Chapter 1

FUNDAMENTALS OF ACCOUNTING

Learning Objectives:
After studying this chapter, you should be able to
1. know the definition of accounting and its functions
2. understand the generally accepted accounting principles and the
basic accounting assumptions,
3. learn and acquire familiarity of financial statements, its characteristics
and preparation
4. gain familiarity of the elements of financial statements, its
classification and account titles as well, and
5. learn what are the forms of business organization and their types of
activities.

DEFINITION OF ACCOUNTING
"It is a service activity. Its function is to provide quantitative
information, primarily financial in nature, about economic entities that is
intended to be useful in making economic decisions." - Accounting
Standards Council (ASC) in its old Statement of Financial Accounting
Standards (SFAS) No.1
"It is the process of identifying, measuring and communicating
economic information to permit informed judgments and decisions by users
of the information.” - American Accounting Association (AAA)
“It is an art of recording, classifying, 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 of the American Institute of Certified
Public Accountants (AICPA)
The four phases of accounting:
Recording - this is the function of accounting which involves the
routine and mechanical process of writing down the business transactions
and events in the books of accounts in a chronological manner called
Journalizing.
Classifying - this is the function of accounting which involves sorting
or grouping of similar transactions and events into their respective kind and
classes This is the process of transferring the entries from the journal to the
ledger called "Posting".
Summarizing - this is the function of accounting which involves the
completion of the financial statements and the accounting requirements as
well. This starts from striking of a trial balance, plotting down of adjusting
entries in the worksheet and the preparations of closing entries, post-
closing trial balance and reversing entries.
Interpreting - this is the function of accounting which involves the
"analytical and interpretative works”. It is then, that when financial
statements are analyzed, interpreted and is communicated to those
interested parties where these could be of great help to management as a
basis for making a sound decision.

BOOKKEEPING vs ACCOUNTING

Bookkeeping is the process of recording systematically the business

transactions in a "chronological manner”. It is systematic because it follows
procedures and principles. It is chronological because the transactions are
recorded in order of the date of occurrence.
Accounting on the other hand, requires complete and accurate
bookkeeping records necessary in the performance of its responsibility
which is the analysis and interpretation of the financial reports. Accounting
could not reach at this final point without first passing through the
bookkeeping process and bookkeeping alone could not arrive at the
desired result of the entire accounting process. In short, while the
bookkeeper does the "how accounting is done, which refers to the
mechanical aspects, the professional accountant does the "why accounting
done" which refers to the analytical and interpretative aspects of accounting
in other words accounting starts where bookkeeping ends.

USERS OF FINANCIAL INFORMATION

Direct
Users:
Internal Users
Owner or The one who puts in capital (such as money or property) in
Investor a business endeavour. To minimize risk of losing money,
an owner or investor must read the financial reports and
seek answers to the following questions:
 1) Is the business profitable?
2) Has it accumulated sufficient financial wealth to
remain stable?
Manager The one who is responsible for running the business.
Financial reports make it possible to evaluate performance
of the business.
1) Are the plans being implemented beneficial to the
business?
2) Is the business operating profitably?
Remember a losing business depletes wealth and is a
reflection of inefficient management.
Employee The employee wants: a) higher wages b) benefits c) good
working conditions, and d) security of tenure.
The employees will assess the ability of the business to
grant these demands through the financial reports.
Remember, a losing business can not afford to give higher
salaries and more benefits.
External Users
Lender or A lender or creditor assesses the paying ability of the
creditor business-borrower by reading the financial reports.
1) Will the business be able to pay its debt when it falls
due?
2) Does it have liquid assets.
Supplier A supplier offers goods or merchandise on cash basis or
on credit term.
1) If offered on credit, will the business who is buying
merchandise in bulk be able to pay its account on the date
it becomes due.
2) Does it have liquid assets.
The accounting information to determine the credit worth of
business as also based on its financial status
Government The government seeks to answer the following questions
by reading the accounting reports:
1) Is the business paying the right taxes?
2) Is it filing all the required documents?
The government through its tax agent, the Bureau of
Internal Revenue, investigates tax returns and assesses
truthfulness of the reported profit as well as the tax liability
paid by the business.
Customer The customer assesses the company’s ability to
continuously supply the goods they need at the right price
and right quality.
Indirect Stock exchange, trade associations, regulatory bodies, and
Users: financial analysts

Accounting Information

Financial Information Statement Users Decisions Made

Profitability Investor Customers Financing Decisions
Liquidity Lender Government Investing Decisions
Solvency Managers Cash & Credit Strategies
Cash Adequacy Labor Relations
Suppliers
Allocation of Resources
Timing Employees Tax Plans

GENERALLY ACCEPTED ACCOUNTING PRINCIPLES (GAAP)

The preparation of financial statements is governed and guided by

Generally Accepted Accounting Principles (GAAP). Generally Accepted
Accounting Principles are uniform set of accounting rules, procedures,
practices and standards that are followed in preparing the financial
statements.

Basic Accounting Principles

1. Economic Entity Principle – states that the business is considered

distinct and separate from the owners.
2. Monetary Unit Assumption Principle – dictates that all activity be
recorded in the same currency, usually in the Philippine peso in the
case of businesses in the Philippines. Also, it states that the
purchasing power of currency remains static over time so that
inflation is generally not considered in the financial reports of a
business, even if that business has existed for several years.

3. Time-period Assumption – states that all financial statements have to

indicate the time period for the activity reported in order for them to
be meaningful to those reviewing them. “As of” means from the
inception of the company up until a certain point, while a date range
(usually presented as “for the period”) means all the days in between
two specific dates, usually the year ends for the previous year and
the current year.

4. Full Disclosure principle – states that a business is required to

disclose all information that that relates to the function of its financial
statements in notes to accompanying the statements.

5. Going concern principle – sometimes referred to as the “non-death

principle”, this principle assumes the business will continue to exist
and function with no defined end date.

6. Matching principle – accounting for revenue and expenses are

matched. Meaning, the revenue and the expenses directly related to
those revenues are reported in the same accounting period.

7. Accrual basis – revenue is generally recognized using the principle of

accounting. Under the accrual basis of accounting, revenue is
reported when it’s earned, regardless of when payment for the
product or service is actually received.

8. Materiality – is an entity-specific aspect of relevance based on the

nature of magnitude, or both, of the items to which the information
relates in the context of an individual entity’s financial report, and that
there is no uniform quantitative threshold for materiality or
predetermined material in a particular situation.
 9. Conservatism – when there is more than one acceptable way to
record a transaction, this principle instructs the accountant to choose
the option that’s best for the business they’re working with.

PROPRIETOR AND BUSINESS HAVE SEPARATE PERSONALITIES

From the “legal point of view”, the proprietor and the business are
one. The proprietor gives birth and life to the business. No business will
exist without the proprietor. They live together and have oneness of
existence. In short, they are inseparable. However, from the “accounting
point of view", the business is considered as an entity that is separate and
distinct from the owner. That the capital he puts into the business belongs
to the business and should be accounted for separate from his personal.
This is the separate entity assumption or business entity concept in
accounting and the first accounting assumption that we have studied.

FINANCIAL STATEMENTS

Financial Statements can be prepared monthly, quarterly, semi-

annually or less than one-year period are called interim financial
statements.
Financial statements must possess the characteristics of
understandability, which means that the language used in financial
reporting could easily be understood by the users. Remember, not all
owners of business are knowledgeable in accounting.
Financial statements must also possess the characteristics of
timeliness. That reports should be submitted on time in order not to defeat
the purpose. What's the use of the financial statements when submitted
late? The financial report must also be prepared in a neutral way. it must be
fairly presented and free from bias. It must be directed towards the interest
of the users; it is not good to give favour to one party in detriment to the
others. This is neutrality in reporting the financial statements
Per revised Philippine Accounting Standards (PAS) No. 1, there are
six (6) basic financial statements but we will focus our studies in four (4)
statements which are as follows:
1. Statement of Financial Position (Balance Sheet)
 2. Statement of Comprehensive Income (Income Statement)
3. Statement of Changes in Owner's Equity
4. Statement of Cash Flows

Statement of Financial Position

Statement of Financial Position which is previously known as
Balance Sheet is a financial statement that shows the financial condition of
the business as of a given date. It shows the Assets, Liabilities and
Owner's Equity which are called "Accounting Values or Accounting
Elements". These are also considered "Permanent Accounts" and are
being outlined below as follows:
Assets - in layman's language, these are the things of value or rights
that are owned and used by the business in the conduct of its operations
such as cash, land, building, inventories, furniture and fixtures, machineries
and equipment, prepaid expenses, etc. It also includes accounts collectible
by the business which we termed as "Receivable" This tells us how much
the business owns.
Liabilities - in layman's language, these are debts or financial
obligations of the business that are payable in cash or in some kind of
assets such as Accounts Payable, Notes Payable, Salaries Payable,
Mortgage Payable, etc. This tells us how much the business owes.
Owner's Equity - in layman's language, this refers to money or value
of property put by the proprietor in to the business to start with which refers
to "Initial Investment Owner's Equity will be increased by profits or
additional investment and decreased by withdrawal, expenses and losses.
Most often, Owner's Equity is the residual interest in assets after deducting
all the liabilities it is expressed in the equation as Assets less Liabilities
equals Owner's Equity (A-LEOE). Thus, if:
the business owns (assets) P100,000.00
less what the business owes (liabilities) 70,000.00
equals what is left for the business (owner's equity) P 30.000.00

This tells us how much is left for the business.

The Statement of Financial Position answers the following questions:

1. How much the business owns? (Referring to Assets)
2. How much the business owes? (Referring to Liabilities)
3. How much is left for the business? (Referring to Owner's Equity)

Statement of Comprehensive Income

 Statement of Comprehensive Income which is previously known as
Income Statement is a financial statement that shows the "results of
operations of the business for a given period of time. The period covered
by the statement may be
"For the month ended ____________________”
"For the quarter ended ___________________”
"For the six months period ended ___________”
"For year ended _________________________”

The information that was presented in the Statement of

Comprehensive Income is usually considered the most important
information provided by financial accounting because profitability is the
paramount concern to those interested in the economic activities of the
enterprise.
Revenues or Income - denote money or proceeds from services
rendered by a servicing company or income from use by other entities of
the resources of the enterprise such as Rent Income, Royalties, etc.
Servicing companies like Auto Repair Shop, Laundry Shop, Barber Shop,
Beauty Parlor, etc. and Professional Income such as Auditing Fees, Legal
Fees, Retainers Fees and others.
Expenses - denote the benefit received by the business from its use
which had helped in carrying out its operation, like salaries expense, rent
expense, repairs and maintenance, taxes and licenses, etc.
Profit (loss) - the excess of revenues over expenses is called "profit,
while the excess of expenses over revenues is “loss”.

Basically, the Statement of Comprehensive Income features the

following:
Sales Revenue or Service Income Pxx
Expenses xx
= Profit Pxx

The Statement of Comprehensive Income answers the following

questions,
1. Does the business make profit?
2. Does the business incur loss?
The business makes "profit" if the revenues earned are bigger than
the expenses incurred. Conversely, if expenses incurred are bigger than
the revenues earned, there is a "loss". If the business makes profit, the
following series of questions can be asked:
 1. Can I afford to hire additional employees?
2. What costs can I cut down to maximize profit?

The information presented in a Statement of Comprehensive Income

is usually considered the most important information provided by financial
accounting because profitability is the paramount concern to those
interested in the economic activities of the enterprise

Statement of Changes In Owner’s Equity

A Statement of Change in Owner's Equity is a financial statement that
summarizes the changes in equity for a given period of time. The beginning
equity of the owner is increased by the additional investment and profit.
Correspondingly, it is decreased by withdrawal and loss.
Capital, beg Pxxx
Additional investment xxx
Add: Profit xxx
Total Pxxx
Less: Withdrawal (xxx)
Capital, end Pxxx

The amount of increase or decrease of owner’s equity is calculated as

follows:

Owner's Equity, end xxx

Owner's Equity, beg xxx
Increase (Decrease) in Owner's Equity xxx

The increase (decrease) in Owner's Equity is accounted for as follows:

Profit (increase in owner's equity) xxx
Add: Additional investment (increase in owner's equity) xxx
Total xxx
Less: Withdrawal (decrease in owner's equity) xxx
Net Increase (Decrease) in Owner's Equity xxx

Statement of Cash Flows

A Statement of Cash Flows is a financial statement that provides
information about the causes of change in the company's cash balance
from the beginning up to the end of specific period.
 Like your Statement of Comprehensive Income, it is dated "for the
period ended". When we speak of accounting periods, it can be at the end
of a "month, quarter or annual”.
Basically, the Statement of Cash Flows is similar to Statement of
Cash Receipts and Disbursements. Receipts are inflows or sources while
Disbursements are outflows or uses of cash.
Illustration in a summary form:
Cash at the beginning of the period P 1,000
Add: Cash Receipts 700
Total Cash Available P 1,700
Less: Cash Disbursements 1,200
Cash balance at the end of the period P 500

As the Statement of Cash Flows will tell us in details, what caused

the changes in cash balance, we grouped the transactions into three (3)
major activities. These are as follows:

Operating Activities - show the inflows and outflows of cash from the
normal operating activities. Examples are:

Cash Inflows:
a. cash received from sale of goods and services
b. cash receive from royalties, fees, commission and other
revenue
Cash Outflows:
a. cash paid to suppliers of goods and services
b. cash paid to employee's salaries
c. cash paid for taxes and licenses
d. cash paid for interest and other operating expenses

There are two (2) methods of presenting Statement of Cash Flows

under the Operating Activities. One is called "direct method" and the other
is called "indirect method". However, per Philippine Accounting Standards
(PAS) No. 7, companies are encouraged to report cash flows from
operating activities using the direct method although indirect method is also
acceptable.
Under the direct method, the company's net cash provided by (used
in) operating activities is arrived at by adding the individual operating cash
inflows and then deduct the individual operating cash outflows while under
indirect method, it derives the net cash provided by (used in) operating
activities by adjusting profit for income and expense item that do not
involved any cash outlay, like depreciation. Depreciation is added back to
profit.

Investing Activities - show the inflows and outflows of each arising from the
following transactions.
Cash Inflows:
a. received from sale of property and equipment
b. Cash receipts from collections of long-term receivable
Cash Outflows:
a. paid for acquisition of property and equipment
b. cash paid for loans to other parties

Financing Activities - show the inflows and outflows of cash arising from the
following transactions.
Cash Inflows:
a. cash received from investments by owner
b. cash receipts from obtaining bank loan

Cash Outflows:
a. cash paid to owner for withdrawal
b. cash paid to bank for loan obtained
c. cash paid to shareholders on corporate dividends

WHEN DOES AN ACCOUNTANT PREPARE FINANCIAL

STATEMENTS?
The business has a continuous life of existence. When it starts, it is
assumed that it will continue to operate for an indefinite period of time
rather than for it to liquidate soon. This is the "continuity" or "going concern
assumption” in accounting. However, if there is strong evidence on the
contrary, that the company may not be able to continue its operation
because of persistent losses it incurs, could no longer pay its creditors on
time and there might be legal proceedings against the company, then, the
going concern concept shall be abandoned.
 Accounting periods can be as follows:
1 Month - where financial statements are prepared at the end of
every month. We call this on a “Monthly Basis”. This is the shortest
accounting period.
3 Months - where financial statements are prepared at the end of
every three months. We call this on a "Quarterly Basis".
6 Months - where financial statements are prepared at the end of
every six months. We call this on a "Semi-Annual Basis.
12 Months - where financial statements are prepared at the end of
every twelve months. We call this on "a Yearly" or "Annual Basis".

The accounting period of less than a year is called fiscal period and
the financial statements prepared are referred to as interim financial
statements.
The owner or management has two (2) annual accounting periods to
choose from as far as periodic reporting of financial statements are
concerned, these are:
Calendar Year - the accounting period will begin on January 1 and
will end on December 31 of the same year.
Fiscal Year - the accounting period will begin on the first day of any
month of the year except January and will end on the last day of the twelfth
month completing the one-year period. Example, if the period begins on
July 1, 20A, it will end on June 30, 20B.

Assessmen
t 1-5
Questions for Review:
1. Differentiate calendar from fiscal year?
2. How many quarters are there in a calendar year? Name them.
3. What are the two (2) annual accounting periods?
4. Name the quarters under the fiscal year.
5. What are the months covering the second quarter of a calendar
accounting period?

True or False
Instruction: White “True” if the statement correct and "False" if incorrect.
1. The accounting period of less than a year is called fiscal period.
2. When fiscal year is chosen for financial reporting, if the period starts on
July 1, 20A it will end on June 30, 20B.
3. The business starts to operate on February 1, 20A and that calendar
quarterly reporting is used, the first quarter report will consist of February,
March and April 20A.

Multiple Choice: Write the letter and answer of your choice.

Example: a. quantitative information
1.The accounting assumption that gives the business a continuous life of
existence-
a. going concern assumption
b. business entity concept
c. periodicity concept
d. stable monetary unit
2. The life of the business is divided into equal periods referred to as-
a. accounting periods
b. calendar period
c. periodic reporting
d. fiscal period
3. The accounting period that will begin on the first day of January and will
end on the last day of December of the same year –
a. calendar year
b. fiscal year
c. natural business year
d. new year
4. The financial statements prepared not completing the one-year period –
a. interim financial statements
b. periodic financial statements
c. quarterly financial statements
d. annual financial statements
5. The shortest accounting period chosen for financial reporting –
a. monthly c. semi-annually
b. quarterly d. annually
6. When financial statements are prepared on a quarterly basis, this
covers-
a. two months period c. four months period
b. three months period d. six months period
ELEMENTS OF FINANCIAL STATEMENTS AND ACCOUNT TITLES
USED
The five (5) types of major accounts are considered the elements that
are directly related to measurement of financial condition in the Statement
of Financial Position are the Assets, Liabilities and Owner's Equity, while
the elements directly related to measurement of performance in the
Statement of Comprehensive Income are Income and Expenses. These
accounting elements are given account name or account titles.
Account titles are identification or brief description of items that fall to
the same kind, class or nature.

STATEMENT OF FINANCIAL POSITION

OR
BALANCE SHEET
(Permanent Accounts)

ASSETS - These are defined as "resources controlled by the enterprise as

a result of past transactions and events and from which future economic
benefits are expected to flow to the enterprise". In layman's term, assets
are defined as things of value that are owned and used by the enterprise in
its operations. Examples are cash, building, land, machinery, furniture &
fixtures, equipment, tools, etc. It also includes inventories, prepaid
expenses and a debt collectible by the enterprise from a customer which
we termed as a Receivable.
Per Philippine Accounting Standards (PAS No. 1), Assets are
classified into two, namely: current assets and non-current assets.

Current Assets - refer to all assets that are expected to be realized, sold
or consumed within the enterprise's normal operating cycle. Operating
cycle is the interval of time from the date of acquisition of merchandise
inventory; sell the inventory to customers and the ultimate collection of
cash from the sale.
Cash - the account title to describe money, either in paper or in coins
and money substitutes like check postal money orders, bank drafts and
treasury warrants. When cash is within the premise of the business, the
account title is Cash on Hand and Cash in Bank if deposited in the bank.
Cash Equivalents - PAS NO. 7 defines cash equivalents as short
term, highly liquid investments that are readily convertible to known
amounts of cash and which are subject to an insignificant risk of changes in
values because of changes in interest rates.
Petty Cash Fund -an account title for money that is separately
placed inside the box and set aside for petty or small expenses. This
usually happens when a company opens a bank account (savings or
current) where it requires a withdrawal slip or issuance of check every time
it makes disbursements. It is time consuming and it is not wise to make
withdrawal slip or issue a check to pay small amount of expenses of let's
say P20.00 for jeepney fares. This fund is a handled by a petty cashier who
is accountable for its disbursements. The petty cashier is warned not to mix
his or her personal money with the petty cash fund.
Notes Receivable - this is a promissory note that is received by the
business from the customer arising from rendering of services, sale of
merchandise, etc. This can either be an interest bearing or non-interest
bearing.
Accounts Receivable - the account title for amounts collectible
arising from services rendered to a customer or client on credit or sale of
goods to customers on accounts. This constitutes an oral or verbal promise
to pay by a customer or client. For example, your friend borrows from you
the sum of P500.00 to buy some bottles of beer during drinking session. In
accounting parlance, this means that you have an Accounts Receivable
from him in the amount of P500.00.
Estimated Uncollectible Accounts - this is an asset-offset or
contra-asset account. It provides for possible losses from uncollectible
account. Although this is not actually an asset, it is classified as such
because it is shown as a deduction from the Accounts Receivable which is
a Current Asset Account. For example, the company has an amount
collectible from various customers. Remember, not all customers are good
payers. Thus, we provide certain percent (%) of what we could not collect
from them. This is called estimated uncollectible accounts or allowance for
doubtful accounts which we previously termed as allowance for bad debts.
Advances to Employees - the account title for amounts collectible
from employees for allowing them to make cash advances which are
deductible against their salaries or wages.
Inventories - Per PAS No. 4, these are assets which are: (1) held for
sale in the ordinary course of business, (2) in the process of production for
such sale, or (3) in the form of materials or supplies to be consumed in the
production process or in the rendering of services.
Supplies Inventory or Unused Supplies - an account title for cost
of stationery and other supplies purchased for use but are left on hand and
still unused. The account title should be specified as to Unused Office
Supplies if intended for the office, Unused Shop Supplies if intended for the
shop, etc.
Prepaid Expenses - account title for expenses that are paid in
advance but are not yet incurred or have not yet expired such as Prepaid
Rental, Prepaid Insurance, Prepaid Interest, Prepaid Advertising, etc.
Accrued Income - account title for income that is already earned but
it has not yet been collected. In other words, it has a semblance of a
"receivable” account. For example, a tenant is renting our building for
P10,000 a month. His rental for the month of January will be paid in
February. So, at the end of January we have Rental income Receivable
from our tenant. The correct account title however, is “Accrued Rental
Income".
These accounts are normally arranged according to liquidity (ready
conversion to cash) in the Statement of Financial Position.

Non-Current Assets:
Property and Equipment - the International Accounting Standards No.16
defines property and equipment as tangible assets which are held by an
enterprise for use in production or supply of goods and services, for rental
to others, or for administrative purposes, and which are expected to be
used during more than one period such as:
Land - an account title for the site where the building used as office
or store is constructed. If land is reserved for future use, it is classified as
“investment property”.
Building - account title for a finished construction owned by the
business where operations and transactions took place.
Equipment - include calculators, typewriters, adding machines,
computers, steel filing cabinets and the like if these are used in the office,
the account title is Office Equipment and if used in the store, Store
Equipment. Trucks, jeeps, vans, automobiles and other kinds of motor
vehicles are used exclusively for delivering goods, the account title is
Delivery Equipment.
Furniture & Fixtures - include chairs, tables, counters, display cases
and the like. If these are used in the office, the account title is Office
Furniture & Fixtures and if these are used in store, the account title is Store
Furniture & Fixtures.
Accumulated Depreciation - this is an asset-offset or contra-asset
account. This is shown as a deduction from property and equipment. Each
property and equipment should be provided with their individual valuation
account.
The assets that are classified as Property & Equipment or Fixed
Assets are called Depreciable Assets and are subject to Depreciation
except "land". Land is not subject to depreciation because it is expected to
be useful to the business enterprise for an indefinite period of time.

LIABILITIES - these are defined as "financial obligations of the business to

its creditors. It represents the claim of the creditors over the assets of the
enterprise". Per PAS No.1, liabilities are classified only into two, namely:
current liabilities and non-current liabilities.

Current Liabilities - are financial obligations of the enterprise which are (a)
expected to be settled in the normal course of the operating cycle; (b) due
to be settled within one year from the Statement of Financial Position date.
Accounts Payable - an account title for a financial obligation of an
enterprise that constitutes an oral or verbal promise to pay. For example,
you borrowed P400.00 from a friend to buy fresh fish for family
consumption. In accounting parlance, this means that you have an
Accounts Payable to him in the amount of P400.00.
Notes Payable (short-term) - same as Accounts Payable in nature
but only the obligation is evidenced by a promissory note. The enterprise is
the one who issued the note.
Accrued Expenses - these are expenses incurred by the enterprise
but are not vet paid. This normally occurs when the accounting period
ended such as rent payable, salaries payable, interest payable, taxes
payable, etc. It has a semblance of a "Payable” account. For example: our
employees have rendered services already for the month of January, we
intend to pay them in February so, at the end of January we will have a
salaries expense payable to our employees. The correct account title
however, is "Accrued Salaries Expense".
Unearned Income - this is an account title for an income collected or
received in advance but services have not been rendered yet.

Non-current Liabilities:
 Notes Payable (long-term) - same nature with that of Notes Payable
(short- term) but only, this requires payment for more than a year.
Mortgage Payable - a financial obligation of the enterprise which
requires a fixed or tangible property to be pledged as a collateral to ensure
payment.

OWNER'S EQUITY OR CAPITAL - this is the “residual interest in the

assets of the enterprise after deducting all its liabilities.” It is expressed in
the equation as Assets less Liabilities equals Owner's Equity or Capital.
It is increased when there is Profit or additional contributions by the owner
and decreased when there is Loss or withdrawal by the owner. In layman's
language, Owner's Equity or Capital is the amount of money or value of
property put by the proprietor into the business to start with the operation
which is referred to as Initial Investment or Initial Capital. Capital is
synonymous to Proprietorship, Proprietary Interest or Net Worth.
The owner's capital can be given a title by indicating the name, with
the word capital written after the name which is separated by a "comma".
Thus, if the owner's name is Altina Chen, the title for his capital account is:
"Altina Chen, Capital"

Withdrawal - The owner's withdrawal is likewise indicated by the use of the

owner's name with the word Drawing or Personal written after the name
which is separated by a comma. Thus, if the owner is Altina Chen who
made withdrawal, the title for his drawing account is:

"Altina Chen, Personal" or "Altina Chen, Drawing"

Income & Expense Summary - this is a temporary account created at the

end of the accounting period where Income and Expenses are temporarily
closed to this account.

STATEMENT OF COMPREHENSIVE INCOME

Or
Income Statement
(Temporary Accounts)

INCOME or REVENUE - this refers to the proceeds from services

rendered by a servicing firm, income from use by other entities of the
resources of the enterprise like royalties income, rent income, interest
income etc. It also includes proceeds from sale of merchandise.

Service Income - In general, this is the account title used for all types of
income derived from rendering of services. Sometimes the account title
used is Service Revenue. Other specific income account titles used are:
Professional Income - the account title generally used by
professionals for Income earned from the practice of their profession or
may be specified as Accounting or Auditing Fees Income for Accountants,
Legal Fees Income for Lawyers, Dental Fees Income for Dentists, Medical
Fees Income for Doctors, etc.
Rental Income - for income earned on buildings, space or other
properties owned and rented out by the business as the main line of its
activity.
Interest Income - for income received by the business arising from
an amount of money borrowed by a customer and usually covered by a
promissory note. This Is typical in lending institutions.
Miscellaneous Income - for income earned by the business which is
not the main line of its activity and could not be clearly classified.

EXPENSES - these are the “gross outflow of economic benefits during the
period arising in the course of ordinary activities of an enterprise when
those outflow result in decrease in equity, other than those relating to
distribution to owners.”

Supplies Expense - this represents cost of supplies that were used

and consumed that bears specific titles as office supplies expense, store
supplies expense, shop supplies expense, etc.
Rent Expense - for the amount paid or incurred for use of property,
usually premises.
Repairs and Maintenance - for expenses incurred in repairing or
servicing the building machineries, vehicles, equipment, etc., which are
owned by the business.
Salaries Expense - for compensation given to employees of a
business. It may be specified as Office Salaries, Salesmen's Salaries, etc.
Uncollectible Accounts - for the anticipated loss that the business
may incur arising from uncollectible accounts.
Depreciation Expense - for the portion of the cost of property and
equipment or fixed assets that has expired based on rational and
systematic allocation procedure.
 Taxes and Licenses - for the amount paid for business permits,
licenses and other government dues except the Income Tax paid which is
not allowable by law as a deduction.
Insurance Expense - account title for the expired portion of the
insurance premium paid.
Utilities Expense - the account title for telephone, light and water
bills.
Interest Expense - an expense incurred from borrowed money. This
is separately shown as a deduction from Profit before finance charges to
arrive at Profit.
Miscellaneous Expense - any amount paid as expense which is not
significant enough to warrant a particular classification.
Gas & Oil - the account title for gasoline, diesoline, lubricants,
grease, fluids, lube oils, etc. for use by company vehicles.

FORMS OF BUSINESS ORGANIZATION

A. Single or Sole Proprietorship

This is the simplest form of business, it is owned by one person
known as the proprietor or entrepreneur.
Advantages Disadvantages
 Sole control over the  Unlimited liability of owner for
operations debts of business
 Less requirements mandated  Difficulty of raising capital
by law  No sharing in the losses
 No sharing of profits  Life of business is dependent
 Income from business is on the owner’s
taxed as personal income
 Easy to dissolve

Assessment 1-7

True or False
Instructions: Write "True" if the statement is correct and "False" if incorrect.
1. The simplest form of business organization where capital is owned by
one person is called sole proprietor.
2. As there is one owner in a sole proprietorship's business, the capital
account is called "owner's equity".
3. Profit of any business cannot be measured if business and personal
assets are combined.
4. Personal affairs of the owner are not recorded in the book of the
business.
5. A proprietor takes full control of his business. He operates without the
interference from anybody.
6. In a sole proprietorship, the owner may be entitled a salary for himself.
7. A proprietor can make withdrawal in cash but not in kind from his
business.
8. One disadvantage of a proprietorship is when the business incurs
losses, he has to bear it all.
9. One advantage of a proprietorship is when the business makes profit
because he shares to nobody.
10. From the legal point of view, the owner and his business are
inseparable. They are one.
11. From the accounting point of view, the business is considered an entity
that is separate and distinct from the owner.
12. In a proprietorship, the business itself does not pay income tax.
13. The income tax of a proprietor is reported as his personal income tax.

B. Partnership
This is formed by two (2) or more persons called Partners who set
forth agreements among themselves on how profits and losses are divided.
Two or more persons may form partnership for the exercise of profession.
A partner may contribute personal services to the partnership.

Since partnership is merely a contract, it can be terminated anytime.

As these are two or more partners, the capital account is called "Partners
Equity”.

Advantages Disadvantages
 Greater source of capital than  Restricted transfer of
single proprietorship ownership, change in
 Pooling of partners’ ownership requires
knowledge dissolution
  Each partner is taxed, as  Life of the business is limited
individual, not the partnership  Unlimited liability of the
business partners
 Partners share in the loss  Partners share in the profits
 Better credit standing than a  One partner’s action can
single proprietorship legally bind the business
 Few legal restrictions than a
corporation

Assessment 1-8

True or False:
Instructions: Write "True" if the statement is correct and "False" if incorrect.
1. Partnership business is always formed by two (2) persons called
"Partners”.
2. Because partnership is a mere contract, it can be terminated when the
partner so desires.
3. Two (2) or more persons may form partnership for the exercise of
profession.
4. One cannot be admitted in an existing partnership without the consent of
the other partners.
5. When there are two partners in a partnership, if one sells his interest to
the other partner, the partnership will be converted into a sole
proprietorship.
6. A contract of partnership may be oral or written.
7. There can never be a partnership to exist without a contribution to a
common fund.
8. A partner may contribute his services to the partnership.
9. The capital account of the partners are called Owner's Equity.

C. Corporation. A business owned by at least five (5) but not more than
fifteen natural persons called "Incorporators" and the corporate charter
which is called “Article of Incorporation” is registered with the Securities
and Exchange Commission (SEC) which is filed together with by laws. In a
Corporation, capital is called Share Capital which is divided into units called
Par Value. There are two (2) classes of share capital: Ordinary and
Preferred Share. Owners of the shares of stocks are called Shareholders.
Their ownership is evidenced by "Share Certificate”. Shares of Stocks can
be transferred without dissolving the corporation so it enjoys unlimited life.
Although the maximum number of years that corporations to exist is 50
years, it can extend its life by amending the Article of Incorporation.

Advantages Disadvantages
 Life of the business is  More difficult and expensive
unlimited to organize
 Owners have limited liability  Subject to more legal
for the debts of the firm restrictions and more
 Ownership is easily government controls
transferable  Subject to higher tax
 Greater source of capital  Owners have little control
over management of the
business

Assessment 1-9

True or False
Instructions: Write "True" if the statement is correct and "False" if incorrect.

1. A corporation may be formed by at least five (5) but not more than fifteen
(15) persons called "Incorporators".
2. The corporate charter of a corporation which is called "Articles of
Incorporation” is registered with the Securities and Exchange Commission
(SEC) together with the by-laws.
3. Incorporators are the persons who originally formed the corporation and
signed the "Articles of Incorporation”.
4. Owner of the share of stocks are called Shareholders.
5. Share Certificate is an evidence of ownership in a corporation.
6. Like a partnership, a shareholder cannot sell or transfer his shares to
other person without informing the other shareholders.
7. The capital account of a corporation is called "Shareholder's Equity”.

Multiple Choice:
Instructions: Write the letter and answer of your choice.
Example: a) quantitative information
1. The capital of a corporation is called-
a) share capital c) share value
b) accumulated profit/loss d) par value
2. The owners of share capital in a corporation are called-
a) incorporators c) par value
b) members d) shareholders
3. The accumulated profit/loss of a corporation is called -
a) accumulated profit/loss c) par value
b) dividends d) share capital
4. The shares in profit of a shareholder is called -
a) dividends c) accumulated profit/loss
b) par value d) share capital
5. The powers of a corporation are vested by a governing body called-
a) Board of Directors c) Board of Juror
b) Board of Governance d) Board of Accountancy
6. The mam number of years that a corporation may exist-
a) 25 years c) 100 years
b) 50 years d) 17 years

Cooperative
This is formed by fifteen (15) or more natural persons who are Filipino
citizen, of legal age, having a common bond of interest and are actually
residing or working in the intended area of operation. Actually, it operates
similar to corporation. Their charter which is called Articles of
Cooperation is registered with Cooperative Development Authority (CDA).
It has its Board of Directors who are elected among its members. The
General Assembly shall be the highest policy-making body of the
Cooperatives. Their voting share is on a one man, one vote.
The net surplus of the cooperative will be divided by among
themselves after deducting the following statutory requirements which are
as follows: 10% - General Reserve Fund, 10% - Cooperative Education
and Training Fund, 7% - Optional Fund, and 3% - Community Development
Fund.
 The balance of 70% is for interest on share capital and patronage
refund which will be given during the Annual General Assembly meeting.
As there are hundreds or thousands of members in Cooperative, the
capital account is called "Members' Equity”.

Assessment 1-10
Quizzers: True or False
Instructions: Write "True" if the statement is correct and "False" if incorrect.
1.Cooperative is formed by fifteen (15) or more natural persons, who are
Filipino citizens, of legal ages and with common bond of interest.
2. Their charter which is called "Articles of Cooperation” is registered with
Cooperative Development Authority (CDA).
3. As requirement, a member should reside or work in intended area of
operation.
4. A cooperative has its own Board of Directors who are elected among
themselves.
5. The voting share of a cooperative is a one-man, one-vote.
6. The General Assembly shall be the highest policy making body of the
Cooperative.

Multiple Choice:
Instructions: Write the letter and answer of your choice.
Example: a) quantitative information
1. Cooperative members who are patronizing their business get a –
a) dividend c) patronage refund
b) net income d) annual bonus
2. What do you call the term used to describe profits of a cooperative?
a) net surplus c) net income
b) net profit d) net gain

TYPES OF BUSINESS ACTIVITIES

Regardless of how they are formed, they may again be classified as to
what type of business activities they are to engage in which are as follows:

Service Concern - the business derived its income from services rendered
to clients in case of professional services, like that of Accountants,
Lawyers, Doctors, Dentists, etc., or to customers in the case of non-
professional services, like that of a hotel where room rental is the main line
of their business, laundry shop, car repair services, janitorial services,
internet cafe, etc.

Merchandising Concern - the business is engaged in buying goods or

commodities or any form of finished products and sells them at a profit. It
might be at a retail or wholesale basis. Grocery stores are best example of
this nature of business. It also includes food and beverage sold in
restaurants and related establishments.

Manufacturing Concern - the business is engaged in buying of raw

materials and supplies to be processed or manufactured, converting them
into finished products for sale at a profit, like that of a furniture shop,
manufacturers of cars and home appliances, etc. Bakeries and restaurants
are no exceptions.

Hybrid Companies - are those involved in more than one type of activity
which are manufacturing, merchandising and service. The trend of our
business establishments nowadays are more of hybrid companies wherein
you can hardly identify as to what activities they are engaged in. For
example, a hotel operating with a restaurant. Hotel industry deals with
services while restaurants are mixture of manufacturing and
merchandising.