FAR Quiz #1

I. Introduction to Accounting

Definition of accounting
• Accounting is a process of identifying, recording and communicating economic information that is useful in making economic decisions.

Essential elements of the definition of accounting

1. Identifying – The accountant analyzes each business transaction and identifies whether the transaction is an “accountable event” or “non-
accountable event.” This is because only “accountable events” are recorded in the books of accounts. “Non-accountable events” are not recorded
in the books of accounts.

2. Recording – The accountant recognizes (i.e., records) the “accountable events” he has identified. This process is called “journalizing.” After
journalizing, the accountant then classifies the effects of the event on the “accounts.” This process is called “posting.”

3. Communicating – At the end of each accounting period, the accountant summarizes the information processed in the accounting system in
order to produce meaningful reports.

Nature of accounting
• Accounting is a process with the basic purpose of providing information about economic activities intended to be useful in making economic
decisions.

Types of information provided by accounting

1. Quantitative information
2. Qualitative information
3. Financial information

Functions of Accounting in Business

1. To provide external users with information that is useful in making investment and credit decisions; and
2. To provide internal users with information that is useful in managing the business.

Financial Accounting
General record-keeping. i.e. maintenance or journals and Ledgers.

All businesses use financial accounting in their record keeping. These records provide information that is also used in the other branches of
accounting.

Management Accounting
Preparation of specifically tailored management reports.

Required by management to aid them in performing their management functions.

Accounting Education
Teaching of accounting and related subjects.

Required by business students, business owners, accounting praculoners if their Continuing Professional Development
(CPD), and other interested parties.

Accounting Research
Accounting research papers, articles and similar publications.

Required by business owners, professional organizations, and other interested parties.

Users of Accounting Information

1. Internal users – those who are directly involved in managing the business.
Examples:
• Business owners who are directly involved in managing the business
• Board of directors
• Managerial personnel

2. External users – those who are not directly involved in managing the business.
Examples:
• Existing and potential investors (e.g., stockholders who are not directly involved in
managing the business)
• Lenders (e.g., banks) and Creditors (e.g., suppliers)
• Non-managerial employees
• Public
II. Accounting Concepts and Principles

Basic Accounting Concepts – (cont’n)

• Separate entity concept – The business is viewed as a separate entity, distinct from its owner(s). Only the transactions of the business are
recorded in the books of accounts. The personal transactions of the business owner(s) are not recorded.
• Historical cost concept (Cost principle) – assets are initially recorded at their purchase cost.
• Going concern assumption – The business is assumed to continue to exist for unknown period of time.
• Matching – Some costs are initially recognized as assets and charged as expenses only when the related revenue is recognized.

Basic Accounting Concepts – (cont’n)

• Reporting Period – The life of the business is divided into series of reporting periods.
• Stable monetary unit – Assets, liabilities, equity, income and expenses are stated in terms
of a common unit of measure, which is the peso in the Philippines. Moreover, the purchasing power of the peso is regarded as stable. Therefore,
changes in the purchasing power of the peso due to inflation are ignored.

Basic Accounting Concepts – (cont’n)

• Materiality concept – An item is considered material if its omission or misstatement could influence economic decisions. Materiality is a
matter of professional judgment and is based on the size and nature of an item being judged.
• Cost-benefit – The costs of processing and communicating information should not exceed the benefits to be derived from the information’s use.

Basic Accounting Concepts – (cont’n)

• Full disclosure principle – Information communicated to users reflect a balance between detail and conciseness, keeping in mind the cost-
benefit principle.
• Consistency concept – Like transactions are accounted for in like manner from period to period.

The PFRSs are Standards and Interpretations adopted by the FRSC. They consist of the following:
1. Philippine Financial Reporting Standards (PFRSs);
2. Philippine Accounting Standards (PASs); and
3. Interpretations

Fundamental vs. Enhancing

• The fundamental qualitative characteristics are the characteristics that make information useful to users.
• The enhancing qualitative characteristics are the characteristics that enhance the usefulness of information

Relevance
• Information is relevant if it can affect the decisions of users.
• Relevant information has the following:
a. Predictive value – the information can be used in making predictions
b. Confirmatory value – the information can be used in confirming past predictions
c. Materiality – is an ‘entity-specific’ aspect of relevance.

Faithful representation
• Faithful representation means the information provides a true, correct and complete depiction of what it purports to represent.
• Faithfully represented information has the following:
a. Completeness – all information necessary for users to understand the phenomenon
being depicted is provided.
b. Neutrality – information is selected or presented without bias.
c. Free from error – there are no errors in the description and in the process by which the
information is selected and applied.

Enhancing Qualitative Characteristics

1. Comparability – the information helps users in identifying similarities and differences between different sets of information.
2. Verifiability – different users could reach consensus as to what the information purports to represent.
3. Timeliness – the information is available to users in time to be able to influence their decisions.
4. Understandability – users are expected to have:
a. reasonable knowledge of business activities; and
b. willingness to analyze the information diligently.

III. The Accounting Equation

Assets = Liabilities + Equity

Five Major Accounts

Five Major Accounts
• ASSETS – are the economic resources you control that have resulted from past events and can provide you with economic benefits.
• LIABILITIES – are your present obligations that have resulted from past events and can require you to give up economic resources when
settling them.

• EQUITY – is assets minus liabilities.

• INCOME – is increases and in economic benefits during the period in the form of increases in assets, or decreases in liabilities, that result in
increases in equity, excluding investments by the business owner.

• EXPENSES – are decreases in economic benefits during the period in the form of decreases in assets, or increases in liabilities, that result in
decreases in equity, excluding distributions to the business owner.

• The difference between income and expenses represents profit or loss.

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

Five Major Accounts

• ASSETS
• LIABILITIES
• EQUITY
• INCOME
• EXPENSES

V. Books of Accounts and Double - Entry System

The Books of Accounts

1. Journal (General and Special)
2. Ledger (General and Subsidiary)

Journal
The journal, also called the “book of original entries,” is the accounting record where business transactions are first recorded.
1. Special Journal – is used to record transactions with similar nature (e.g., Sales journal, Purchases journal, Cash receipts journal, and Cash
disbursements journal)
2. General Journal – All other transactions that cannot be recorded in the special journals are recorded in the general journal.

Ledger
• The ledger is used to classify the effects of business transactions on the accounts. It is also called the “book of final entries.”
1. General ledger – contains all the accounts appearing in the trial balance.
2. Subsidiary ledger – provides a breakdown of the balances of controlling accounts.

VI. Business Transactions and Their Analysis

Steps in the Accounting cycle

1. Identifying and analyzing
2. Journalizing
3. Posting
4. Unadjusted trial balance
5. Adjusting entries
6. Adjusted trial balance (and/or Worksheet)
7. Financial statements
8. Closing entries
9. Post-closing trial balance
10. Reversing entries

Identifying and analyzing transactions and events

• Only accountable events are recorded. Accountable events are those that affect the assets, liabilities, equity, income or expenses of the business.
• Accountable events are normally identified from source documents, such as sales invoice, official receipts, delivery receipts, and the like.

Types of Events
1. External events – are transactions that involve the business and another external party.
2. Internal events – are events that do not involve an external party.

Journalizing
Journalizing refers to recording an identified accountable event in the journal by means of a journal entry.

VII. Posting to the Ledger

Posting
Posting, the third step in the accounting cycle, is the process of transferring data from the journal to the appropriate accounts in the ledger.

Trial balance
• A trial balance is a list of general ledger accounts and their balances. It is prepared to check the equality of total debits and total credits in the
ledger.

Types of Trial balance

a. Unadjusted trial balance – this is prepared before adjusting entries are made.
b. Adjusted trial balance – this is prepared after adjusting entries but before the financial
statements are prepared.
c. Post-closing trial balance – this is prepared after the closing process.

VIII. Adjusting Entries

Adjusting entries
• Adjusting entries are entries made prior to the preparation of financial statements to update certain accounts so that they reflect correct balances
as of the designated time.

Purpose of adjusting entries

a. To take up unrecorded income and expense of the period.
b. To split mixed accounts into their real and nominal elements.

Real, Nominal and Mixed Accounts

a. Real Accounts (Permanent accounts) – accounts that are not closed at the end of the accounting period. These accounts include all balance
sheet accounts, except the “Owner’s drawings” account.
b. Nominal Accounts (Temporary accounts) – accounts that are closed at the end of the accounting period. These accounts include all income
statement accounts, drawings account, clearing accounts and suspense accounts.
c. Mixed accounts – accounts that have both real and nominal account components. These accounts are subject to adjustment.

Methods of Initial Recording of Income

1. Liability method – under this method, cash receipts from items of income are initially credited to a liability account. At the end of the period,
the earned portion is recognized as income while the unearned portion remains as liability.
2. Income method – under this method cash receipts from items of income are initially credited to an income account. At the end of the period,
the unearned portion is recognized as liability while the earned portion remains as income.

Methods of Initial Recording of Expenses

1. Asset method – under this method cash disbursements for items of expenses are initially debited to an asset account. At the end of the period,
the incurred portion (‘used up’ or ‘expired’) is recognized as expense while the unused portion remains as asset.
2. Expense method – under this method, cash disbursements for items of expenses are initially debited to an expense account. At the end of the
period, the unused portion (‘not yet incurred’ or ‘unexpired’) is recognized as asset while the incurred portion remains as expense.

XI. Accounting Cycle of a Service Business

Worksheet
A worksheet is an analytical device used to facilitate the gathering of data for adjustments, the preparation of financial statements, and closing
entries.

Financial statements
• The financial statements are the end product of the accounting process. Information from the journal and the ledger are meaningless to most
users unless they are summarized and communicated through the financial statements.

Financial Statements
• Statement of financial position (or Balance sheet) – shows information on assets, liabilities and equity.
• Statement of profit or loss (or Income statement) – shows information on income and expenses, and consequently, the profit or loss for the
period.
• Closing entries - are entries prepared at the end of the accounting period to “zero out” all nominal accounts in the ledger. This is done so that
the transactions during the period will not commingle with the transactions in the next period.