Qualifying Exam Reviewer 2

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Prepared by:

Laron Yvette Vicente de Ocampo



Bookkeeping and Accounting Distinguished

Bookkeeping – a procedural element of accounting which primarily deals with the systematic method of recording and classifying financial transaction of business

Accounting – as defined by the American Institute of Certified Public Accountants (AICPA), is the art or recording, classifying and summarizing in a significant manner and in terms of money, transactions and events that are, in part at least, of a financial character, and interpreting the results thereof

 as defined by the Philippine Institute of Certified Public Accountants, is a system that measures business activities, processes given information into reports, and communicates those findings to decision-makers

Accounting as the “Language of Business”

Accounting is often referred to as the language of business because it is the medium of communication between a business firm and various parties interested in its financial activities by providing quantitative financial information through financial statements.

Major information needed is as follow:

Financial Condition or Position – amount and kinds of its assets and liabilities

Financial Performance or Results of Operations – whether the operating activities of the business resulted to net income or net loss

Financing and Investing Activities – sources and applications of fund which are responsible for the changes in the financial resources of the business during a given period of time


Brief History of Accounting

The development of accounting is a result of Italian merchants’ needs of information. In that commercial climate, Luca Pacioli published the first known description of double-entry bookkeeping entitled Summa de Arithmetica, Geometria, Proportioni et Proportionalite (Everything about Arithmetic, Geometry and Proportion) published in Venice in November 1494.

The pace of accounting development increased during the Industrial Revolution as the economics of developed countries began to mass-produce goods. Merchandise was price-based on managers’ hunches about cost until competition required merchants to adopt more sophisticated accounting system.

The growth of corporation during the 19th century spurred the development of accounting. Corporate owners were no longer necessary the managers of their business. Managers then, had to create accounting systems to report to the owners the status of the business.

Accounting supplied the concept of income. When the government started using the income tax, it further helped accounting develop. Also, government at all levels has assumed expanded roles in health, education, labor and economics planning. To ensure that the information that it uses to make decisions is reliable, the government has required strict accountability in the business community.

At the beginning of third millennium, there would still be a lot of developments in the field of

accounting. The great challenge of globalization and the effects of new technologies pose a shift in the structure and pattern in this field. More and better information are now being required and therefore, accounting, being the means in communicating business and financial information must also evolve into a more efficient level.

Users of Financial Statements

Internal Users – those who are directly involve in the business

Owners – those who provide the money/capital in the business who would need accounting information to properly manage and monitor the business and analyze whether or not they can expect reasonable return from their investment

Management – uses accounting information to set goals for the organization, to evaluate the progress made toward those goals and to take corrective actions if necessary

Employees – uses accounting information to assess the ability of the enterprise to compensate for the services, industry or labor they are contributing to the business, to provide retirement benefits and other employee opportunities and benefits

External Users – those who are indirectly involved in the business

Potential Investors – use accounting information to evaluate what income they can reasonably expect from their investment


Creditors – use accounting information to determine the business’ ability to meet scheduled payments

Customers – use accounting information to know whether the business will continue operating especially when they have long-term involvement with, or are dependent on that company’s offerings of either services or goods

Taxing Authorities – use accounting information to determine the amount of tax that should be charged to the business

Government Regulation Agencies – use accounting information to determine regulatory activities to be imposed to the business

Nonprofit Organization – use accounting information the same way the profit-oriented businesses do

Other Users – use accounting information to know that amount of income the company is earning

Forms of Business Organization

According to Ownership – business is classified based on owner/s investing or putting capital on a business being started

Sole or Single Proprietorship – only one person makes the investment

Partnership – two or more persons, who are therefore called partners, agree to operate the business

Corporation – a body formed and authorized by law to act as a single person although

constituted by one or more persons, called the stockholders/shareholders, and legally endowed with various rights and duties

According to Operations of Activity – business is classified based on the nature of its activities Service Concern – rendering of services for a fee

Merchandising or Trading Concern – buying and selling of goods

Manufacturing Concern – processing of products or conversion of raw materials into finished goods that are then sold

Basic Accounting Concepts

Generally Accepted Accounting Principles (GAAP) – are concepts which are developed by the accounting profession over the years to serve as ground rules that govern how accountants measure, process and communicates financial information and to provide a consistent system of financial reporting in a constantly changing business environment

Entity Concept – business is regarded as having a separate and distinct personality from that of the owner/s – generating its own revenue, incurring its own expenses, owning its own assets and owing its own liabilities thus, personal transactions of the owner/s must not be combined with the transaction of the business


- Business Transactions – events that can be measured in terms of money that affects the enterprise

Monetary Concept – money is used as the unit of measure in preparing various financial reports of the company

- Stable Money Concept – assumes that monetary unit does not change overtime, even if in fact it does

Time Period/Periodicity Concept – divides the life of the business into regular intervals at the of which financial statements are prepared (usually one year)

- Calendar Year – a twelve-month period beginning with January 1 and ending December 31 - Fiscal Year – does not start with January 1 and end on December 31

Revenue Realization Concept – income is recognized when earned regardless whether cash is received as long as it meets the following conditions:

 when services are fully rendered

 when goods or merchandise are fully delivered

- Income – is the inflow of assets that results from producing goods or rendering services Accrual Concept – income be recorded when earned regardless whether cash is received and an

expense be recognized when incurred

Accrual Method of Accounting – attempts to record the financial effects on a company of transactions and other events and circumstances in the periods in which those transactions, events and circumstances occur rather that only the periods in which cash is received or paid by the firm

Cash Basis – records a journal entry upon exchange of cash, typically does not require many adjusting entries

Matching Concept – all expenses incurred to generate revenues must be recorded in the same period that the income are recorded to properly determine net income or net loss of the period Revenues – inflows of resources from providing goods or services to customers

Expenses – outflows of resources incurred in generating revenue

Objectivity/Reliability Concept – all transactions must be evidenced by business documents free from personal biases and independent experts can verify reports

Cost Concept – assets are acquired in business transactions conducted at arm’s length

transactions – transactions between a buyer and a seller at a fair value prevailing at the time of the transaction

Going Concern Concept – assumes that the business is to continue its operations indefinitely meaning, the business will stay in operation for a period of time sufficient to carry out contemplated operations, contracts and commitments

Conservatism Concept – assumes that when uncertainty exists, the users of financial statements are better served by understatement than by overstatement of net income and assets

Consistency Concept – states that once a method is adopted, it must not be changed from year to year to allow comparability of financial statements between years and between businesses Materiality Concept – refers to relative importance of an item or event


Material – if knowledge of it would influence the decision of prudent users of financial statements

Disclosure Concept – all relevant and material event affecting the financial condition/position of a business and the results of its operations must be communicated to users of financial

statements in variety of ways:

 Parenthetical Comments/Modifying Comments - placed on the face of the financial statements

 Disclosure Notes – conveying additional insights about company operations, accounting principles, contractual agreements and pending litigation

 Supplemental Financial Statements – report more detailed information that is shown in the primary financial statements

The Accounting Profession

Public Accountants – are those who serve the general public and collect professional fees for their work Private Accountants – work for a single business

Certified Public Accountants (CPA) – professional accountant who earns his title through a combination of education, qualifying experience and an acceptance score in the written national examination given by the Board of Accountancy – prepares grades and gives results of the examination to the Professional Regulation Commission (PRC) – who then issues licenses that allow qualifying examinees to practice accounting as CPAs

Ethical Values – provide foundation on which civilized society exists whose purpose in the business world is to direct business men and women to abide by a code of conduct that facilitates public confidence in their products and services

 Honesty  Integrity  Promise-keeping  Fidelity  Fairness  Caring

 Respect for Others  Responsible Citizenship  Pursuit of Excellence  Accountability



Forms of Statement of Financial Position

Statement of Financial Position – shows what the business is worth in terms of the properties it owns, the debts it owes and the investment of its owners

Account Form – assets are listed on the left side of the report and the liabilities and proprietorship on the right side

Report Form – shows assets on the tope section of the statement and the liabilities and owner’s equity on the bottom section

Parts of the Statement of Financial Position

Statement Heading – name of the business, kind of statement and the date Asset, Liability and Proprietorship – special captions on which items are grouped Captions – classifications of each group appearing on the left margin of the statement Account Titles – individual account titles are indented

Current Assets – listed in order of their liquidity

Plant, Property, Equipment – listed in order of their expected useful life

Note (#) – explaining in detail the aggregated amount presented on the face of the financial statement Current Liabilities – listed in order of due date with the earliest due date appearing first

Captions Indicating Totals – group of items which is indented further Single Rule Line – last figure in each group

Final Totals – double ruled

Peso Sign – are used (a) to the left of the first amount of a group of amounts being combi

ned and (b)

to the left of each final total

Peso Amount – shown in one column

The Accounting Equation

Total Assets of the business is exactly equal in amount to the sum of the Total Liabilities and the Capital ASSETS = LIABILITIES + OWNER’S EQUITY


Assets – includes anything owned or possessed by the business which represents the resources of the business

Current Assets  Cash

 Investment in Trading Securities  Notes Receivable  Interest Receivable  Accounts Receivable  Advances to Employees  Merchandise Inventory  Accrued Income  Supplies on Hand  Prepaid Insurance  Prepaid Rent  Non-Current Assets  Land  Building  Equipment

 Furniture and Fixtures  Accumulated Depreciation

Liabilities – economic obligations payable to an individual or an organization outside the business Current Liabilities  Accounts Payable  Notes Payable  Interest Payable  Deferred Income  Taxes Payable  Non-Current Liabilities

 Notes Payable Long Term  Installment Contracts Payable  Mortgage Payable

Owner’s Equity – claim of an owner of a business over the assets of the business after the claims of the creditors have been satisfied

 Capital  Withdrawal



Forms of Income Statement

Income Statement – summary of the results of business operations covered in an interval known as the accounting period, which shows whether or not the business achieved its primary objective of earning profit or net income

Natural Form – arranges all income accounts in one group, all expense accounts in another group and then deducts the total expenses from the total income in a single-step operation of subtraction to arrive at the final result of net income or net loss

Functional Form – clearly shows specific sections of income, costs and expenses in a series of arithmetic operations and requires that cost of goods sold and expenses be subtracted in steps to arrive at the net income

Income Accounts

Service Income – income from services rendered

Other Income – refers to income from sources other than the principal line of activity of the business Interest Income – revenue to the payee for loaning out a principal amount to a borrower Dividend Income – income earned in investing cash in stocks of other businesses

Expense Accounts

Salaries – cost of services rendered by employees Rent – rental cost of office space, equipment, etc

Office Supplies – refers to the cost of office supplies used

Utilities – refers to the cost of light, water and telephone facilities used

Taxes and Licenses – refers to all payments required to be made to the Bureau of Internal Revenue Transportation – cost incurred by office employees when commuting from the office to the place of the business of clients

Traveling – used when business trips are made out of town Gas and Oil – refers to the cost of gas and oil consumed

Representation – cost incurred when entertaining clients or prospective clients Depreciation – refers to the expense associated with the use of the company’s PPE


Bad Debts – allocation or provision for this future uncollectibility of some of the accounts of credit customers

Donations and Contributions – refers to the contribution made to charitable institutions or any other worthwhile projects

Miscellaneous – any other costs of operations that may not be sufficiently big in amount to be classified separately are charged to this account


Statement of Changes in Owner’s Equity/Capital Statement – presents a summary of the changes that occurred in the owner’s equity of the entity during a specific time period

 opens with the owner’s capital balance at the beginning of the period, add net income (deduct in case of net loss), add additional investment, subtract withdrawals and the statement ends with owner’s capital balance at the end of the period

Withdrawals – withdraw assets for personal use

Temporary Withdrawal – withdraw business assets for personal use in anticipation of profits Permanent Withdrawal – capital withdrawal that is substantial in amount wherein the owner

intends to remove the assets permanently from the business operations


Forms of Statement of Cash Flows

Statement of Cash Flows – reports the firm’s receipt and disbursement of cash which are classified according to the company’s major activities:

Operating – cash effects of revenue and expense transactions

Investing – relating to investing activities involving plant assets, intangible assets and investments

Financing – result from debt and financing activities

Direct Method – list the receipts of cash from specific operating, investing and financing activities Indirect Method – normally used by companies that employ accrual method rather than cash method in their accounting system

Usefulness of the Statement of Cash Flows

 Company’s ability to produce future cash flows  Firm’s ability to meet current and future obligations


 The reasons for the difference between net income and net cash provided (used) by operating activities

 The cash investing and financing transactions during the period


Recording Salary Expense

Payroll Register – the summary of employees

Net Pay – the remaining cash after deducting the following from the salary:  Social Security System

 Philhealth  PAG-Ibig

 Withholding Income Tax


Promissory Note – an unconditional promise to pay a definite sum of money on demand or at a future date


Maker – person who signs the note

Payee – the person to whom the promise to pay is made Principal Amount – the amount loaned by the payee Interest – the cost of borrowing the principal amount

Interest Period- the period of time during which interest is to be computed

Interest Rate- percentage rate that is multiplied to the principal amount and the term of note Maturity Date – date when payment is due

Maturity Value – sum of principal and interest

Place of Issue – locality where maker executed the note

Typical Transactions

The client receives services of goods and issued promissory note as payment

The client has an outstanding account and wishes to extend the payment of his account A loan is extended to a borrower who issues promissory note

Interest on Note


Interest Bearing – provides payment for interest so that the amount paid at maturity date is the maturity value – principal plus interest

Non-Interest Bearing – does not provide any payment for interest so the amount that would be paid on maturity date is exactly the same as the face value of the note

Discounting a Note Receivable

Discounting a Note Receivable – endorsing a note before maturity during which the payee would receive lesser amount than the maturity value – the price the payee is willing to pay for wanting to receive cash earlier

Endorsing may either be:

With Recourse – there is a contingent liability on the part of the endorser (payee), which is equal to the maturity value plus any protest fee, in any case that the bank does not collect any payment from the payer or maker of the note

Without Recourse – words “Without Recourse” must appear at the back of the note - exempts the endorser for any contingent liability

Contingent Liability may be presented in the Statement of Financial Position as:  Contingent Liability on the Liability side

 Deduction from Notes Receivable

 Footnote to the Statement of Financial Position with the Notes Receivable reported at net amount

 Parenthetical Note in the Notes to the Financial Statements

Discounting Own Note Issued

Discounting Own Note – creditor would collect interest the same day the loan was granted


Accounting Cycle – a series of sequential steps done every accounting period

Journalizing – chronological recording of business transactions in the journal – book of original entries

Posting to the General Ledger – summary of the journalized accounts in the ledger – book of final entry – which may be posted in two forms:

 Standard Form  Running Balance Form

Chart of Accounts – lists of account titles being used by the business in its operations Preparing Trial Balance – a list of schedule of open accounts in the general ledger with their

corresponding balances


Preparing Worksheet – an optional step in the accounting cycle but greatly aids in preparation of the financial statements

Adjusting Entries – done with the purpose of updating some accounts to prevent their overstatement or understatement

Preparing Financial Statements – the end points of the whole accounting cycle

Closing the Books – done with the purpose of closing all the nominal accounts to the capital Preparing Post-Closing Trial Balance – presents only real accounts which will be carried on to

the next accounting period




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