LESSON 3: FINANCE AND ACCOUNTING

Both finance accounting deal with money. Accounting records financial transactions
which involve finance that needs to be properly accounted for. Therefore, finance and
accounting are related in that they both deal with money and financial transactions.
Objectives:
1. Define accounting and its components
2. Explain the financial statements and their significance.
3. Discuss the accounting equation and its application
4. Describe the balance sheet, income statement, cash flow statement and their
components
Lesson 1:
Accounting – is the art of recording, classifying, and summarizing transactions and
events, which are, in part at least, of a financial character and interpreting the results
thereof.
- It is a service activity in that it serves the need of decision makers by providing
them with the needed financial information regarding a business unit.
- It presents the financial statements which show the results of operation of a firm
(Statement of Comprehensive Income or Income Statement), the firm’s financial
condition or position (Statement of Financial Condition or Statement of Financial
Position or Balance Sheet), the changes that occurred in the owner’s equity,
and/or the sources and uses of funds.
-
Human capital – includes human resources, i.e., the employees, including the rank and
file employees, the managerial employees, consultants, auditors, among others are
utilized by the company to attain its goals and objectives.
Finance & Accounting:
Finance is concerned with funds, and accounting for these funds is essential.
While finance deals with sources and uses of funds, accounting deals with recording
financial transactions to determine results of operation and financial condition of the
business which will determine if funds were acquired and utilized effectively.
Profit maximization – the ultimate objective of any business firm because it is the best
way to increase owner’s wealth and the value of the company.
Accounting profits – are the measure managers and owners use to measure
performance of firms.
Financial accounting – the branch of accounting that deals with recording of business
transactions and ultimately, the preparation of the financial statements.
- The basic objective is to provide the objective financial information about how the
business is performing and how stable the company is.
Managerial accounting – the branch of accounting concerned with providing information
to managers, those inside the organization, and those who direct and control the
company’s operation.
- It presents information that is apart from what is contained in the basic financial
statements.
- It focuses on the role of accounting information in the decision-making process of
managers with responsibilities inside the organization (Welsch and Anthony
1991).
Financial management – concerned with the efficient and effective allocation,
acquisition, and use of funds.
- Financial managers are responsible for forecasting and planning, making major
investment and financing decisions, coordination and control, and dealings with
the financial markets.

Financial statements – help managers to decide whether a company still needs

improvement or needs to be expanded. They are indispensable tool of the finance
managers.
Internal users – are the owners, managers, and employees.
External users – are the government and other regulatory agencies, the
suppliers, the creditors, the competitive firms, and the community the business is
in.
Finance – is the management of money or the money resources itself.
Non-human capital –includes tangible and intangible resources needed by a
company to attain its goal.

TYPES OF FINANCIAL STATEMENTS

1. Statement of Changes in Financial Position or Balance Sheet - shows the

financial condition/ position of a business as of given period. It consists of the
assets, liabilities, and capital.
2. Statement of Comprehensive Income or Income Statement - shows the
 result of operations for a given period. It consists of the revenue, cost, and
expenses.
3. Statement of Changes in Owner’s Equity or Statement of Owner’s Equity –
show the changes in the capital or owner’s equity as a result of additional
investment or withdrawals by the owner, plus or minus the net income or net loss
for the year.
4. Statement of Cash Flows – summarizes the cash receipts and cash
disbursements for the accounting period. it summarizes the cash activities of the
business by classifying cash inflows and cash outflows into operating, investing, and
financing activities.

Balance sheet accounts, namely asset, liabilities, and owner’s equity, are
classified as…

ASSETS – these are economic resources owned by the business expected for future
gain. they are property and rights of value owned by the business.
LIABILITIES – these include debts, obligations to pay, and claims of the creditors on the
assets of the business.
OWNER’S EQUITY OR CAPITAL – this includes the interest of the owners of the
business; claims of the owners on the assets of the business; and the investment of
the owner plus or minus the results of operations.

The fundamental accounting equation:

Assets = liabilities + owner’s equity

Assets - liabilities = owner’s equity
Assets - owner’s equity = liabilities

ILLUSTRATION:
Assets = Liabilities + Owner’s Equity
100,000 = 40,000 + 60,000
Assets - liabilities = owner’s equity
100,000 - 40,000 = 60,000
Assets - owner’s equity = liabilities
100,000 - 60,000 = 40,000

Classification of assets:
Current Assets – include cash and other assets or resources which are reasonably
expected to be realized in cash or sold or consumed during the normal operating
cycle.
Non-current Assets – when the assets are not expected to be realize into cash within 12
months, not for resale or restricted from being exchanged.

Classification of Current Assets:

Cash – includes coins, currencies, checks, bank deposits, and other cash items readily
available for use in the operations of the business.
Accounts receivable – the amount collectible from the customer to whom sales have
been made or services have been rendered on account or credit.
Notes receivable – a promissory note issued by the client or the customer in
exchange for services as evidence of his/her obligation to pay.
Interest receivable – amount of interest collectible on promissory notes received
from customers and clients.
Advances to employees – certain amount of money loaned to employees payable in
cash or through salary deductions.
Merchandise inventory – goods that are remain unsold.
Prepaid insurance – insurance premiums paid in advance.
Prepaid rent – rent paid in advance.

Contra-Asset Accounts:
Allowance for bad debts – these are losses due to uncollectible accounts.
Accumulated depreciation – represents the expired cost of property, plant and
equipment as a result of usage and passage of time.

Classification of Non-current Assets:

Long-term investments – assets held by an enterprise for the accretion of wealth
through capital distribution such as interest, royalties, dividends and rentals, for
capital appreciation or for other benefits to the investing enterprise.
Property, Plant, and Equipment – tangible assets that are held by an enterprise for
use in the production of supply of goods or services, or for administrative purposes
and which are expected to be used for more than one period.

Examples of Property, Plant, and Equipment:

Land – a piece of lot or rea estate owned by the enterprise on which a building can be
constructed for business purposes.
Building – a structure used to accommodate the office, store, or factory of a business
enterprise in the conduct of its operation.
Equipment – includes typewriter, air-conditioner, calculator, filing cabinet, cars used
by the business in its office, store, or factory.
Furniture and Fixtures – include tables, chairs, carpets, curtains, and wall decors.
Intangible assets – they are identifiable, non-monetary assets without physical
substance held for use in the production or supply of goods or services, or for
administrative purposes. these include goodwill, patents, copyrights, licenses,
franchise, trademarks, etc.
Intangible assets – include goodwill, copyrights, tradenames and brands, among others.

Classification of liabilities:

Current Liabilities – obligations that are reasonably expected to be liquidated through

the use of existing current assets or the creation of other current liabilities within
the normal operating cycle or one year.
Non-current Liabilities – long term liabilities or obligations which are payable for a
period longer than one year.

Classification of Current Liabilities:

Accounts payable – includes debts arising from purchase of an asset or acquisition of
services on account.
Notes payable – includes debts arising from purchase of an asset or acquisition of
services on account evidenced by a promissory note.
Loan Payable – a liability to pay the bank or other financing institution arising from
funds borrowed by the business from these institutions payable within 12 months or
shorter.

Classification of Current Liabilities:

Utilities payable – an obligation to pay utility companies for services received from
them.
Unearned revenues – represent obligations of the business arising from the advance
payments received before goods are services are provided to the customer.
Accrued liabilities – include amounts owed to others for expenses already incurred
but not yet paid. examples: salaries payable, interest payable, etc.

Classification of Non-current Liabilities:

Mortgage payable – a long-term debt of the business with security or collateral in the
 form of real properties.
Long-term notes payable – notes payable that are due after one year.

Owner’s Equity
Capital – an account bearing the name of the owner representing the original and
additional investment of the owner of the business increased by the amount of net
income earned during the year. it is decreased by the cash or other assets
withdrawn by the owner as wells as the net loss incurred during the year.
Drawing – represents the withdrawals made by the owner of the business either in
cash or other assets.
Income summary – a temporary account used at the end of the accounting period to
close income and expense accounts. the balance of this account shows the net
income or net loss for the period it is closed to the capital account.
FORMS OF INCOME STATEMENT:

Natural Form – otherwise called the nature of expense method, presents expenses
according to nature. this type of income statement is used in a service business.
Functional form – otherwise known as the cost of sales method, presents expenses
according to function. this type is used in a merchandising business.
Income account in a service concern:
1. SERVICE INCOME – represents charges to clients or customers for services
rendered. example: laundry services by a laundry shop
Rent income – represents charges for the uses of assets.
Repair income – represents charges to costumer for repair services rendered.
Laundry income – represents charges to customers for laundry services rendered.

Income account in a merchandising company:

1. Sales – represents the total gross selling price of goods sold on cash or credit.
2. Sales returns – represents the selling price for defective, damaged or
unacceptable goods
returned by the customers.
3. Sales allowances – represents the reduction in the selling price for defective or
damaged goods
sold.
4. Sales discounts – represents the reduction in the amount to be collected from a
customer due to his payment within the discount period.

Cost accounts – (represents the value of the goods sold)

Purchases – represents the original acquisition price of the goods for resale.
Purchase returns – represents the cost of goods purchased but returned to supplier
because they are damaged, defective or unacceptable.
Purchase allowances – represents the reduction in the cost of defective or damaged
goods bought but not returned to the supplier.
Purchase discounts – represents the reduction in the amount to be paid to the
supplier due to payment of account within the discount period.
Freight in – represents the cost of transporting goods purchased from the supplier to
the store or the warehouse of the business.

Expense accounts:
Salaries or wages expense – includes all payments, made to employees or workers
for rendering services to the company.
Utilities expense – an expense related to the use of electricity, fuel, water, and
telecommunications facilities.
Supplies expense – covers office supplies used by the business in the conduct of its
daily operations.
Insurance expense – the expired portion of premiums paid on insurance coverage.
Depreciation expense – the annual portion of the cost of a tangible asset such as
buildings etc. charged as expense for the year.
Interest expense – the amount of money charged to the borrower for the use of
borrowed funds.

Forms of Balance sheet:

Account Form – follows the accounting equation where assets are listed on the left-
hand column of the report with the liabilities and owner’s equity on the right-hand
column.
Report form – shows in one straight column the assets, followed by the liabilities and
owner’s equity.

Components of the Statement Flows classified according to activities:

 Operating activities
 Investing activities
 Financing activities

Operating activities
the cash inflows (receipts) and the cash outflow (payments) arising from the normal
operations of the business.
Receipts of cash:
• collections from customers for the performance of services or sale of goods
• royalties, fees, commissions received
• interest, dividends, and other income received
Payment of cash:
• to suppliers for services and goods acquired
• employee’s salaries
• government licenses and taxes
• interest expense and other operating expenses

Investing activities
the cash inflows (receipts) and the cash outflow (payments) from the purchase and
sale of property and equipment, investment in debt or trading securities.

Financing activities
the cash inflows (receipts) and the cash outflow (payments) from the owners and
creditors of the business.
• Receipts of cash:
• original and additional investment by owner
• proceeds of loan
Payments of cash:
cash withdrawal of owner
payment for the principal balance of loan