Principles of Accounting

Engineering Economy

Introduction
Accounting is the process of recording all the transactions of

the company which affect any investment of capital, so that at

any time the results of the investment may be known.
Accounting has also been defined as the body of principles by
means of which all business transactions expressible in terms
of money are recorded, classified, and periodically
summarized and interpreted.

Bookkeeping
Is the systematic recording of all business transactions in

financial terms. The study of bookkeeping usually emphasizes

technique, while the study of accounting gives emphasis on
theory. Accounting is a more comprehensive process as
compared to bookkeeping.

Accounting
The main purpose of accounting for any business enterprise

is to provide all the necessary financial information to the

management for the proper and efficient operation of the
enterprise. Errors in judgement of the management are
minimized if the records are presented in a proper manner by
the accountant. Records are needed by entities operated for
profit as well as non-profit making organizations, such as the
government and associations operating for religious,
philanthropic or fraternal purposes. Records are also need to
record financial transactions of individuals for taxation and
other purposes.

Accounting Terms
Assets are defined as anything of value possessed by an

enterprise. They consist of property and the right to

property, tangible, or intangible, which may be used for the
payment of debt.
Liabilities are debts or claims of anyone other than the
owners of the property upon the assets of the company. They
consist of all the obligations of the company to other persons
in the form of money, other assets, services, to be paid now
or in the future.

Accounting Terms
Ownership or proprietorship is the excess of assets over

liabilities. It represents the investment of a person or several

persons in the enterprise.
Equities are the claims of anyone against the assets of the
enterprise. It therefore includes the liabilities to creditors as
well as the claims of the owners.

Types of Assets
Assets are classified and described as follows:
Fixed Assets properties that will not be converted into

cash or transformed into saleable form. Buildings, land,

machinert, equipment, furniture, and fixtures which are used
in the productions of goods. It does not mean however that
fixed assets are stationary or incapable of motion. The buses
of a transportation company or the airplanes of an airplane
are fixed assets, but they are not stationary.

Types of Assets
Current or Liquid Assets These are the items of value which

include cahs, accoutns receivable within a short time or at least

within the present accounting period, raw materials, goods in the
process of production, and finished goods ready for sale.
Prepaid Expense these are the assets in the form of money
paid for certain materials not yet delivered or services not yet
rendered to the company. The advance payment for insurance or
rental are prepaid expenses until the term for which they were
paid has expired. In certain cases the company may order and pay
for its materials well in advance of delivery date of the same, in
which case the amount paid is considered an asset until delivery is
made.

Types of Assets
Intangible Assets have no physical substance. Principal

examples are: goodwill, leaseholds, copyrights, patents,

franchises, licenses, and trademarks. Accounting for an
intangible asset os rendered somewhat difficult because the
lack of physical substance makes evidence of its existence
more elusive, may make its value debatable, and its useful life
may be questionable. The inclusion of intangible assets on the
balance sheet is justified only when there is good evidence
that future earnings will be obtained from these assets.

Types of Assets
Copyright is an exclusive right granted by the government to

protect the production and sale of literary or artistic work for a

period of 50 years or during the lifetime of the author.
Patent is an exclusive right granted by the government fro the
manufacture, use, and sale of a specific product. When a company
acquires a patent or copyright by purchase from the owner, the
purchase price is classified as an asset.
To obtain the exclusive right to the use of a trademark,
brandname, or commercial symbol all one has to do is to register
it with the proper government entity. The expenses incurred in
registering it is included in the balance sheet as an intangible asset.

Types of Liabilities
Fixed Liabilities which are not due payment until sometime

in the future, usually after a period exceeding one year.

Current Liabilities these are the liabilities which mature
within a short time; usually a year
Prepaid Income these are the liabilities representing
income which have been paid to the enterprise, but for which
the goods have not been delivered or any service rendered to
the payer.

Types of Ownership
For an individual ownership or sole propriertorship, the

owneship will be in the capital account of the sole owner.

For a partnership, the ownership will be in the capital
account of the partner.
For a corporation, the ownership is vested in the shares of
common and preferred stock of the persons who have
invested in them.

Fundamentals Equation of Accounting

The fundamental equation of accounting is:
Assets = Equities
Equities = Liabilities + Ownership
Assets = Liabilities + Ownership
In other words, the sum total of the things of value possessed by the
enterprise equals the sum total of the claim against the enterprise
which consist of the claims of persons aside from the owners and
claims of the owners themselves against the enterprise.

Balance Sheet
Is a financial summary showing the relationship among assets,

liabilities, and ownership in the corporation on a specific

date. It is considered to be the most important financial
statement of any enterprise and is conceded to the goal of all
accounting activity. Basically, it enumerates the nature and
amount of the assets, liabilities, and ownership in the
company.

Balance Sheet
There are two forms of balance sheets.They are:
The account or Horizontal Form: In this form, the assets are

summarized on the left side of the page, and the liabilities

and ownership on the right side. The totals on either side are
equal, thus conforming to the fundamental equation of
accounting
Assets = Liabilities + Ownership

Balance Sheet
The report or Vertical Form: The assets are listed first and

immediately below them the liabilities followed by the

ownership. As required by the fundamental equation of
accounting, the total assets must equal the total of the
liabilities and ownership.
It is important to note that the balance sheet must be
prepared as of a given date, for any transaction, no matter
how small, will effect the totals on either side of the balance
sheet.

Balance Sheet

The Profit and Loss Statement

Is a summary of the income and expenses of an individual or

company for a given period. Profit results from an excess of

income over expenses. A loss is indicated if the expenses exceed
the income for the given period.
Income is defined to be the value of personal and professional
services rendered or of goods sold in the operation of the business.
It is classified into two divisions:
Operating Income results from the primary operation of the
company from the sale of its products or from the rendering of the
services for which the enterprise was established.
Non Operating Income this is due to the loan or sale of the assets
not needed in the primary operation of the business or in the
rendering of unusual service not included in the basic services
rendered by the company.

The Profit and Loss Statement

Expense is defined as the cost of producing income or

revenue. It is subdivided into

Operating Expense are incurred in the pursuit of the primary
operations of the business.
Non-operating Expense are incurred in operations different
from the basic operations of the business.

Financial Ratios
A ratio is a simple mathematical expression of the

relationships between two items. For a ratio to have a

meaning, there must be a significant relationship between
two figures. Ratios are an aid to analysis and interpretation of
financial statements.

Financial Ratios
Current Ratio
Indicates capacity of the company to pay short-term debts

Quick ratio (Acid-test ratio)

Indicates the short-term liquidity of a firm

Financial Ratios
Inventory Turnover
Shows the ability of management to control investment in

inventory

Accounts Receivable Turnover

Indicates effectiveness of collections

Financial Ratios
Asset Turnover
A high asset turnover indicates that the management makes

better use of the assets

Debt Ratio
Gives the percentage of assets financed through borrowing

Financial Ratios
Number of times interest earned
Indicates capacity to pay on interest on debts, particularly

long-term debts

Equity Ratio
Shows the protection to creditors and measures proportion

of total assets financed by stockholders

Financial Ratios
Return on total assets
Measures the productivity of assets

Operating expense ratio

Indicates adequacy of control over expenses

Financial Ratios
Price earnings ratio
Indicates whether price of stock is compatible with earnings

Dividend yield
Gives the rate earned per share based on current price per

share

Financial Ratios
Times preferred dividends earned
Indicates the adequacy of current earnings to pay dividends

on preferred stock

Return on common stockholders equity

Gives the earning power of common stockholders equity

Financial Ratios
Earnings per share on common stock
Gives the amount of earnings of one share of common stock

Book value per share of common stock

Indicates the recorded value of net assets for each share of

common stock