Definitions ACCTBA1 QUIZ 1 Reviewer

1. ACCTBA Q1 REVIEWER
I. INTRODUCTION TO ACCOUNTING
 Definitions
 Accounting is a service activity. Its function is to provide quantitative information, primarily financial in nature, abut economic entities, that is intended to be useful in making economic decision. (Accounting Standards Council)
 Accounting is the art of recording, classifying and summarizing in a significant manner and in terms of money, transactions and events which are in part at least of a financial character and interpreting the results thereof. (Committee on Accounting Terminology)
 Accounting is the process of identifying, measuring and communicating economic information to permit informed judgment and decision by users of information. (American Accounting Association)
 Three Important Activities in the Accounting Process
 Identifying
o Recognition or non-recognition of accountable events
 Measuring
o Determining the monetary amounts at which the elements of the financial statements are to be recognized and carried in the financial statements
 Communicating
o Process of preparing and distributing accounting reports to potential users of accounting information. For this reason, accounting is called the “language of business”
o Implicit here are the processes of recording, classifying and summarizing
 Recording/Journalizing
 Systematically maintaining a record of all economic business transactions after being identified and measured
 Classifying
 Sorting or grouping of similar and interrelated economic transactions (accomplished by posting to the ledger)
 Summarizing
 Preparation of financial statements
 Basic Purpose of Accounting
 Provide quantitative financial information about a business that is useful to statement users in making economic decisions
 Users of Financial Statements
 Investors
o Providers of risk capital and their advisers are connected with the risk inherent in and return provided by their investments
o Interested in information to help them assess the ability of the entity to provide return on their investment
 Management
o Set goals for the organization
o Evaluate the progress made towards those goals
o Take corrective action if necessary
 Employees
o Interested in information about the stability and profitability of the entity
o Interested in information which enables them to assess the ability of the entity to provide remuneration, retirement benefits and employment opportunities
 Lenders
o Interested in information which enables them to determine whether their loans and interest thereon will be paid when due
 Suppliers and other Trade Creditors
o Interested in information which enables them to determine whether amounts owing to them will be paid on maturity
 Customers
o Interested in information about the continuance of an entity especially when they have a long- term involvement with or are dependent on the entity
 Government and its Agencies
o Require information to regulate the activities of the entity, determine taxation policies and as a basis for national income and similar statistics
 Public
o Financial statements may assist the public by providing information about the trends and recent developments in the prosperity of the entity and the range of its users
 Forms of Business Organizations
 Sole proprietorship
o Business organized by one person who usually acts as manager
 Partnership
o Two or more persons bind themselves to contribute money, property or industry into a common fund with the intention of dividing the profits among themselves (partners)
 Corporation
o Body formed and authorized by law to act as a single person although constituted by one or more persons and legally endowed with various rights and duties.
 Types of Business Operation/Activities
 Service
o Simplest type of business which performs service, for a fee, to a client or customer
 Merchandising
o Buys and sells goods or merchandise
 Manufacturing
o Buys raw material first and after changing the form, sells the products to the customer or distributor

2.  Generally Accepted Accounting Principles
 Overview
o Represent the rules, procedures, practice and standards followed in the preparation and presentation of financial statements
o Must receive authoritative support from regulatory bodies in accounting and government
 Purpose
o Statement users are assured of relevant and reliable financial information
o Provide companies and accountants guidance on how to account for and report economic activities
o Provide independent auditors of financial statements with basis for evaluating the fairness and completeness of those statements
 Accounting Concepts
o Accrual
 Income is recognized when earned regardless of when received
 Expense is recognized when incurred regardless of when paid
 Recognition of accounts receivables, accounts payable, prepaid expenses, accrued expenses, deferred income and accrued income
o Going Concern
 The accounting entity is viewed as continuing in operation indefinitely
 Foundation of the cost principle
o Entity
 The business is separate from those who constitute the firm
 The transactions of the enterprise should not be merged with the transactions of the owners
o Time Period
 The indefinite life of an enterprise is subdivided into time periods or accounting periods which are usually of equal length for the purpose of preparing financial reports on financial position, performance and cash flows
 Accounting period = one year
 Calendar year – 12 month period that ends on December 31
 Natural business year (fiscal year) – 12 month period that ends on any month when the business is at its lowest
o Monetary Unit
 Quantifiability
 Assets, liabilities, equity, income and expenses should be stated in terms of a unit of measure
 Stability of peso
 Purchasing power of the peso is stable or constant
o Objectivity
 All transations must be evidenced by business documents free from personal biases
o Cost Principle
 Assets should be recorded initially at original acquisition cost
o Disclosure
 All significant and relevant information leading to the preparation of financial statements should be clearly reported
o Materiality
 Strict adherence to GAAP is not required when the items are not significant enough to affect the evaluation, decision and fairness of the financial statements
 Also known as the doctrine of convenience
o Consistency
 Accounting methods and practices should be applied on a uniform basis from period to period
 Does not mean that no change in accounting method can be made
o Conservatism
 When alternatives exist, the alternative which has the least effect on equity should be chosen (lower figure/outcome)
II. FINANCIAL STATEMENTS
 Overview
 Financial statements are means by which the information accumulated and processed in financial accounting is periodically communicated to users
 End product or main output of the financial accounting process
 Structured financial representation of the financial position and financial performance of an entity
 Components
 Statement of financial position
 Income statement (if presented separately from the statement of comprehensive income)
 Statement of comprehensive income
 Statement of changes in equity
 Statement of cash flows
 Notes to financial statements
 Objective
 Provide information about the financial position, financial performance and cash flows of an entity that is useful to a wide range of users in making economic decisions
 Elements of Financial Statements
 Assets
o Resources controlled by the entity as a result of past transactions or events from which future economic benefits are expected to flow to the entity
 Liabilities

3. o Present obligations of the entity arising from past transactions or events the settlement of which is expected to result in an outflow from the entity of resources embodying economic benefits
 Equity
o Residual interest in the assets of the entity after deducting all of its liabilities
 Revenue (Income)
o Increase in economic benefit during the accounting period in the form of an inflow or increase in asset or decrease in liability that results in increase in equity, other than contribution from equity participants
 Expense
o Decrease in economic benefit during the accounting period in the form of an outflow or decrease of asset or increase of liability that results in decrease in equity, other than distribution to equity participants
 Four Recognition Principles
 Asset Recognition
o Asset is recognized if future economic benefits will flow to the entity
o The cost or value of asset can be measured reliably
 Liability Recognition
o It is probable that an outflow of economic benefits will be required for the settlement of a present obligation
o The amount of obligation can be measured reliably
 Revenue Recognition
o Revenue is recognized if future economic benefits will flow to the entity as a result of an increase in an asset or a decrease in liability
o The economic benefits can be measured reliably
 Expense Recognition
o Expense is recognized if it is probable that a decrease in future economic benefits has occurred
o The decrease in economic benefits can be measured reliably
 Other Principles
 There should be simultaneous or combined recognition of revenues and expenses that result directly from the same transaction and events
o Cause and effect association
 Expense is recognized when the revenue is already recognized (strict matching concept)
 Ex: merchandise inventory
o Systematic and rational allocation principle
 Some costs are expensed by simply allocating the over the periods benefited
 Ex: Depreciation of property, plant and equipment, amortization of intangibles, prepayments
o Immediate recognition
 Cost incurred is expensed outright because of uncertainty of future economic benefits
 Ex: salaries, advertising, most distribution costs and payments to settle lawsuits
III. STATEMENT OF FINANCIAL POSITION
 Definition
 Formal statement showing the three elements comprising financial position
 Investors, creditors and other statement users analyze the SOFP to evaluate factors such as economic resources, liquidity, solvency, financial structure and capacity for adaptation
 Definition of Terms
 Economic resources
o Refers to the assets owned by the entity
 Liquidity
o Availability of cash in the near future to cover currently maturing debt
 Solvency
o Availability of cash over a long term to meet financial commitments when they fall due
 Financial structure
o Source of financing for the assets of the equity
 Capacity for adaptation
o Ability of the entity to use its available cash for unexpected requirements and investment opportunities
 Current assets
 Asset is cash or a cash equivalent unless restricted from being exchanged or used to settle a liability for at least 12 months after the reporting period
 The asset is for the purpose of trading
 The asset is to be realized within 12 months after the reporting period
 The asset is to be realized or intended to be sold or consumed within the entity’s operating cycle
o Operating cycle
 Period of time it takes for cash to be converted back to cash
 Presented in the SOFP in order of liquidity
o Cash/cash equivalents
 Cash on hand
 Cash in bank
 Cash equivalents
 Short term, highly liquid investments with a term three months or was purchased three months or less prior to its maturity
o Financial assets at fair value through profit or loss (investment in trading securities)
 Stocks and bonds that are held for a short term duration
o Trade and other receivables
 Trade receivables (notes, accounts)

4.  Other receivables (interest, rent)
 Allowance for doubtful accounts
o Inventories
 Represents the stock of goods available for sale
o Prepaid expenses
 Non-current assets
 Whatever’s not current 
o Property, plant and equipment
 Used for production of supply of goods and services, for rental to others, or for administrative purposes
 Expected to be used during more than one period
o Long-term investments
o Intangible assets
o Other non-current assets
 Current Liabilities
 Liability can be settled within the entity’s normal operating cycle
 Entity holds the liability primarily for the purpose of trading
 Liability is due to be settled within twelve months after the reporting period
 Entity does not have an unconditional right to defer settlement of liability for at least 12 months after the reporting period
 Line items:
o Trade and other payables
 Accounts payable, notes payable, interest payable, salaries payable
o Current portion of long term debt
 Partial portion of a long-term debt which is due within twelve months after the reporting period
 Non-current liability
 Whatever’s not current 
o Notes payable (long term)
o Mortgage payable
o Bonds payable
 Usually from five to ten years supported by a formal contract
 Income Statement
 Formal statement showing the financial performance of an entity for a given period of time
 Sources of income
o Sale of merchandise to customers (merchandising and manufacturing)
o Rendering of services
o Use of entity resources (interest, rent, dividend)
o Disposal of resources other than products
 Functional presentation
o Traditional and common form
o Also known as the cost of sales method
o Classifies expenses according to their function
 Cost of sales
 Distribution costs
 Constitutes costs which are directly related to selling, advertising and delivery of goods to customers
 Administrative expenses
 Finance cost
 Expenses incurred as a result of obtaining outside financing
 Other expenses
 Natural Presentation
o Nature of expense method
o Expenses are aggregated according to their nature and not allocated among the various functions within the entity
 Statement of Changes in Equity
 Basic statement that shows the movements in the elements or components of the owner’s equity
 Items that affect the owner’s equity
o Investment by the owner (+)
o Withdrawal by the owner (-)
o Revenues during the year (+)
o Expenses during the year (-)