INTRODUCTION

Accounting Definition

ACCOUNTING is the system of recording and summarizing business

and financial transactions and analyzing, verifying, ...

is the measurement, processing, and communication of financial and

non-financial information about economic entities ...

•Recording
•Classifying
•Summarizing
•Analyzing
•Interpreting
•Communicating
- Transactions & Events in Monetary Terms

Recording
•Process in which the financial transactions and events
that are identified are recorded in Books
•These typically would be
–Cash Book/ Bank Book
–Purchase and Sales Books
–Bills Receivable and Bills Payable Books
–Purchase and Sales Return Books
–Journal Book (other than above)

Classifying
•Process where transactions or entries of one or similar
nature are grouped.
•The book containing classified information is called “Ledger”.
•For Example, there may be separate account heads for
Sales, Purchases, GST, Salaries,
Rent, Office Expenses, Taxes Paid, Advertisement
expenditure etc.,

Summarizing
•Involves preparation and presentation of the Classified
Data in a manner useful to various
internal and external users.
•Leads to the preparation of the following financial statements
- Trial Balance
- Profit and Loss Account
- Balance Sheet
- Cash-Flow Statement

Analysis & Interpretation

•Includes analyzing and then interpreting the financial data
To make a meaningful judgment of the
Profitability and financial position of the business.
•The financial statement should explain not only
–„what had happened‟but also
–„why it happened‟and also
–„what is likely to happen under specified conditions‟

Communicating
•It is concerned with the transmission of analyzed
and interpreted information to the end-
users to enable them to make rational decisions

•This includes preparation and distribution

of accounting statements/Annual Reports

TYPES OF BUSINESS ORGANIZATION:

There are 4 main types of business organization:
A. Sole proprietorship
B. Partnership
C. Corporation,
D. and Limited Liability Company, or LLC.

Sole Proprietorship
The simplest and most common form of business ownership,
sole proprietorship is a business owned and run by someone for their own benefit.
The business’ existence is entirely dependent on the owner’s decisions,
so when the owner dies, so does the business.

Advantages of sole proprietorship:

All profits are subject to the owner
There is very little regulation for proprietorships
Owners have total flexibility when running the business
Very few requirements for starting—often only a business license

Disadvantages:
Owner is 100% liable for business debts
Equity is limited to the owner’s personal resources
Ownership of proprietorship is difficult to transfer
No distinction between personal and business income

Partnership
These come in two types: general and limited. In general partnerships, both owners
invest their money, property, labor, etc. to the business and are both 100% liable for
business debts.
In other words, even if you invest a little into a general partnership, you are still
potentially responsible for all its debt. General partnerships do not require a formal
agreement—partnerships can be verbal or even implied between the two business
owners.
Limited partnerships require a formal agreement between the partners.
They must also file a certificate of partnership with the state.
Limited partnerships allow partners to limit their own liability for business
debts according to their portion of ownership or investment.
 Advantages of partnerships:
Shared resources provides more capital for the business
Each partner shares the total profits of the company
Similar flexibility and simple design of a proprietorship
Inexpensive to establish a business partnership, formal or informal

Disadvantages:
Each partner is 100% responsible for debts and losses
Selling the business is difficult—requires finding new partner
Partnership ends when any partner decides to end it

Corporation
Corporations are, for tax purposes, separate entities and are considered a legal
person. This means, among other things, that the profits generated by a corporation
are taxed as the “personal income” of the company. Then, any income distributed to the
shareholders as dividends or profits are taxed again as the personal income of the owners.

Advantages of a corporation:
Limits liability of the owner to debts or losses
Profits and losses belong to the corporation
Can be transferred to new owners fairly easily
Personal assets cannot be seized to pay for business debts

Disadvantages:
Corporate operations are costly
Establishing a corporation is costly
Start a corporate business requires complex paperwork
With some exceptions, corporate income is taxed twice

USERS OF FINANCIAL INFORMATION:

INTERNAL USERS
•Board of Directors
•Partners
•Managers
•Officers
•Employees

EXTERNAL USERS
•Investors
•Lenders
•Suppliers
•Government
•Customers

Functions of Accounting

Measurement

Measures past performance

of the business entity and
depicts its current financial
position
 Forecasting Helps in forecasting future
performance and financial
position of the enterprise
using past data

Decision-making Provides relevant information to

the users of accounts to aid
rational decision making

Comparison & Assesses performance achieved

Evaluation in relation to targets which is
important for predicting,
comparing and evaluating the
financial results

Control Defines weaknesses of the

operational system and provides
feedbacks regarding effectiveness
of measures adopted to check
such weaknesses

Govt. Regulation & Provides necessary information

Taxation to the government to exercise
control on the entity as well as
in collection of tax revenues

Financial Statements
Financial Statements are Summary-level reports about an
organization's financial results,
financial position and cash flows.
Useful for:

•Determine the ability of a business to generate cash, and the sources

and uses of that cash.
•Determine whether a business has the capability to pay back its debts.
•Track financial results on a trend line to spot any profitability issues.
•Investigate the details of certain business transactions

Standard contents of a set of financial statements:

•Balance Sheet: Shows the entity's assets, liabilities, and shareholders'
equity as of the report
date.

•Income Statement: Shows the results of the entity's operations and

financial activities for the
reporting period. It includes revenues, expenses, gains, and losses.
•Statement of Cash Flows: Shows changes in the entity's cash flows
during the reporting
period.
•Supplementary Notes: Includes explanations of various activities,
additional detail on some
accounts, and other items as mandated by the applicable accounting
framework, worldwide

Profit and Loss Account(P&L)

•Financial statement that summarizes the revenues, costs, and expenses
incurred during a
specified period, usually a year or even Quarterly (for Stock Exchange
Listed Companies).

•This Statement provide information about a company's ability or inability to

generate profit by increasing revenue, reducing costs, or both.

•P&L Management refers to how a company handles its Profit or Loss

through revenue and
cost management, by taking suitable decisions

Balance Sheet
•A balance sheet is a financial statement that reports a company's assets,
liabilities and
shareholders' equity at a specific point in time, and provides a basis for
computing rates of
return and evaluating its capital structure.
•It is a financial statement that provides a snapshot of what a company
owns and owes, as well
As the amount invested by shareholders.

BALANCE SHEET GROUP:

Assets:
Cash
Accounts Receivable
Notes Receivable
Fixed Assets – Land, Building
Investments
Bank Accounts

Liabilities :
Accounts Payable
Notes Payable
Loans Payable
Secured Loans
Unsecured Loans

Capital
Owner’s Equity

Computerization of Accounts
•Like all functions which are being automated now, Accounting is also
automated through

Computerization & Specific Accounting Softwares

•Computerized Accounting System is Accounting Information System

which processes financial
produce Reports as per User Requirement

•Based on the size of organization, there may be „Single User‟ software

or there may be a „Server having Software‟ with number of users

•„Tally‟ and „Focus‟ are most widely used Softwares

Manual Accounting
•It is a system of accounting that uses physical account books for keeping
financial records.

•All the calculation is performed manually.

•Entries are made in Book of Original Entry.

•The final result is to provide the Financial Statements at the end of the year.

Computerized Accounting

•It is a system of accounting that uses an accounting software for recording

financial transactions electronically

•Only data input is required, the calculations are performed by computer system.

•Entries are recorded in software like Tally, Focus, Quick Books etc.

•The final result is to provide Financial Statements at any time in a given year.

Cash Flow Statement

•Cash Flow Statement summarizes the amount of cash and cash equivalents entering
and leaving a company during a particular period of time

•The cash flow statement (CFS) measures how well a company generates cash to pay
its debt obligations and fund its operating expenses

Annual Report

•An annual report is a publication that public corporations must provide annually to
Shareholders to describe their operations and financial conditions and contains
detailed financial and operational information.
•The intent of the required annual report is to provide public disclosure of a company's
corporate activities over the past year.

•The report is typically issued to shareholders and other stakeholders who use it to
evaluate the firm's financial performance.

CHART OF ACCOUNTS
A chart of accounts is a list of financial accounts set up, usually by an accountant, for an
organization, and available for use by the bookkeeper for recording transactions in the
organization's general ledger.

RULES OF DEBIT AND CREDIT

How do you record debit and credit in journal entries?

Debits are always entered on the left side of a journal entry. Credits: A credit is an accounting
transaction that increases a liability account such as loans payable, or an equity account such as
capital. A credit is always entered on the right side of a journal entry.

ACCOUNTING EQUATION:
Assets = Liabilities + Owner's Capital. (Equity)
Owner's equity = Assets - Liabilities.
Liabilities = = Assets - Net Worth

.Normal Account Balance

A normal balance is the expectation that a particular type of account will have either a debit or a
credit balance based on its classification within the chart of accounts.

Journal entry:

Question
Juan de la Cruz began professional practice as a system analyst on July 1. He plans to
prepare a monthly financial statement. During July, the owner completed these transactions

July 1. Owner invested PHp 500,000 cash along with computer equipment that had a
market value of php. 120,000 two years ago but was now worth Php. 100,000 only.

July 2. Paid php. 15,000 cash for the rent of office space for the month.

July 4. Purchased php. 12,000 of additional equipment on credit (due within 30 days).

July 8. Completed awork for a client and immediately collected the php. 32,000 cash.

July 10. Completed work for a client and sent a bill for php. 27,000 to be paid within 30 days.

July 12. Purchased additional equipment for php. 8,000 in cash.

July 15. Paid an assistant php. 6,200 cash as wages for 15 days.

July 18. Collected php. 15,000 on the amount owed by the client.

July 25. Paid php. 12,000 cash to settle the liability on the equipment purchased.

July 28. Owner withdrew php. 500 cash for personal use.
July 30. Completed work for another client who paid only php. 40,000 for 50% of the
system design.

July 31. Paid salary of assistant php. 700.

July 31. Received PLDT bill, php. 1,800 and Meralco bill php. 3,800.
Required:
Prepare the journal entries, T accounts and trial balance for this business.

Types of Accounting Ratios

Typically, the accounting ratios are classified based on the purpose for which a particular ratio is
calculated. Accordingly, ratios can be classified into following categories:

 Liquidity Ratios
 Solvency Ratios
 Activity (Turnover) Ratios
 Profitability Ratios

I. Liquidity Ratios
Liquidity ratio analysis helps in measuring the short-term solvency of a business. That is, a
company’s ability to meet its short-term obligations. Liquidity suggests how quickly assets of a
company get converted into cash. Further, it ensures uninterrupted flow of cash to meet its current
liabilities. Also, liquidity of a company indicates whether it has sufficient funds to meet its day-to-day
business operations.
Types of Liquidity Ratios

1. Current Ratio
Current ratio evaluates a company’s ability to meet its short-term obligations that are typically due
within a year. A current ratio lower than the industry average suggests higher risk of default on the
part of the company. Likewise companies having too high a current ratio relative to the industry
standard suggests that they are using their assets inefficiently.

Current Ratio Formula = (Current Assets/Current Liabilities)

2. Quick Ratio
Quick ratio is a more cautious approach towards understanding the short-term solvency of a
company. It includes only the quick assets which are the more liquid assets of the company.

Quick Ratio Formula = (Cash and Cash Equivalents + Marketable Securities + Accounts
Receivable)/(Current Liabilities)
3. Cash Ratio
Cash ratio measures company’s total cash and cash equivalents relative to its current liabilities.
Such a ratio indicates the ability of the company to meet its short-term debt obligations using its
most liquid assets.

Cash Ratio Formula = (Cash + Cash Equivalents/Current Liabilities)

II. Solvency Ratios
The term solvency refers to the ability of the company to meet its long – term debt obligations.
Solvency ratios help in determining the amount of debt used by the company as against the owner’s
fund. Further, these help in ascertaining if the company’s earnings and cash flows are sufficient to
meet interest expenses as they accrue in future.
Types of Solvency Ratios

1. Debt To Asset Ratio

This ratio measures the amount of debt taken by a business as against the equity. It helps in
determining the financial leverage of the business.

Debt To Asset Ratio Formula = Total Debt/Total Assets

2. Debt To Capital Ratio
This ratio also helps in measuring the financial leverage of the company. It helps the investors to
have a fair idea about the financial structure of the company. Thus, investors get an understanding
if it is good to invest in a particular company or not. So, higher debt equity ratio indicates higher risk
associated with the company.

Debt to Capital Ratio = Debt(Both Short-Term and Long-Term Debt)/Total Capital (Debt +
Shareholders Equity)
3. Debt To Equity Ratio
This ratio evaluates the amount of debt capital of the company as against its equity capital. Higher
the ratio, weaker the solvency of a company.

Debt To Equity Ratio Formula = Total Debt/Total Shareholders Equity

4. Interest Coverage Ratio
Interest Coverage Ratio determines number of times the EBIT (Earnings before interest and taxes)
of a company can cover its interest payments. This ratio thus indicates the solvency of a firm.
Higher the interest coverage ratio, greater is its solvency.

Interest Coverage Ratio Formula = EBIT/Interest Payments

5. Fixed Charge Coverage
This ratio determines number of times earnings (before interest, taxes and lease payments) of a
company are able to cover the interest and the lease payments of the company. Thus, a higher
fixed charge coverage ratio indicates greater solvency suggesting that the company can pay off its
debt from its earnings.

Fixed Charge Coverage Ratio Formula = (EBIT + Lease Payments)/(Interest Payment + Lease
Payment)
III . Profitability Ratios
Profitability ratios determine the ability of the company to generate profits as against : (i) Sales, (ii)
Operating Costs, (iii) Assets and (iv) Shareholder’s Equity. This means such ratios reveal how well
a company makes use of its assets to generate profitability and create value for shareholders.
Types of Profitability Ratios

1. Gross Profit Margin Ratio

Gross Profit Margin measures the Gross Profit against the sales revenue of a business. This margin
reveals the amount of earnings that a company is generating after considering the costs incurred to
produce goods and services.

Gross Profit Margin Ratio Formula = Gross Profit/Revenue

2. Operating Profit Margin Ratio
Operating Profit Margin is calculated by dividing operating Profit with Net Sales. Where the
operating profit is the difference between gross profit and sum of operating costs such as selling,
general and administrative expenses.
Operating Profit Margin Formula = Operating Profit/Revenue
3. Pre-Tax Margin Ratio
Pre-Tax Margin Ratio is calculated by dividing Pre-Tax Income with the total revenue. Where Pre-
Tax Profit is nothing but Operating Profit less interest.

Pre-Tax margin Formula = Earnings Before Tax But After Interest (EBT)/Revenue
4. Net Profit Margin Ratio
Net Profit Margin refers to the percentage of profit a company generates from its revenues. In other
words, this ratio indicates the amount of net profit a company is able to generate for every unit of
increase in revenue.

Net Profit Margin = Net Income/Revenue

5. Return On Assets Ratio
Return on assets indicates return generated by a company on its assets. A higher return on assets
ratio indicates that the company is able to generate more income from the given amount of assets.

Return On Assets Formula = (Net Income + Interest (1-Tax Rate))/Average Total Assets