ACC15 : FUNDAMENTALS OF ACCOUNTING First Sem, AY 2011-2012 Finance and Accounting Department John Gokongwei School of Management Ateneo

de Manila University INTRODUCTION TO ACCOUNTING

Lecture Notes

P. Cunanan

Accounting The art of recording, classifying, and summarizing in a significant manner, and its terms of money, transactions and events which are, in part at least, of a financial character, and interpreting the results thereof. Called the language of business. Users of Accounting Information Internal Users Those who own, manage, or are employed by the business users whose decisions affect the internal affairs of the enterprise. E.g., owners, managers, officers, employees External Users Those who use financial information to facilitate decisions about their financial relationship with the enterprise. E.g., investors, creditors , suppliers, customers, government agencies Forms of Business Organization: By Nature of Operations Service Business renders services to clients or customers for a fee. Merchandising Business one which buys goods from suppliers with the aim of selling these goods at a higher price. Manufacturing Business similar to merchandising business. However, instead of buying ready-made goods from suppliers, the manufacturers actually produces the goods it sells to customers. Forms of Business Organization: By Legal Form Sole Proprietorship has a single owner, called a proprietor, i.e., small retailers or individual professional businesses. Partnership formed by two or more persons who agree to contribute money, property or industry to a common fund. Owners are called partners. Corporation a business whose capital is divided into shares of stock. Owners are called stockholders. Generally Accepted Accounting Principles (GAAP) Cost Principle Focus is on the cost of the asset rather than on their market value. Assets are initially recorded in the accounts at historical cost. Revenue Recognition Principle Under the accrual basis of accounting, revenues are recognized when goods or services are delivered or rendered. Matching Principle Expenses incurred during the period should be recognized/matched against the related income which was generated in the same period. Accrual Basis Transactions are recorded when they occur, not when cash is received/paid. Accounting Assumptions Business Entity Assumption This concept advocates that a business enterprise is separate and distinct from the persons who supply the assets. Personal transactions of the owner are not included in the records of the business. Going Concern Financial Statements are prepared on the assumption that the company will continue to operate indefinitely unless there is evidence to the contrary.

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Monetary Unit Assumption All business transactions are recorded in terms of money. Only facts/transactions that can be expressed in monetary units are recorded. Time Period Assumption The life of the business must be divided into short accounting periods of equal length. Divide the economic life into time periods.

Accounting Equation The accounting system reflects two basic aspects of a company: what it owns and what it owes. Assets are resources with future benefits that are owned or controlled by a company. These resources are expected to yield future benefits. Liabilities are creditors claims on assets. These claims reflect company obligations to provide assets, products or services to others. Equity refers to the claims of its owners. Assets = Liabilities + Equity Revenues increase equity and are the assets earned from a companys earning activities. Expenses decrease equity and are the cost of assets or services used to earn revenue. Assets = Liability + Equity + Revenues Expenses Transaction Analysis In every transaction there is value received and value parted with. External Transactions are exchanges of value between two entities, which yield changes in the accounting equation. Internal Transactions are exchanges within an entity. E.g. use of supplies Events refer to happenings that affect an entitys accounting equation and can be reliably measured. Types and Effects of Transactions Source of Assets (SA). An asset account increases and a corresponding claims (liab or equity) account increases. Example: Purchase of supplies on account. Increase in Assets = Increase in Liabilities Increase in Assets = Increase in Equity Exchange of Assets (EA). One asset account increases and another asset account decreases.

Example: Inventory purchased for cash.

Increase in one Asset = Decrease in another Asset Use of Assets (UA). An asset account decreases and a corresponding claims (liab or equity) account decreases. Example: Payment of accounts payable Decrease in Asset = Decrease in Liabilities Decrease in Asset = Decrease in Equity Exchange of Claims (EC). One claims (liab or equity) account increases and another claims (liab or equity) account decreases. Example: Received bill for electricity but the owner did not

pay.
Increase Increase Increase Increase Example: 1. 2. 3. 4. in in in in Liabilities = Decrease in Equity Equity = Decrease in Liabilities one Liab = Decrease in another Liab one Equity = Dec. in another Equity

Investment by Owner Purchase Supplies for Cash Purchase Equipment for Cash Purchase Supplies on Credit

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5. 6. 7. 8. 9. 10.

Provide Services for Cash Payment of Expenses in Cash Provide Services and Facilities for Credit Receipt of Cash from Accounts Receivable Payment of Accounts Payable Withdrawal of Cash by Owner

The Double-Entry System For every debit (left side) entry, there must be a corresponding credit (right side) entry. This would maintain the accounting equation. In every transaction, there must be one or more accounts debited and one or more accounts credited. Each transaction affects at least two accounts (one debit, one credit). To maintain the equation, total debits for a transaction must equal total credits. Debit = Dr. Credit = Cr. The Journal is the book of original entry. It is where transactions are initially recorded in chronological order. The Ledger contains the entire accounts of a business. The process of transferring the entries from the journal to the accounts in a ledger is called posting. Trial Balance is a list of all accounts and their balances. Indicates whether total debits equal total credits. This only proves however, that all entries made have equal debits and credits; it does not guarantee that all transactions have been recorded. Chart of Accounts is a list of all the accounts of the business and their respective account numbers. Arranged as: Assets, Liabilities, Equity, Income, and Expenses. Footing means adding all the debits and the credits. The debit total and the credit total are compared and the difference is obtained. T-account helpful tool in analyzing the effects of transactions and events on individual accounts. COMPREHENSIVE EXAMPLE Halley Burton began a Web Consulting practice and completed these transactions during September of the current year:

Sept.

1 2 3 4 8 15 20 30 30

Invested $100,000 of his personal savings into a checking account opened in the name of the business. Rented office space and paid $1,200 cash for the month of September. Purchased office equipment for $30,000, paying $8,000 cash and agreeing to pay the balance in one year. Purchased office supplies for $750 cash. Completed work for a client and immediately collected $2,700 cash for the services. Completed $3,600 services for a client on credit. Received $3,600 from a client for the work completed on September 15. Paid the office secretary's monthly salary, $3,000 cash. Burton withdrew $2,000 for personal use.

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