Accounting-concepts-and-principles.pptx

ACCOUNTING CONCEPTS AND PRINCIPLES

- Encompass the conventions, rules and procedures necessary to define accepted practice at a particular time. - Developed on the basis of experience, reason, custom, usage and practical necessity.

Accounting Assumptions- are the basic notions or fundamental premises on which the accounting process is based. They are also known as postulates.

GOING CONCERN- the only assumption mentioned in the New Conceptual Framework. - means that in the absence of evidence to the contrary, the accounting entity is viewed as continuing in operation indefinitely.

1.ENTITY CONCEPT -states that the transactions associated with a business must be separately recorded from those of its owners or other businesses. (e.i. MPA’s Coffee Shop & Mr. Marianne Palma Allamino) Sample transactions: o The owner of a company personally acquires an office building, and rents space in it to his company at P50,000 per month. This rent expenditure is a valid expense to the company, and is taxable income to the owner. o The owner of a business loans P100,000 to his company. This is recorded by the company as a liability, and by the owner as a loan receivable.

2. PERIODICITY CONCEPT/ TIME PERIOD ASSUMPTION - requires that the indefinite life of an entity is subdivided into time periods or accounting periods which are usually of equal length for the purpose of preparing financial reports. -need for timely reports. 3. STABLE MONETARY UNIT  Quantifiability aspect- means assets, liabilities, equity/capital, income and expenses should be stated in terms of a unit of measure which is peso in the Philippines.  Stability of Peso Assumption- stability of peso is stable or constant and its instability is ignored. -the basis for ignoring the effects of inflation in the accounting records.

 HISTORICAL COST- states that acquired assets should be recorded at their actual cost and not at what management thinks they’re worth as at reporting date.  REVENUE RECOGNITION- income shall be recognized when earned. – delivered/rendered

 MATCHING PRINCIPLE- costs and expenses incurred in earning a revenue shall be reported in the same period.  EXPENSE RECOGNITION PRINCIPLE- application of matching principle. It means that expenses are recognized when incurred.

 OBJECTIVITY- accounting records and statements are based on the most reliable data available so that they will be as accurate and as useful as possible.  ADEQUATE DISCLOSURE- all significant and relevant information leading to the preparation of financial statements shall be clearly reported.  MATERIALITY- Financial reporting is only concerned with information that is significant enough to affect evaluations and decision. It depends on relative size and nature of the item judged in the particular circumstances of its omission.  CONSISTENCY- the accounting methods and practices should be applied on a uniform basis from period to period.

CONCEPTUAL FRAMEWORK -describes the basic concepts that underlie the preparation and presentation of financial statements for external users.

o Framework is not PFRS and hence does not define standards for any particular measurement or disclosure issue. o In those cases where there is a conflict, the requirement of the PFRS prevail over those of the framework.

Scope The Conceptual Framework addresses: 1. The objective of financial reporting 2. The qualitative characteristics of useful financial information 3. The reporting entity 4. The definition, recognition and measurement of the elements from which financial statements are constructed 5. Concepts of capital and capital maintenance

1. OBJECTIVE OF FINANCIAL REPORTING -to provide financial information about the reporting entity that is useful to present and potential investors, lenders and other creditors in making decisions in their capacity as capital providers.

2. QUALITATIVE CHARACTERISTICS -attributes that make the information provided in the financial statements useful to users.  Fundamental  Enhancing

 FUNDAMENTAL QUALITATIVE CHARACTERISTICS -contribute to decision usefulness of financial reporting information. a.

RELEVANCE- capable of making a difference in decision

made by users. 1. Predictive Value- influences the economic decisions of users by helping them evaluate past, present and future events. 2. Confirmatory Value (Feedback Value)- confirming or correcting their past evaluation..

 FUNDAMENTAL QUALITATIVE CHARACTERISTICS b. FAITHFUL REPRESENTATION- to be useful, financial information must not only be relevant, it must also represent faithfully the phenomena it purports to represent. 1. Completeness- information must be complete but within the bounds of materiality and cost. 2. Neutrality- free from bias toward predetermined result. 3. Free from error- absence of material error. *Substance over form- if information is to represent faithfully the transactions and other events it purports to represent, it is necessary that they are accounted in accordance with their substance and reality and not merely their legal form.

 ENHANCING QUALITATIVE CHARACTERISTICS (VCUT)

a. VERIFIABILITY- means that different knowledgeable and independent observers could reach consensus, although not necessarily complete agreement, that a particular depiction is faithful representation. b. COMPARABILITY- can be compared with a similar information about other entities and with similar information about the same entity for another period or another date.  Intercomparability- between and across entities  Intracomparability- within the entity

 ENHANCING QUALITATIVE CHARACTERISTICS (VCUT) c. UNDERSTANDABILITY- classifying, characterizing and presenting information clearly and concisely makes it understandable. d. TIMELINESS- means that information is available to decision-makers in time to be capable of influencing their decisions.

*COST-BENEFIT CONSTRAINT- cost of providing information should not exceed benefits derived from it.

3. REPORTING ENTITY- no discussion yet. 4. ELEMENTS OF FINANCIAL STATEMENTS- are the “building blocks” from which financial statements are constructed. Relating to Financial Position: a. ASSET- resources controlled by the entity as a result of past events and from which future economic benefit are expected to flow to the entity.

Relating to Financial Position: b. LIABILITY- present obligation of the entity arising from past events, the settlement of which is expected to result in an outflow from the entity of resources embodying economic benefits. c. EQUITY- the residual interest in the asset of the entity after deducting all its liabilities.

Relating to Performance:

a. INCOME- increases in economic benefits during the accounting period in the form of inflows or enhancements of assets or decreases of liabilities that result in increases in equity, other than those relating to contributions from equity participants. *Encompasses both revenue and gains. REVENUE- arises in the course of the ordinary activities of an entity and is referred to by a variety of different names including sales, fees, interest, dividends, royalties and rent.

Relating to Performance:

b. EXPENSE- decreases in economic benefits during the accounting period in the form of outflows or depletions of assets or incurrences of liabilities that result in decreases in equity, other than those relating to distributions to equity participants. *Encompasses losses as well as those expenses that arise in the course of the ordinary activities of the entity.

Recognition- process of incorporating in the financial statements an item that meets the definition of an element and satisfies the following criteria for recognition: o Asset Recognition Principle- asset is recognized in the balance sheet when it is probable that the future economic benefits will flow to the entity and the asset has a cost or value that can be measured reliably. o Liability Recognition Principle- liability is recognized in the balance sheet when it is probable that an outflow of resources embodying economic benefits will result from the settlement of a present obligation and the amount at which the settlement will take place can be measured reliably.

o Income Recognition Principle- income is recognized in the income statement when an increase in future economic benefit related to an increase in an asset or a decrease of a liability has arisen that can be measured reliably. o Expense Recognition Principle- expense is recognized in the income statement when a decrease in future economic benefit related to a decrease in an asset or a increase of a liability has arisen that can be measured reliably  Cause & Effect Association  Systematic & Rational Allocation  Immediate Recognition

MEASUREMENT OF THE ELEMENTS OF FINANCIAL

STATEMENTS -involves assigning monetary amounts at which the elements of the financial statements are to be recognized and reported. 1. HISTORICAL COST- is the amount of cash or cash equivalent paid or the fair value of the consideration given to acquire an asset at the time of acquisition. 2. CURRENT COST- is the amount of cash or cash equivalent that would have to be paid if the same or equivalent asset was acquired currently.

MEASUREMENT OF THE ELEMENTS OF FINANCIAL

STATEMENTS 3. REALIZABLE VALUE- is the amount of cash or cash equivalent that could currently be obtained by selling the asset in an orderly disposal. 4. PRESENT VALUE- is the discounted value of the future net cash inflow that the item is expected to generate in the normal course of business.

CONCEPTS OF CAPITAL  Financial Concept of Capital- synonymous with the net asset or equity of the entity.  Physical Concept of Capital- capital is regarded as the productive capacity of the entity based on, for example, units of output per day.

CONCEPTS OF CAPITAL MAINTENANCE AND DETERMINATION OF PROFIT a.

FINANCIAL CAPITAL MAINTENANCE- profit is earned only if

the financial amount of net assets at the end of the period exceeds the financial amount of net assets at the beginning of the period, after excluding any distributions to, and contributions from, owners during the period. b. PHYSICAL CAPITAL MAINTENANCE- profit is earned only if the physical productive capacity of the entity at the end of the period exceeds the physical productive capacity at the beginning of the period, after excluding any distributions to, and contributions from, owners during the period.

ACCOUNT - a basic summary device of accounting. -defined as a detailed record of the increases, decreases and balance of each element that appears in an entity’s financial record. T-ACCOUNT-simplest form of the account.

3 PARTS OF ACCOUNT 1. Account Title 2. Debit Side 3. Credit Side

Financial Statements

– are the final products of accounting.

THE ACCOUNTING EQUATION- most basic tool of accounting.

ASSET= LIABILITIES + OWNER’S EQUITY THE DOUBLE-ENTRY SYSTEM - the dual effects of a transaction is recorded. - a debit side entry must have a corresponding credit side entry. -each transaction affects at least two accounts. -total debits for a transaction must always equal the total credits.

DEBIT- left side. Latin word, DEBERE. CREDIT- right side. Latin word, CREDERE. When there is a change in an account, that change is indicated by either debiting or crediting that account according to following rules:

Assets and Expenses An increase is recorded as debit (left side) A decrease is recorded as credit (right side) Liabilities, Equities and Revenues A decrease is recorded as debit (left side) An increase is recorded as credit (right side)

NORMAL BALANCE OF AN ACCOUNT Increases Recorded by Account Category ASSET

Debit

Credit



LIABILITIES

Normal Balance

Debit

Credit

 







OWNER’S EQUITY: OWNER’S CAPITAL

WITHDRAWALS

 

INCOME EXPENSES





 

EXAMPLES:

1. The owner brings cash from his personal account into the business. 2. Wages payable are paid. 3. Revenue is earned but not yet received. 4. Purchased Furniture & Fixtures on account. 5. Paid Rent Expense for the month.

ACCOUNTING EVENTS AND TRANSACTIONS ACCOUNTING EVENT- is an economic occurrence that causes changes in an enterprise’s assets, liabilities, and/or equity. TRANSACTION- is a particular event that involves the transfer of something of value between two entities.

TYPES AND EFFECTS OF TRANSACTIONS TYPES: 1. SOURCE OF ASSETS (SA)- an asset account increases and a corresponding claims (liabilities/ owner’s equity) account increases. 2. EXCHANGE OF ASSETS (EA)- one asset account increases and another asset account decreases. 3. USE OF ASSETS (UA)- an asset account decreases and a corresponding claims (liabilities/equity) account decreases. 4. EXCHANGE OF CLAIMS (EC)- one claims(liabilities/equity) account increases and another claims (liabilities/equity) account decreases.

EFFECTS: 1. 2. 3. 4. 5. 6. 7. 8. 9.

Increase in Assets= Increase in Liabilities (SA) Increase in Assets= Increase in Owner’s Equity (SA) Increase in one Asset= Decrease in another Asset (EA) Decrease in Assets= Decrease in Liabilities (UA) Decrease in Assets= Decrease in Owner’s Equity (UA) Increase in Liabilities= Decrease in Owner’s Equity (EC) Increase in Owner’s Equity= Decrease in Liabilities (EC) Increase in one Liability= Decrease in another Liability (EC) Increase in one Owner’s Equity= Decrease in another Owner’s Equity (EC)

TYPICAL ACCOUNT TITLES USED STATEMENT OF FINANCIAL POSITION

ASSETS (Current and Non-current) According to PAS 1, an entity shall classify assets as current when: 1. it expects to realize the asset, or intends to sell or consume it, in its normal operating cycle; 2. it holds the asset primarily for the purpose of trading; 3. It expects to realize the asset within 12 months after the reporting period; or 4. the asset is cash or a cash equivalent unless the asset is restricted from being exchanged or used to settle a liability for at least 12 months after the reporting period. ALL OTHER ASSETS SHOULD BE CLASSSIFIED AS NON-CURRENT.

Current Assets Cash. Cash is any medium if exchange that bank will accept for deposit at face value. It includes coins, currency, checks, money order, bank deposits and drafts.

Cash Equivalents. Per PAS No. 7, these are 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 value. Notes Receivable. A note receivable is written pledge that the customer will pay the business a fixed amount of money on a certain date. Accounts Receivable. These are claims against customers arising from sale of services or goods on credits. This type of receivable offers less security than a promissory note.

Inventories. Per PAS No.2, these are assets which are (a) held for sale in the ordinary course of business; (b) in the process of production for such sale; or (c) in the form of material or supplies to be consumed in the production process or in the rendering of services. Prepaid Expenses. These are expenses paid for by the business in advance. It is an asset because avoids having to pay cash in the future for a specific expense. These include insurance and rent. These prepaid items represent future economic benefits-assets-until the time these start to contribute to the earning process; these, then, become expenses. Non-current Assets Property, Plant and Equipment. Per PAS No. 16, these are tangible assets that are held by an enterprise for use in the production or supply of goods or services, or for rental to others, or for administrative purposes and which are expected to be used during more than one period. Included are such items as land, building, machinery and equipment, furniture and fixtures, motor vehicles and equipment.

Accumulated Depreciation. It is a contra account that contains the sum of the periodic depreciation charges. The balance in this account is deducted from the cost of the cost of the related assets- equipment or buildings – to obtain book value. Intangible assets. Per PAS No. 38, these are identifiable, nonmonetary assets without physical substance held for use in the production or supply of goods or services, for rental to others, or for administrative purpose. These includes goodwill, patents, copyrights, licenses, franchises, trademarks, brand names, secret processes, subscription lists and non-competition agreements

LIABILITIES According to PAS 1, an entity shall classify a liability as current when: 1. it expects to settle the liability in its normal operating cycle; 2. it holds the liability primarily for the purpose of trading; 3. the liability is due to be settled within 12 months after the reporting period; or 4. the entity does not have an unconditional right to defer settlement of the liability for at least 12 months after the reporting period. ALL OTHER LIABILITIES SHOULD BE CLASSIFIED AS NONCURRENT.

Current Liabilities. Accounts Payable. This account represents the reverse relationships of the accounts receivable. By accepting the goods or services, the buyer agrees to pay for them in the near future. Notes Payable. A note payable is like a note receivable but in a reverse sense. In the case of a note payable, the business entity in the maker of the note; that is, the business entity is the party who promises to pay the other party a specified amount of money on a specified future date. Accrued Liabilities. Amounts owed to others for unpaid expenses. This account includes salaries payable, utilities payable, interest payable and taxes payable. Unearned revenues. When the business entity receives payment before providing its customers with gods or services, the amounts received are recorded in the unearned revenue account (liability method). When the goods o0r services are provided to the customer, the unearned revenue is reduced and income is recognized.

Current Portion of Long-Term Debt. These are portions of mortgage notes, bonds and other long-term indebtedness which are to be paid within one year from the balance sheet date.

Non-current Liabilities Mortgage-Payable. This account records long-term debt of the business entity which the business entity has pledged certain assets as security to the creditor. In the event that the debt payments are not made, the creditor can foreclose or cause the mortgage assets to be sold to enable the entity to settle the claim. Bonds Payable. Business organizations often obtain substantial sums of money from lenders to finance the acquisition of equipment and other needed assets. They obtain these funds by issuing bonds. The bond is a contract between the issuer and the lender specifying the terms of repaying and the interest to be charged.

Owner’s Equity Capital (from the Latin capitalis, meaning ”property”). This account is used to record the originality and additional investments of the owner of the business entity. It is increased by the amount of the profits earned during the year or is decreased by a loss. Cash or other assets that the owner may withdraw from the business ultimately reduce it. This account title bears the name of the owner. Withdrawals. When the owner of a business entity withdraws cash or other assets, such are recorded in the drawing or withdrawal account rather than directly reducing the owner’s equity account. Income Summary. It is a temporary account used at the end of the accounting period to close income and expenses. This account shows the profits or loss for the period before closing to the capital account.

INCOME STATEMENT Income Service Income. Revenues earned by performing services for a customer or client; for example, accounting services by a CPA firm, laundry services by a laundry shop. Sales. Revenues earned as a result of sale of merchandise; for example, sale of building materials by a construction supplies firm. Expenses Cost of sales. The cost incurred to purchase or to produce the product sold customers during the period; also called cost of goods sold. Salaries or Wages Expense. Includes all payments as a result of an employeremployee relationship such as salaries or wages, 13th month pay, cost of living allowances and other related benefits. Utilities Expenses. Expenses related to use or consumption of electricity, telephone, fuel and water.

Rent Expenses. Expense for space, equipment or other asset rentals. Supplies Expense. Expense of using supplies(e.g. offices supplies) in the conduct of daily business. Insurance Expenses. Portion of premiums paid on insurance coverage (e.g. on motor vehicle, health, life, fire, typhoon or flood) which has expired. Depreciation Expense. The portion of the cost of a tangible asset(e.g. building and equipment)allocated or changed as expense during an accounting period. Uncollectible Accounts Expense/ Doubtful Accounts Expense. The amount of receivable estimated to be doubtful of collection and charged as expense during an accounting period. Interest Expense. An expense related to use of borrowed funds.

Sample transactions Mar.1 Mar.2 Mar. 3 Mar. 4 Mar. 5 Mar. 9 Mar. 11 Mar. 16 Mar. 17 Mar.19 Mar. 20 Mar. 21 Mar. 27 Mar. 31

Medina started his new business by depositing P350,000 in the bank account in the name of Medina Graphics Design at BPI Poblacion Branch. Computer equipment is acquired by issuing a P50,000 note payable to Orcajada Office Systems. The note is due in six months. Medina paid P15,000 to Grande Suites for rent on the studio for the months of March, April and May. Received advance payment of P18,000 from Marco Polo Davao Hotel for web site updating for the next three months. Computer equipment costing P140,000 is acquired on cash basis. Computer supplies in the amount of P25,000 are purchased on account. Medina Graphics Design collected P88,000 in cash for designing web sites. Medina paid P18,000 to Bills Express for the semi-monthly utilities. Medina billed clients P35,000 for services already rendered during the month. Medina partially paid P17,000 for the Mar.9 purchase of computer supplies. Received checks totaling P25,ooo from clients for billings dated Mar.17. Medina withdrew P20,000 from the business for his personal use. Loqueloque billed Medina for P8,000 ads. Medina will pay next month. Medina paid his assistant designer salaries of P15,000 for the month.