenses

2.8.1.2 Review: Accrued Revenues 2.8.1.3 Review: Prepaid Expenses 2.8.1.4 Review: Unearned Income 2.8.1.5 Review: Amortization of Discount 2.8.1.6 Depreciation (Straight-Line Method) 2.8.1.7 Doubtful Accounts (Allowance Method)

2.8.1.7.1 Estimation: Balance Sheet Approach 2.8.1.7.2 Write-off and Recovery

Write-off

- bad debts is not increased when the write-off occurs using the Allowance Method

- write-off only affects the Statement of Financial Position accounts and not the Income Statement Recovery

- two entries are required to record the recovery of a receivable written-off: (1) the entry made in writing off the account is reversed to reinstate the

customer’s account and (2) the collection is journalized in the usual manner

2.8.1.8 Merchandise Inventory (Periodic Inventory System) 2.8.2 Bank Reconciliation Statement

- the use of bank account contributes significantly to good internal control over cash

- the asset account Cash maintained by the depositor is the reciprocal of the bank’s liability account for each depositor and it should be possible that these accounts agree at any time

Bank Statement – shows the depositor’s bank transactions and balances. It shows:

a. checks paid and other debits and transfers that reduce the balance in the depositor’s accounts

b. deposits and other credits and transfers the increase the balance in the depositor’s account

c. the account balance after each day’s transactions

Check – a written order signed by the depositor directing the back to pay a specified sum of money to a designated recipient

2.8.2.1 Preparing a Simple Bank Reconciliation Statement (Adjusted Balance Method)

Reconciling Items of the Depositor: a. Direct Debits

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1. Bank Fee - monthly fee charged by bank for its services

2. Dishonored Check/Bouncing Check- a deposit check from customer which bounces because of insufficient fund b. Direct Credits

1. Notes Receivables collected by bank in behalf of the depositor

c. Transfers

1. Transfers from Electronic Fund Transfer (EFT) – are payment systems that use wire, telephone or internet to transfer cash from one location to another

d. Errors

Reconciling Items of the Bank

a. Outstanding Deposits – deposits recorded by the depositor that have not been recorded by the bank

b. Unpresented Checks – issued checks recorded by the business that have not been presented by the recipient to the bank for payment

c. Errors

2.8.2.2 Recording Adjusting Entries for Reconciling Items 2.8.3 Preparing a Work Sheet

2.8.4 Preparing Financial Statement

2.8.4.1 Functional-Form Income Statement

2.8.4.2 Report-Form Statement of Financial Position 2.8.4.3 Statement of Changes in Equity

2.8.4.4 Direct-Method Statement of Cash Flows 2.8.4.5 Notes to Financial Statements

2.8.5 Journalizing and Posting Closing Entries 2.8.6 Preparing Post-Closing Trial Balance 2.8.7 Journalizing and Posting Reversing Entries 2.9 Introduction to Voucher System

Voucher System – is a network of approvals by authorized individuals acting independently to ensure that all payment by check are proper

Voucher – is an authorization from prepared for each expenditure and is required for all types of cash payments except those from petty cash fund

2.10 Establishment and Replenishment of Petty Cash Fund under the Imprest System Petty Cash Fund – is a cash fund used to pay relatively small amount but still satisfactory control

Imprest System – operation of petty cash fund which involves three steps: a. establishing the fund

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3. appointing a petty cash custodian/cashier 4. determining the size of the fund

b. making payments from fund c. replenishing the fund

ACTPACO

I. Introduction to Partnership as a Business Organization 1.1 Forms of Business Organization

1.2 Definition and Special Features of a Partnership

Partnership – is an association of two or more persons carrying on a business in common with a view to making a profit

- each partner is required to have his or her own capital account Characteristics of Partnership:

a. Association of Individuals – easy formation because two or more individuals may form a partnership by a simple act as a handshake b. Mutual Agency – each partner may act in behalf of the partnership when

engaging in partnership business

c. Limited Life – it may be ended voluntarily at any time through acceptance of a new partner or the withdrawal of a partner and/or death or incapacity of a partner

d. Unlimited Liability – each partner is personally and individually liable for all partnership liabilities

e. Co-Ownership of Property – partnership assets are owned jointly by the partners. If the partnership is dissolved, the assets do not legally revert to the original contributor. Each partner has a claim on total assets equal to the balance in his or her respective capital account

f. Co-Ownership of Profit (or Loss) – if the partnership contract does not specify to the contrary, all profit or loss is shared equally by the partners 1.3 Kinds of Partnership and Kinds of Partners

Kinds of Partnership:

a. Limited Partnership – one or more partners have unlimited liability and one or more partners have limited liability for the debts of the business

b. Incorporated Limited Partnership – is a special type of partnership primarily used for people engaged in high-risk venture-capital projects

Kinds of Partners:

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b. Limited Partners/Special Partners/Sleeping Partners – are responsible for the debts of the partnership up to the limit of their investment in the business

1.4 Advantages and Disadvantages of a Partnership Advantages:

a. combining skills and resources of two or more individuals b. ease of formation

c. not subject to as much government regulation as companies d. ease of decision making

e. no taxation or partnership profits Disadvantages:

a. mutual agency b. limited life c. unlimited liability

d. partners must be able to work together II. Accounting for Partnership Formation

2.1 Opening Entries of a Partnership upon Formation 2.1.1 Organization of a New Partnership

Each partner’s initial investment in a partnership is entered in the

partnership records. These investments should be recorded at the fair value of the assets at the date of their transfer to the partnership – that is, the fair market value at the time the partnership is formed

2.1.2 Conversion of Sole Proprietorship(s) into a Partnership using New Set of Books

III. Accounting for Division of Profits and Losses 3.1 Methods of Dividing Profits and Losses

Partnership profit or loss is shared equally unless the partnership contract or partnership agreement indicates otherwise or the Profit-and-Loss Ratio – used to identify the basis for dividing profit and loss

3.2 Accounting for Interest on Capital Balances, Salary Allowance, and Bonuses as Part of Profit Distribution

Salaries to partners and interest on partners’ capital are not expenses of the partnership Salaries Expense – pertains to the cost of services performed by employees

Interest Expense – relates to the cost of borrowing from creditors

Partners, as owners of the business, are not considered either employees or creditors, thus salary to partners and interest on partners’ capital do not enter into the

determination of profit or loss 3.3 Preparation of Financial Statements

The financial statements of a partnership are similar to those of a proprietorship. The only difference is due to the number of owners involved

Statement of Changes in Partnership’s Equity – used to explain the changes in each partner’s capital or current account and in total partnership equity during the year

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IV. Partnership Dissolution without Liquidation 4.1 Distinction between Dissolution and Liquidation

Partnership Dissolution – occurs whenever a partner withdraws or a new partner is admitted but does not necessarily mean that then business ends

Partnership Liquidation – ends the economic life of the entity 4.2 Accounting for Admission of New Partner(s) using Bonus Method

Admission of new partner results in the dissolution of the existing partnership and the beginning of a new one

The new partner may be admitted either by:

a. Purchasing the Interest of an Existing Partner – personal transaction between one or more existing partners and the new partner

b. Investing Assets in the Partnership – is transaction between the

partnership and the new partner which increases both the net assets and total equity of the partnership

Bonus to Old Partners – results when the new partner’s investment in the partnership is greater than the capital credit on the date of admittance

Bonus to New Partner – results when the new partner’s investment in the business is less than his or her capital credit

4.3 Withdrawal or Retirement of a Partner

A partner may withdraw from the partnership voluntarily be selling his or her equity in the partnership. He or she may also withdraw involuntarily by reaching mandatory retirement age or by dying. Like admission of new partner, withdrawal also dissolves existing partnership

Withdrawal may be accomplished by:

4.3.1 Purchase of Interest by Other Partners or by an Outsider – is a personal transaction between partners

4.3.2 Settlement of Interest by the Partnership – is a transaction that involves the partnership

Bonus to Retiring Partner – may be paid to a retiring partner when (1) there is

unrecorded goodwill resulting from the partnership’s superior earnings record and (2) the remaining partners are anxious to remove the partner from the partnership Bonus to Remaining Partners – the retiring partner may give bonus to the remaining partner when (1) the partnership has a poor earnings record and (2) the partner is anxious to leave the partnership

V. Partnership Dissolution with Liquidation: General Partnership 5.1 Introduction to the Two Kinds of Liquidation

5.1.1 Lump-Sum Method 5.1.2 Installment Method

5.2 Accounting for the Liquidation of a General Partnership under the Lump-Sum Method To liquidate partnership, it is necessary to:

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b. allocate gain/loss on realization to the partners based on their profit-and-loss ratio

c. pay partnership liabilities in cash

d. distribute remaining cash to partners on basis of their capital balances No Capital Deficiency – when a partnership is liquidated and all partners have credit balances in their capital accounts

Capital Deficiency – at least one partner’s capital account has a debit balance

5.2.1 Deficient Partner is Solvent – the partner with capital deficiency pays the amount owed to the partnership

5.2.2 Deficient Partner is Insolvent – the partner with capital deficiency is unable to pay the amount owed to the partnership thus the partners with credit balances absorb the loss or the deficiency

5.3 Accounting for the Liquidation of a General Partnership under the Installment Method 5.3.1 Preparation of Schedule of Safe Payments

Schedule of Cash Payments – is used to determine the distribution of cash to the partners in liquidation of partnership

VI. Accounting for Corporate Formation and Operation 6.1 Introduction to Corporation

6.1.1 Definition of a Corporation

Company/Corporation – is a legal entity that has most of the rights and privileges of a person such as:

a. the right to vote

b. the right to hold public office

- is subject to the same duties and responsibilities as a person - it may be classified by:

a. Purpose 1. Profit 2. Non-profit b. Ownership

1. Publicly Held Company – may have thousands of shareholders

2. Privately Held Company – often referred to as a proprietary limited company, usually has only few shareholders

Company Constitution – regulates company’s internal management

Preliminary Expenses – costs incurred in the formation of a company which are capitalized as the definition of an asset since it is expected to provide future economic benefits to the entity

Preference Shares – have contractual provisions that give them preference or priority over ordinary shares in certain areas as (1) distribution of profits (dividends), (2) assets in the event of liquidation

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a. vote in the election of BOD

b. share the company’s profits through receipt of dividends

c. Preemptive Right – keep the same percentage ownership when new shares are issued

d. Residual Claim – share in assets upon liquidation in proportion to their holdings

Shareholders Certificate/Stock Certificate – proof of share ownership Issued Shares – shares on the hands of the shareholders

Par Value – arbitrary amount assigned to each share

Share Capital – total amount of cash and other assets paid in to the company by shareholders

Retained Earnings – profit retained in a company

Issue Price – the price that the company receives from the issue of shares

Forfeited Shares/Treasury Shares – shares lost by a person due to failure to pay his or her share when the call is due, which may later be re-issued

Prior-Period Error – corrected by reinstating comparative amounts and opening retained earnings as soon as the error has been discovered

6.1.2 Characteristics of a Corporate Form of Business Organization

Separate Legal Entity – the company acts under its own name rather that in the name of its shareholders

No Mutual Agency – acts of shareholders do not bind the company unless such shareholders are duly appointed agents of the corporation

Limited Liability of Shareholders – creditors have recourse only to the company assets to satisfy their claim because the liability of the shareholders is normally limited to their investments in the company Transferable Ownership Rights – ownership of a company is held in shares which are transferable units

Ability to Acquire Capital – easy to obtain capital through the issue of shares

Continuous Life – its continuance as a going concern is not affected by the withdrawal, death or incapacity of a shareholder, employee or senior executive

Separation of Ownership and Management – the owners who are the shareholders of the company are not the same ones who manage it rather, it is the Board of Directors (BOD) who does

Government Regulations – subject to numerous state and federal regulations

Company Taxation – owner’s share of profits from corporations is reported on his or her personal income tax return

6.1.3 Distinction between Partnership and Corporation 6.1.4 Types of Corporation

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6.1.6 Definition of Terms VII. Accounting for Share Capital Transactions

7.1 Accounting for Par Value Shares 7.1.1 Journal Entry Method 7.1.2 Memorandum Method

7.2 Accounting for Preference Shares and Ordinary Shares 7.3 Accounting for No-Par Value Shares

7.4 Incorporating a Partnership 7.5 Accounting for Delinquent Shares 7.6 Accounting for Treasury Share

7.6.1 Reacquired through Purchase

7.6.2 Reacquired through Donation (Memo Entry)

7.6.3 Subsequent Sale At Cost, Below Cost, or Above Cost 7.7 Shareholders’ Equity Presentation – Contributed Capital

VIII. Accounting for Accumulated Profits/Loss (Retained Earnings) 8.1 Definition of Retained Earnings

8.2 Appropriation from Retained Earnings for Legal, Contractual or Voluntary Reasons Retained Earnings Restrictions – are portion of the retained earnings balance currently unavailable for dividends due to the following causes:

a. Contractual – the restriction that limits the use of company assets for payment of dividends

b. Voluntary – made voluntarily for specific purposes 8.3 Kinds of Dividends

Dividend – distribution by a company to its shareholders on a pro rata (proportional) basis which can take four forms:

a. Cash – pro rata distribution of cash to shareholders For a company to pay cash dividend, it must have:

1. Retained Earnings 2. Adequate Cash

3. A Declaration of Dividends b. Property

c. Scrip – a promissory note to pay cash

d. Shares/Bonus Shares – pro rata distribution to shareholders of the company’s own shares

- may be expressed in two ways as (1) as a percentage of the stated value of the share or (2) as dollar (peso) amount per share

8.4 Accounting for Cash and Bonus Issue – upon Declaration and Distribution of Dividends Declaration Date – when the company formally declares the cash dividend and announces it to the shareholders

Record Date – when ownership of the issued shares is determined for dividend purposes

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8.5 Preparation of Statement of Changes in Shareholders’ Equity IX. Special Topics

9.1 Book Value Per Share

Figure

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References