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ACC10 Introduction to Accounting C.

Gomez Discussion and Illustrations Basics of Financial Statements & the Accounting Equation

What are Financial Statements?


Financial statements (FS) are the means by which the information accumulated and processed in financial accounting is periodically communicated to the users. The FS are the end product or main output of the financial accounting process.

The Elements of Financial Statements


1. Financial position the relationship between/among a. b. c. 2. Financial performance the relationship between/among a. b.

What is considered a complete set of FS?


A complete set of FS includes all of the following:
Balance sheet Income statement Statement of changes in equity Cash flow statement Notes to the financial statements

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ACC10 Introduction to Accounting C. Gomez Discussion and Illustrations Basics of Financial Statements & the Accounting Equation

The Accounting Equation


The basic accounting equation reflects the components of the balance sheet or the entitys financial position.

ASSETS = LIABILITIES + EQUITY


What is an Asset?
It is a resource: a. controlled by the entity as a result of past transactions and events b. from which future economic benefits are expected to flow from the entity Examples of assets:
Cash Supplies Accounts Receivable Equipment Notes Receivable Buildings Prepaid Accounts Land

REMEMBER: Under the business entity concept, the business has a personality separate and distinct from the business owner. Hence, if Bill Gates owns Microsoft, the assets of Microsoft (cash, equipment, etc.) do not belong to Bill Gates; these assets belong to Microsoft as a separate entity. In the corollary, Bill Gates luxury cars and mansions are not assets of Microsoft. These properties are owned by Bill Gates alone.

What is a Liability?
It is a present obligation of the entity: a. arising from past events, b. the settlement of which is expected to result in an outflow from the entity of resources embodying economic benefits. Examples of liabilities:
Accounts Payable Unearned Revenue Notes Payable Accrued Liabilities

REMEMBER: Going back to Bill Gates and Microsoftif Microsoft owes rent to the landlord of the building where its head office is located, under the business entity concept, this rent payable is a liability of Microsoft alone. The landlord shall collect from Microsoft, the business, and not from Bill Gates, its owner. So if, on the other hand, Bill Gates owes his car dealer for a Ferrari he had just purchased, this is not a liability of Microsoft, but a separate and distinct liability of Bill Gates.

What is Equity?
It is the residual interest in the assets of the entity after deducting all its liabilities. Since the owner of the entity does not own the entitys assets, what he/she (owner) actually owns is represented by the entitys equity. Equity accounts:
Owner, Capital Owner, Withdrawals

Other accounts that affect equity:


Revenues/Sales Supplies Expense Cost of Services/Sales Rent Expense Salaries and Wages Expense Utilities Expense Advertising Expense Insurance Expense

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ACC10 Introduction to Accounting C. Gomez Discussion and Illustrations Basics of Financial Statements & the Accounting Equation

Illustration
ASSETS P25,000 P100,777 P89,000 LIABILITIES P5,300 P48,825 P92,000 EQUITY P5,250 P15,250

The Expanded Accounting Equation


The expanded accounting equation takes a more detailed approach especially as regards equity. It incorporates not only financial position, but also financial performance. Hence, it also includes the components of the income statement which are: revenues and expenses.

What is Owner, Capital?


Owner, here, denotes the name of the owner of the business (e.g. Juan dela Cruz, Capital or dela Cruz, Capital) The owners capital represents his/her: o o Investment in the business Interest in the companys past net income or losses

What are Withdrawals?


These are assets that are taken out of the business, permanently, for the owners personal use. Withdrawals is a temporary account which is closed against Owner, Capital. Thus, every time there is a withdrawal, the capital account will be decreased subsequently.

What is Revenue?
It is a the gross inflow of economic benefits during the period arising in the course of the ordinary activities of an entity when those inflows result in increases in equity, other than increases relating to contributions from equity participants. Example of revenue: Sales (of goods or services) If, for example, Talyer Co. is engaged in the business of vehicle repairs and John, a customer, pays Talyer P4,000 to replace his cars fan belt, Talyer will have a revenue from the sale of service (repairs) amounting to P4,000. Applying the revenue recognition concept under accrual accounting, the P4,000 will be recorded in the books of Talyer not ______________________________, but at the time ________________________________ __________________________________________.

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ACC10 Introduction to Accounting C. Gomez Discussion and Illustrations Basics of Financial Statements & the Accounting Equation

What are Expenses?


They are decreases in economic benefits during the accounting period in the form of outflows or depletions of assets or incurrences of liabilities that result in decreases in equity, other than those relating to distributions to equity participants. Example of expenses: Utilities (electricity, water, telephone, internet), Salaries (of employees who work for the company), Advertising (or the cost to promote the business to the public) If, for example, NetCafe Co. is engaged in the internet caf business and Jill, its employee, has a monthly salary of P15,000, NetCafe Co. will have salaries expense amounting to P15,000. Applying the expense recognition concept under accrual accounting, the P15,000 will be recorded in the books of NetCafe as an expense not on the date payment to Jill is made, but at the end of the month to which her salary or service pertains.

What is Net Income?


It is the excess of revenues over expenses. In the event that expenses exceed revenues, the situation can no longer be described as net income. It is already a net loss. The term revenue differs from net income in that the former is a gross amount, while the latter is already a net amount after which deductions for expenses have been made.

Illustration
ASSETS LIABILITIES
Owner, Capital

EQUITY Net income


Owner, Withdrawals Revenues Expenses

P500,000 P750,000 P1,200,000

P175,000 P350,000 P300,000

P225,000 P480,000 P1,400,000

P0 P100,000 P0

P1,000,000 P900,000 P20,000 P1,280,000 P2,000,000 P2,500,000

Statement of Changes in Owners Equity

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ACC10 Introduction to Accounting C. Gomez Discussion and Illustrations Basics of Financial Statements & the Accounting Equation

Illustration
In its first year of operations, Mr. Mal E. Nis, owner of Mr. Clean Janitorial Services, made an investment in his business amounting to P50,000. During the year, revenues and expenses amounted to P105,000 and P79,000, respectively. Also, he made a withdrawal amounting to P5,000. At the end of the first year, how much is total Nis, Equity? _____________________ Will your answer change if expenses for the year amounted to P110,000 instead of P79,000? _____________________ If yes, what will your answer be? _____________________

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