Basic Accounting

Edmund E. Hilario, CPA, MBA

History of Accounting









History of Accounting
1. The Florentine vs. the Venetian approach to reporting
The Florentine Approach is the introduction of double-entry
bookkeeping system. It was in the 14th century when Amanito
Manucci, created a recording system where there's at least one
account debited and one account credited and where the total
of debits equals the total of credits. Notice that this system of
recording is the system of double-entry bookkeeping.
Thus, Manucci was tagged as the inventor of double-entry
bookkeeping.
In Venetian Approach of reporting, the merchants kept their
records in bilateral form (alla veneziana), where the debits are
recorded on the left side of the page across the credits. This
method is further described as ledger postings in our time. The
Venetian Method was introduced in the books of the merchant
Andrea Bargarigo (1418-1449).
History of Accounting
(Continuation)
Luca Pacioli (1445-1517), the father of modern
accounting. Pacioli explained the use of books (of
accounts). It was described that the each transaction
was first noted in the memorandum book then listed the
transaction in debit and credit form in the journal, and
finally posted the entries in the ledger.
2. Savary and the Napoleonic Commercial Code
Jacques Savary(1622-1690) introduce historical cost as the
basis of valuation (in his Commercial Code of France, 1673)
Napoleon Bonaparte 1769-1821, exemplified that assets
must be carried at their market value / fair value or
replacement cost (in his Commercial Code).
Eugen Schmalenbach (1873-1955) utilized price level
accounting as the basic valuation.
History of Accounting
(Continuation)
3. The industrial revolution (late 18th and early 19th century) was
the eras when there are major changes happened in the
economy which has a profound effect on socio-economic
and cultural conditions throughout the world. Also, during this
period, new accounting practices were introduced, to wit:
Depreciation, allocation of overhead, inventory
accounting;
Progression of accounting for business entities like sole
proprietorship, partnership, share companies and stock
exchange listed corporations;
Intensified and improved business regulations on
financial reporting and new tax accounting systems and
procedures.
History of Accounting
(Continuation)
4. The arrival of income taxation
It was in AD 10 when the fist known income tax was instituted
by Emperor Wang Mang (45 BC-AD of Xin Dynasty of China,
where the income tax rate is 10% flat rate of profits.
While the first graduated income tax system (from 8.33% to
10%) was implemented in 1798 in Britain by William Pit
In the United States, the first income tax was imposed in July
1861 with a rate of 3% of all income over 600 dollars.
In the Philippines, the first income tax law was created on
March 31, 1913. Currently, our tax laws imposes a graduated
tax rates from 5% to 32% for the Individual Taxpayers, while a
flat rate of 30% was implemented for the taxable income for
partnerships and corporations
History of Accounting
(Continuation)
The arrival of income taxation laws, became another major
event in accounting history for tax Accounting was born as
a specialized field of accounting. In tax accounting,
accountants offered services regarding tax computations,
tax planning, and tax advisory to legally minimize taxes of
clients.
5. Income taxation conflict with financial accounting
History of Accounting
(Continuation)
6 The rise of the group companies and the need for consolidated
accounts
Since the end of World War II, there has been rapid growth
of domestic and multinational corporation which business
enterprises expand not only in terms of new facilities but
most of all business combination, either as merger or a
consolidation
7 Internationalization of markets and reporting
With globalization, the traditional borders associated with
business is fast disappearing, instead, businesses everywhere
needs to operate globally to remain competitive.
Accounting variations
among countries

Accounting variations
among countries
People and users of financial information are not exactly alike
more so among countries, there is a barrier in cultural, legal and
political landscape, geographic constraints, among others. Hence,
accounting variations of accounting practices may be due to the
following factors:
1. Political and economic ties with other countries
2. Status of the accounting profession
3. Existence of a conceptual framework (language,
terminologies, valuation, currency, and recognition principles
used)
4. Quality of accounting education
5. Type of reporting regimes, type of business entity, type of
capital market, type of legal system
6. Level of enforcement & level of inflation.
Linkage of Tax laws and accounting
principles requirements
In the preparation of financial reports, the applicable
accounting standards must be followed but for ITR purposes,
the tax law must prevail.
Deferred income tax refers to the discrepancy in the amount
of financial accounting income from taxable income.
Because of this, tax laws are in conflict with accounting
standards
In 1994, the committee on Accounting Procedure issued ARB
No. 23 providing that the amount of income tax expense
shown in the statement of comprehensive income may not
necessarily be the amount currently payable for income taxes.
Reconciliation between financial income and taxable income
must be made to determine the deferred or accrued income
tax liability.
Degree of Development of
the capital markets
A capital market is known to be equity-oriented when companies
turn to stock market as their main source of capital.
A capital market is known to be debt-oriented when companies
turn to bank financing as their main source of capital
The level of sophistication of financial instruments and the level of
globalization of capital markets have a significant impact on the
financial reporting both in substance and in form, meaning the
financial statements disclosure requirement and financial
reporting level will be likewise be more sophisticated.
Due to the globalization of capital markets, the accounting
variations, the ever-changing demand for the internationalization
of accounting and auditing practices, and among others, there is
now a need to truly address the harmonization of financial
reporting requirement among countries.
Harmonization of
Accounting standards
In 1973, the International Accounting Standards Committee (IASC)
was created to look into the harmonization of Accounting
Standards. However, in 2001, efforts have been made to
harmonize the accounting standard across countries. In fact, this
is the main objective of International Accounting Standard Board
(IASB) - to develop a uniform set of high quality, understandable,
and enforceable global accounting standards. Its purpose is to
achieve a higher degree of comparability and transparency of
financial reporting to help the worlds capital markets and other
users make a better economic decision.
The accounting standards promulgated by the IASC are called
International Accounting Standards (IAS)
The accounting standards promulgated by the IASB are called
International Financial Reporting Standards (IFRS)
Harmonization of Accounting
standards (Continuation)
Currently, the IFRS consists of the following: (1) IFRS, (2) IAS (3)
Interpretation of IFRS & IAS
In 2002, the European Union (EU) required all publicly traded
EU companies to adopt IFRS starting 2005
Countries like the USA, Japan, Singapore, Taiwan, Thailand
and other retained some of their national standards but
converged them closely with IFRS
Other non-European countries such as Philippines changed
their national accounting standards to IFRS.
As of 2007, at least 119 countries have already adopted the
IFRS.
The Financial Reporting
Standard Council (FRSC)
In 1981, the Philippine Institute of Certified Public Accountants (PICPA),
created the Accounting Standard Council (ASC) as the accounting
standard body in the Philippines, the objective of which is to establish
and improve accounting standards that will be generally accepted in
the Philippines.
The accounting standards in the Philippine at that time is called
Statement of Financial Accounting Standards (SFAS) a US-based
GAAP
In 1997, gradually our country started to adopt the IAS and IFRS, the
reasons of which are the followings:
Increasing globalization of businesses
Recognition of IAS by the global communities such as World Bank,
World Trade Organization, Asian Development Bank among others
Complete support by the Philippine Regulatory Agencies
The Financial Reporting Standard
Council (FRSC) (continuation)
In 2004, RA 9298, the Philippine Accountancy Act of 2004 was
passed. Hence, created the Financial Reporting Standard
Council (FRSC) to assist the Board of Accountancy (BOA) to
carry out its functions as provided by RA 9298.
The same year, the Philippines decided to adopt the
accounting standards issued by the IASC and IASB hence, the
approved Philippine accounting standards are known as
Philippine Financial Reporting Standard (PFRS), Philippine
Accounting Standards (PAS) and Interpretation of the
PFRS/PAS, which took effect on January 1, 2005.
Philippine Regulatory
Agencies
The following Philippine agencies that regulate the financial reports
and professional activities of CPAs:
Bureau of Internal Revenue (BIR)
Local Government Unit (LGU)
Security and Exchange Commission (SEC)
Banko Sentral ng Pilipinas (BSP)
Philippine Institute of Certified Public Accountant (PICPA)
Professional Organizations
of CPAs in the Philippines
The accounting profession in the Philippine has grown rapidly since
its formal recognition with the passing of the first Accountancy Law
(RA 3105) in 1923
This law formally recognized accounting as a profession by
restricting its practice to persons possessing a CPA certificate.
It created the Board of Accountancy (BOA) vesting it with authority
to conduct CPA examination, issues CPA certificates and regulate
the practice of public accounting.
Professional Organizations of CPAs
in the Philippines(continuation)
In 1929, CPAs in the Philippines formed the professions national
organization called PICPA, with the following objectives:
1. Protect and enhance the credibility of the CPA certificate
2. Maintain high standards in accounting education
3. Instill ideals of professionalism, ethics, and competence
among accountants
4. Forster unity and harmony among its members
PICPA is the policy making body of
the following accounting
organizations:
ACPAE Association of CPA in education
ACPACI Association of CPA in commerce and industry
ACPAPP Association of CPA in public practice
GACPA Government association of CPAs.
The professional organizations of
CPAs in the field of management
accounting are as follows:
PAMA Philippine Association of Management Accountants
PIMA Philippine Institute of Management Accounting
Chapter 2
THE ACCOUNTING PROFESSION
DEFINITIONS OF
ACCOUNTING
Recording
Classifying
Summarizing money
Transactions
Events
As Defined by American Institute of
Certified Public Accountants (AICPA)
Accounting
is a
the art of
in a
significant
manner and
in terms of
Which are in part at least of
financial character and
interpreting the results
thereof.
C1
1-22
provide
quantitative
information
primarily financial
in nature
that is
intended to
be useful
As Defined by Accounting
Standard Council (ASC)
Accounting
is a service activity.
Its function is to
about
economics
entities
in making economic
decisions.
C1
1-23
identifying
measuring &
communicating to permit
informed
judgment
As Defined by American
Accounting Association (AAA)
Accounting
is the
process of
economic
information

and decisions by
users of the
information.
C1
1-24
Nature of Accounting
A
Discipline
Accounting is a discipline that observe professional
standards and professional ethics. Those who work in
the field of accounting must possess a high degree of
professional integrity and good reputation. Ethics in
accounting is of utmost importance.
A Service
activity
Accounting profession is involved in providing professional
services regarding the financial activities of economic entities
for economic decisions.
An art &
science
Accounting is considered an art because it requires the use
of skills and creative judgment. One has to be trained in this
discipline to be able to perform accounting functions well.
Same manner, accounting is also considered a science
because it is a body of knowledge and is regulated by
accounting rules, principles, standards, postulates and
theories. However, it is not an exact science because the
rules, principles, and standards are constantly changing.
Nature of Accounting
(continuation)

The
language of
business
Accounting serves as a means of communication. It
communicates the results of business operations to
various parties who are directly or indirectly interested
on the economic affairs of the business, such as
1. It informs the economic status of the business
2. It provides the basis for planning, budgeting and
decision making
3. It determine the profitability, liquidity, stability,
capital structure and financial flexibility

The Eyes of
the Business
1. Accountants are the board scorer of the financial
progress of the business.
2. Accountant are economic detectives
3. Accountant are facilitators
Functions of Accounting
1. Basic function of accounting is to provide financial
reports to various end-users for economic decisions.
2. Critical or advance function of accounting is the audit
functions.
Identifying
business
Activities
Record
business
Activities

Communicating
Business
Activities
Basic functions of
Accounting
C 1
1-28
to test the
reliability of the
financial
reports
trace
fraudulent
transactions
locate and
rectify
accounting
errors
Critical or advance
functions of Accounting
C 1
1-29
Purpose of Accounting
The purpose of accounting is to help end-users see the true picture
of the business in financial terms. To achieve this purpose, the
financial reports must be:
1. Understandable
2. Relevant
3. Reliable
The financial reports must contain information that is:
1. Complete
2. Neutral
3. Free from error

Objectives of Accounting
The overall objective of financial reporting is to provide general
purpose financial statements which helps users at least partly, on
the information provided in the financial statements. Particularly,
the objectives can be summarized as follows:
To ascertain the results of operations during a period
To ascertain the financial position
To maintain control over assets
To aid management in planning and performance evaluation
To provide information to government agencies and other
legal purposes
Users of Accounting
Information
External Users
Lenders
Shareholders
Governments
Consumer Groups
External Auditors
Customers
Internal Users
Managers
Officers
Internal Auditors
Sales Staff
Budget Officers
Controllers
C 2
1-32
Users of Accounting
Information
External Users
Financial accounting provides
external users with financial
statements (shareholders,
lenders, etc.).
Internal Users
Managerial accounting provides
information needs for internal
decision makers (officers,
managers, etc.).
C 2
1-33
Opportunities in
Accounting
Financial
Preparation
Analysis
Auditing
Regulatory
Consulting
Planning
Criminal
investigation
Managerial
General accounting
Cost accounting
Budgeting
Internal auditing
Consulting
Controller
Treasurer
Strategy
Taxation
Preparation
Planning
Regulatory
Investigations
Consulting
Enforcement
Legal services
Estate plans
Accounting-
related
Lenders
Consultants
Analysts
Traders
Directors
Underwriters
Planners
Appraisers
NBI investigators
Market researchers
Systems designers
Merger services
Business valuation
Forensic accountant
Litigation support
Entrepreneurs
C 2
1-34
Accounting Jobs by Area
Private
accounting
60%
Public
accounting
24%
Government,
not-for-profit,
& education
16%
C2
1-35
Beliefs that
distinguish
right from
wrong
Accepted
standards of
good and bad
behavior
Ethics
EthicsA Key Concept
C 3
1-36
Identify
ethical concerns
Analyze
options
Make ethical
decision
Use personal
ethics to
recognize an
ethical concern.
Consider all good
and bad
consequences.
Choose best
option after
weighing all
consequences.
Guidelines for Ethical Decisions
C3
1-37
Business Entity Forms
Sole
Proprietorship
Partnership Corporation
C 4
1-38
Sole Proprietorship

Easy to establish
Owned and operated by one individual
Income generated is taxed at the proprietors
personal tax rate
Not recognized as a separate legal entity
Owner faces unlimited liability with respect to
his/her business
Partnerships

Involves two or more owners
Not recognized as a separate
legal entity
Partnership income taxed as personal income
Details of each partners responsibilities are
outlined in a partnership agreement

Two Types of Partnerships
General Partnerships
- partners face
unlimited liability
- partners are
involved in the
day-to-day
operation of the
business
- partners are jointly
liable for all the
obligations of the
partnership
Limited Partnerships
- must have at least
one general partner
involved in business
- limited partners
cannot be involved
in business
operations
- liability is limited to
the amount
invested in the
partnership
Corporations
Dominate in terms of assets and sales
Recognized as separate entities
Profits are taxed based on corporate tax rates
Transfer of ownership is relatively easy
Shareholders exert influence over the corporation
by electing board of directors
Financial accounting standard is governed by
concepts and rules known as PAS & PFRS.
Philippine Accounting Standards
(PAS) & Philippine Financial
Reporting Standards (PFRS)
Relevant
Information
Affects the decision of
its users.
Reliable Information Is trusted by
users.
C 4
Comparable
Information
Used in comparisons
across years & companies.
1-43
The basic Financial statement
& its objective


The objective of financial statement is to provide information about the
financial position, performance and cash flows of an entity that is useful
to a wide range of users in making economic decisions.
Financial
position.

It comprises its assets, liabilities and equity at a particular
time. It pertains to the economic resources, liquidity,
solvency, financial structure and capacity for adaptation of
an entity. This information is pictured in the balance sheet.
Economic resources are useful in predicting the ability of
the entity to generate cash and cash equivalent in the
future.
Liquidity is the availability of cash in the near future to
cover currently maturing obligations.
Solvency is the availability of cash over a long term to
meet financial commitments when they fall due.
The basic Financial statement
& its objective (continuation)

Financial structure is the source of financing for
the assets of the entity.
Capacity for adaptation is the ability of the
entity to use its available cash for unexpected
requirements and investment opportunities.
Financial
Performance
It is the level of income earned by the entity
through the efficient and effective use of its
resources. It is previously known as results of
operation and is portrayed in the income
statement.
Cash flows. Cash flow is useful in order to assess the operating,
investing and financing activities of the entity
during a period. This information is found in the
cash flow statement.
Underlying assumptions
Accounting assumptions are the basic notions or fundamental premises
on which the accounting process is based. It serves not only the
foundation of accounting in order to avoid misunderstanding but rather
enhance the understanding and usefulness of the financial statements.
It is also known as postulates. The conceptual framework mentions two
assumptions, namely accrual and going concern. Anent to this,
implicit in accounting are the basic assumptions of accounting entity,
time period and monetary unit.
Accrual
accounting
The preparation of financial statements every
accounting period is usually based on accrual
accounting. Accrual accounting means that income
is recognized when earned regardless of when
received and expense is recognized when incurred
regardless of when paid. In other words, the essence
of accrual accounting is the recognition of accounts
receivable, accounts payable, prepaid expenses,
accrued expenses, deferred income and accrued
income.
Underlying assumptions
(Continuation)
Going
concern
or continuity
In the absence of evidence to the contrary, the
accounting entity is viewed as continuing in operation
indefinitely. Thus, assets are normally recorded at cost.
Market values are ignored. This postulate is the very
foundation of the cost principle. A case in point, Property,
Plant and Equipment are presented not at what they will
realize if sold but at cost reduced by accumulated
depreciation. If there is evidence that the company would
experience large and persistent losses or that the
companys operations are to be terminated, the going
concern assumption is abandoned.
Time period
assumptions
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 on financial position, performance & cash flows.
Underlying assumptions
(Continuation)
Accounting
entity
is the specific business enterprise, which it may be a
proprietorship, partnership or corporation. Under this
assumption, the business enterprise is separate from the
owners, managers, employees who constitute the firm.
Accordingly, the transactions of the enterprises should not
be merged with transaction of the owners. The reason for
this assumption is to have a fair presentation of financial
statements. The personal transactions of the owners
should not be allowed to distort the financial statements of
the enterprise.
Monetary
unit
assumptions
this assumption has 2 aspects, namely quantifiability and
stability of the peso. The quantifiability aspect means that
the assets, liabilities, capital, income and expenses should
be stated in terms of a unit of measure which is the peso in
the Philippines. The stability aspect of the peso means that
the purchasing power of the peso is stable or constant
and the instability is insignificant and therefore may be
ignored.
Qualitative characteristics
of financial statements

These are the qualities or attributes that make
financial accounting information useful to the uses.
The primary qualities are relevance and reliability,
this relates to content of the financial statements.
the secondary qualities are understandability and
comparability, this relates to the presentation of
the financial statements.
Relevance
This means that the capacity of information to make a
difference in a decision by helping users form prediction
about the outcome of past, present, and future events or
confirm and correct prior expectations. Ingredients of
relevance:
Predictiv
e value
Information has predictive value when it can
help users increase the likelihood of correctly or
accurately predicting or forecasting the
outcome of events.
Feedbac
k value
Information has feedback value when it enables
users to confirm or correct earlier expectations.
Timelines
s
It means providing information to decision
maker while it has the capacity to affect a
decision.
Reliability
This is the quality of information that assures users that
the information is free from bias and error, and
faithfully represents what it purports to represent. The
following enhance the reliability of financial
information:
Faithful representation
Substance over form
Neutrality
Conservatism or prudence
Completeness
Understandability
This requires that the financial
information must be
comprehensible or intelligible if
it is to be useful.
Comparability
This means the ability to bring together for the
purpose of noting points of likeness and
difference. Comparability may be made
within an entity or between and across
entities. Implicit in this characteristic is the
principle of consistency. This principle
requires that the accounting methods and
practices should be applied on a uniform
basis from period to period.

Accounting constraint
of the conceptual framework

Accounting constraint are the factors that may affect the relevance and reliability
of financial accounting information. They are as follows:
Timeliness. Timeliness requires that the accounting information must be
available or communicated early enough when a decision is to be made.
Information furnished after a decision has been made is of no value.
Information may lose its relevance if there is a undue delay in its reporting.
Cost-benefits. The cost-benefit constraint is a consideration of the cost
incurred in generating information against the benefit to be obtained from
having the information. The rule is the benefit derived from the information
should exceed the cost incurred in obtaining the information.
Materiality. Materiality is a practical rule in accounting that dictates that
strict adherence to GAAP is not required when the items are not significant
enough to affect the evaluation, decision, and fairness of the financial
statements. This concept is also known as the doctrine of convenience. In
determining whether an item is material or not, this will dependent on good
judgment, professional expertise and common sense.
Elements of
Financial Statements


The elements of financial statements refer to the
quantitative information shown in the balance
sheet and income statements, they are as follows:
(1) assets, (2) liabilities, (3) equity, (4) income, and
(5) expense.

Recognition of elements this means that the
process of reporting an asset, liability, income or
expense on the face of the financial statements of
an entity. There are four main recognition
principles to be followed in the preparation and
presentation of financial statements namely:
Asset recognition principle
An asset is recognized in the balance sheet when it is
probable that future economic benefits will flow to the
entity and the asset has a cost or value that can be
measured reliably. Thus, it has 2 conditions for the
recognition of an asset:
That it is probable that future economic benefits
will flow to the entity. The term probable means
that the chance of the future economic benefits
arising is more likely rather than less likely.
That cost or value of the asset can be measured
reliably.
Liability recognition
principle
A liability is recognized in the balance sheet when it is
probable that an outflow or resources embodying economic
benefits will be required for the settlement of a present
obligation and the amount of the obligation can be measured
reliably. Again, it has 2 conditions for the recognition of
liability:
That it is probable that an outflow of economic benefits will
be required for the settlement of a present obligation.
That the amount of obligation can be measured reliably.
In the Philippines, the development of generally accepted
accounting principles (GAAP) is formalized initially
through the creation of the Accounting Standard Council
or ASC. The approved statements of the ACS are called
previously as Statement of Financial Accounting
Standards or SFAS. These SFAS are now known as PAS
and PFRS.
Setting Accounting
Principles
The Financial Reporting Standards Council or FRSC replaces
the ACS and is now the accounting standard setting body.
C4
The International Accounting Standards Board (IASB) issues inter-
national standards that identify preferred accounting practices
in other countries. More than 100 countries now require or permit
companies to prepare financial reports following IFRS standards.
1-58

Principles and Assumptions
of Accounting
C 4
Measurement principle (also called
cost principle) means that accounting
information is based on actual cost.
Going-concern assumption means
that accounting information reflects a
presumption the business will
continue operating.
Monetary unit assumption means we
can express transactions in money.
Revenue recognition principle
provides guidance on when a
company must recognize revenue.
Business entity assumption means
that a business is accounted for
separately from its owner or other
business entities.
Matching principle (expense
recognition) prescribes that a
company must record its expenses
incurred to generate the revenue.
Full disclosure principle requires a
company to report the details behind
financial statements that would impact
users decisions.
1-59
Time period assumption presumes
that the life of a company can be
divided into time periods, such as
months and years.
Sarbanes-Oxley Act
In response to a number of publicized
accounting scandals (Enron, WorldCom,
Tyco, ImClone), Congress passed the
Sarbanes-Oxley Act (also called SOX) in 2002
to help curb financial abuses at companies
that issue their stock to the public. The act
requires that public companies apply both
accounting oversight and stringent internal
controls. The desired results include more
transparency, accountability, and
truthfulness in reporting transactions.
1-60
C 4
Assets
Liabilities
+ Equity
Accounting Equation
Liabilities Equity Assets
= +
A1
1-61
Land
Equipment
Buildings
Cash
Vehicles
Store
Supplies
Notes
Receivable
Accounts
Receivable
Resources
owned or
controlled
by a
company
Assets
A1
1-62
Taxes
Payable
Wages
Payable
Notes
Payable
Accounts
Payable
Creditors
claims on
assets
Liabilities
A1
1-63
Owners
claim on
assets
Dividends
Contributed
Capital
Retained
Earnings
Equity
A1
1-64
Liabilities Equity Assets
= +
Expanded Accounting
Equation
Revenues Expenses
Contributed
Capital
Dividends
_
+
_
Retained Earnings
Liabilities Equity Assets
= +
A1
1-65
Transaction Analysis
Business activities can be described in terms
of transactions and events. External
transactions are exchanges of value
between two entities, which yield changes in
the accounting equation. Internal
transactions are exchanges within any entity;
they can also affect the accounting
equation. Events refer to happenings that
affect an entitys accounting equation and
can be reliably measured. Transaction
analysis is defined as the process used to
analyze transactions and events.
1-66
P1
Transaction Analysis
Assets = Liabilities + Equity
Cash Supplies Equipment
Accounts
Payable
Notes
Payable
Common
Stock
(1) 20,000 $ 20,000 $
20,000 $ - $ - $ - $ - $ 20,000 $
20,000 $ = 20,000 $
J. Santos invests $20,000 cash to start
the business in return for stock.
P1
1-67
Transaction Analysis
Purchased supplies paying $1,000 cash.
Assets = Liabilities + Equity
Cash Supplies Equipment
Accounts
Payable
Notes
Payable
Common
Stock
(1) 20,000 $ 20,000 $
(2) (1,000) 1,000 $
19,000 $ 1,000 $ - $ - $ - $ 20,000 $
20,000 $ = 20,000 $
P1
1-68
Transaction Analysis
Assets = Liabilities + Equity
Cash Supplies Equipment
Accounts
Payable
Notes
Payable
Common
Stock
(1) 20,000 $ 20,000 $
(2) (1,000) 1,000 $
(3) (15,000) 15,000 $
4,000 $ 1,000 $ 15,000 $ - $ - $ 20,000 $
20,000 $ = 20,000 $
Purchased equipment for $15,000 cash.
P1
1-69
Transaction Analysis
Assets = Liabilities + Equity
Cash Supplies Equipment
Accounts
Payable
Notes
Payable
Common
Stock
(1) 20,000 $ 20,000 $
(2) (1,000) 1,000 $
(3) (15,000) 15,000 $
(4) 200 1,000 1,200 $
4,000 $ 1,200 $ 16,000 $ 1,200 $ - $ 20,000 $
21,200 $ = 21,200 $
Purchased Supplies of $200 and
Equipment of $1,000 on account.
P1
1-70
Transaction Analysis
Assets = Liabilities + Equity
Cash Supplies Equipment
Accounts
Payable
Notes
Payable
Common
Stock
(1) 20,000 $ 20,000 $
(2) (1,000) 1,000 $
(3) (15,000) 15,000 $
(4) 200 1,000 1,200 $
(5) 4,000 4,000 $
8,000 $ 1,200 $ 16,000 $ 1,200 $ 4,000 $ 20,000 $
25,200 $ = 25,200 $
Borrowed $4,000 from Banko De Oro (BDO)
P1
1-71
Assets = Liabilities + Equity
Cash Supplies Equipment
Accounts
Payable
Notes
Payable
Common
Stock
Bal. 8,000 $ 1,200 $ 16,000 $ 1,200 $ 4,000 $ 20,000 $
8,000 $ 1,200 $ 16,000 $ 1,200 $ 4,000 $ 20,000 $
25,200 $ = 25,200 $
Transaction Analysis
The balances so far appear below. Note that the
Balance Sheet Equation is still in balance.
P1
1-72
Transaction Analysis
Now, lets look at transactions involving revenue, expenses
and dividends.

P1
1-73
Assets = Liabilities +
Cash Supplies Equipment
Accounts
Payable
Notes
Payable
Common
Stock Revenue
Bal. 8,000 $ 1,200 $ 16,000 $ 1,200 $ 4,000 $ 20,000 $
(6) 3,000 3,000 $
11,000 $ 1,200 $ 16,000 $ 1,200 $ 4,000 $ 20,000 $ 3,000 $
28,200 $ = 28,200 $
Equity
Transaction Analysis
Provided consulting services receiving
$3,000 cash.
P1
1-74
Transaction Analysis
Assets = Liabilities +
Cash Supplies Equipment
Accounts
Payable
Notes
Payable
Common
Stock Revenue Expenses
Bal. 8,000 $ 1,200 $ 16,000 $ 1,200 $ 4,000 $ 20,000 $
(6) 3,000 3,000 $
(7) (800) (800) $
10,200 $ 1,200 $ 16,000 $ 1,200 $ 4,000 $ 20,000 $ 3,000 $ (800) $
27,400 $ = 27,400 $
Equity
Remember that expenses decrease equity.
Paid salaries of $800 to employees.
P1
1-75
Transaction Analysis
Assets = Liabilities +
Cash Supplies Equipment
Accounts
Payable
Notes
Payable
Common
Stock Dividends Revenue Expenses
Bal. 8,000 $ 1,200 $ 16,000 $ 1,200 $ 4,000 $ 20,000 $
(6) 3,000 3,000 $
(7) (800) (800) $
(8) (500) (500) $
9,700 $ 1,200 $ 16,000 $ 1,200 $ 4,000 $ 20,000 $ (500) $ 3,000 $ (800) $
26,900 $ = 26,900 $
Equity
Remember that dividends decrease equity.
Dividends of $500 are paid to shareholders.
P1
1-76
Financial Statements
Lets prepare the Financial Statements reflecting the
transactions we have recorded.
1. Income Statement
2. Statement of Retained Earnings
3. Balance Sheet
4. Statement of Cash Flows
P2
1-77
Net income is the
difference
between
Revenues and
Expenses.
Revenues:
Consulting revenue 3,000 $
Expenses:
Salaries expense 800
Net income 2,200 $
Scott Company
Income Statement
For Month Ended December 31, 2011
The income statement describes a
companys revenues and expenses along
with the resulting net income or loss over a
period of time due to earnings activities.
Income Statement
P2
1-78
The net income of
$2,200 increases
Retained Earnings by
$2,200.
Retained Earnings, Dec. 1, 2011 - $
Plus: Net income 2,200
Less: Dividends 500
Retained Earnings, Dec. 31, 2011 1,700 $
Scott Company
Statement of Retained Earnings
For Month Ended December 31, 2011

Revenues:
Consulting revenue 3,000 $
Expenses:
Salaries expense 800
Net income 2,200 $
Scott Company
Income Statement
For Month Ended December 31, 2011
Statement of Retained
Earnings
P2
1-79
Cash 9,700 $ Accounts payable 1,200 $
Supplies 1,200 Notes payable 4,000
Equipment 16,000 Total liabilities 5,200
Common stock 20,000
Retained earnings 1,700
Total assets 26,900 $
Total liabilities and equity
26,900 $
Equity
Assets Liabilities
Scott Company
Balance Sheet
December 31, 2011
The Balance Sheet describes
a companys financial position
at a point in time.
Balance Sheet
Retained Earnings, Dec. 1, 2011 - $
Plus: Net income 2,200
Less: Dividends 500
Retained Earnings, Dec. 31, 2011 1,700 $
Scott Company
Statement of Retained Earnings
For Month Ended December 31, 2011
P2
1-80
Cash flows from operating activities:
Cash received from clients 3,000 $
Purchase of supplies (1,000)
Cash paid to employees (800)
Net cash provided by operating activities 1,200 $
Cash flows from investing activities:
Purchase of equipment (15,000)
Net cash used in investing activities (15,000)
Cash flows from financing activities:
Investment by Shareholders 20,000
Borrowed at bank 4,000
Dividends Paid (500)
Net cash provided by financing activities 23,500
Net increase in cash 9,700 $
Cash balance, December 1, 2011 -
Cash balance, December 31, 2011 9,700 $
Statement of Cash Flows
For Month Ended December 31, 2011
Scott Company
Statement of Cash Flows
P2
1-81
ROA is a profitability
measure.
Return on Assets (ROA)
Net income
Average total assets
Return
on
assets
=
A2
1-82
End of Chapter 01
1-83