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LEARNING OBJECTIVES
Basic
Accounting
Concepts and 1. Read and interpret basic financial statements.

Techniques 2. Analyze typical business transactions using the balance

sheet equation.
3. Distinguish between the accrual basis of accounting and
the cash basis of accounting.
JAYSON R. SORIANO
4. Make adjustments to the accounts under accrual
JIMSON R. TAN accounting.
RUBY H. VERAYIN
5. Explain the nature of dividends and retained earnings.
JAN CARLO M. VILLANUEVA
ASTHER G. VILLAREAL
6. Select relevant items from a set of data and assemble
them into a balance sheet and an income statement.

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THE NEED FOR ACCOUNTING THE NEED FOR ACCOUNTING

Accounting information can be used to assess past financial
performance of a company and help predict its future
performance. All kinds of organizations—government
agencies, nonprofit organizations, and others —rely on
accounting to gauge their progress.
The accounting process begins with a transaction. A
transaction is any event that affects the financial position
of an organization and requires recording.

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THE NEED FOR ACCOUNTING THE NEED FOR ACCOUNTING

Financial statements are used to summarize the recorded Managers, investors, and other internal groups want the
accounting transactions. answers to two important questions:

How well did

the organization Where does
perform? the organization
stand?

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THE NEED FOR ACCOUNTING BALANCE SHEET

Accountants answer these questions with three major The balance sheet (also called statement of financial
financial statements: position or statement of financial condition) is a snapshot
of the financial status of an organization at a point in time.

Balance Income The balance sheet has two sections:

sheet statement
(1)assets and

(2)liabilities plus owners’ (stockholders’) equity.

Statement
of Cash Flows

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BALANCE SHEET BALANCE SHEET

Assets = Liabilities + Owners’ equity The owners’ equity of a corporation is called stockholders’
equity.
– Assets are economic resources that are expected to
benefit future activities of the organization. Stockholders’ equity

– Liabilities are the entity’s economic obligations to non-

owners.
Paid-in Retained
– Owners’ equity is the excess of the assets over the
liabilities. capital earnings

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KING HARDWARE TRANSACTIONS KING HARDWARE TRANSACTIONS

The following additional transactions occurred during
AN EXAMPLE March:

– King Hardware Company began business as a

corporation—a business organized as a separate legal
entity and owned by its stockholders. The company’s first
transaction occurred on February 28, 20X1, when its
stockholders invested a total of $100,000 cash.

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KING HARDWARE TRANSACTIONS BALANCE SHEET

Analysis of Transactions (in dollars) for March

144,000 144,000

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REVENUES AND EXPENSES REVENUES AND EXPENSES

– Revenues are increases in ownership claims arising from
the delivery of goods or services.
– Recognize revenue by formally recording it in the
accounting records during the current period only after it
meets two tests:
– Expenses are decreases in ownership claims (stockholders’
equity) arising from delivering goods or services or using up
assets.
– Income (also called net income, profits, or earnings), is the
excess of revenues over expenses. It increases
stockholders’ equity.

1. The company must earn the revenues. That is, it must deliver the
goods or render the services to customers.
2. The revenue must be realized or realizable.
– An income statement summarizes revenues and expenses.
It measures an organization’s performance by matching its
revenue and its expenses for a span of time, often a month,
a quarter, or a year.

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RELATIONSHIP BETWEEN BALANCE SHEET AND
INCOME STATEMENT
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THE ANALYTICAL POWER OF THE BALANCE SHEET
EQUATION
– The balance sheet equation can highlight the link
between the income statement and balance sheet.
– Assets (A) = Liabilities (L) + Stockholders’ equity (SE)
– A = L + Paid-in capital + Retained income
– A = L + Paid-in capital + Revenue – Expenses
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INCOME STATEMENT
– The income statement shows that General Mills’
stockholders’ equity (retained earnings) increased by
$1,804 million because of profitable operations in the year
ended May 29, 2011. This $1,804 million is included in the
$6,612 million of stockholders’ equity on the May 29, 2011,
balance sheet.
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ACCRUAL BASIS AND CASH BASIS
– The accrual basis of accounting recognizes revenues and
expenses when they occur regardless of when cash is
received or disbursed.
– The cash basis of accounting recognizes revenue and
expense when cash is received and disbursed.
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ACCRUAL BASIS AND CASH BASIS
– The major deficiency of the cash basis of accounting is
that it is incomplete.
– It fails to match efforts and accomplishments in a
manner that properly measures economic performance
and financial position.
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ADJUSTMENTS TO THE ACCOUNTS
– Explicit transactions are easy to identify because they
are supported by source documents.
– Implicit transactions are recorded at the end of each
accounting period by using adjusting entries.
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ADJUSTMENTS TO THE ACCOUNTS
Under the accrual basis of accounting, record:
1. Explicit transactions-day-to-day routine events
1. Implicit transactions - events that day-to-day
recording procedures temporarily ignore, such as
expiration of prepaid rent or accrual of interest due to the
passage of time.
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PRINCIPAL ADJUSTMENTS
Four types of principal adjustments:
1. Expiration of unexpired costs
2. Recognition (earning) of unearned revenues
3. Accrual of unrecorded expenses
4. Accrual of unrecorded revenues
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ADJUSTMENT TYPE I: ADJUSTMENT TYPE I:

EXPIRATION OF UNEXPIRED COSTS
– Assets other than cash and receivables are viewed as
economic services awaiting future use—prepaid or stored
costs, and they are carried forward to future periods.
The values of assets frequently decline (and eventually
disappear) because of the passage of time.
EXPIRATION OF UNEXPIRED COSTS
Rather than immediately charge these costs as expenses,
they are charged as expenses in future periods when the
services are used.

– When a company uses services represented by a

particular cost, the cost expires. An unexpired cost is any
asset that managers expect to become an expense in
future periods.

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EXPIRATION OF UNEXPIRED COSTS DEPRECIATION

– Assets frequently expire because of the passage of time. To account for long-lived assets, assets that will provide
services for more than one year:
– Assets other than cash and receivables are viewed as
economic services awaiting future use. 1. predict the length of the asset’s useful life

– Unexpired costs are assets that managers expect to 2. predict the residual value
become expenses in future accounting periods.
3. allocate the cost of the equipment to the years of its
useful life in a systematic way.

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ADJUSTMENT TYPE II: ADJUSTMENT TYPE III:

UNEARNED REVENUE (DEFERRED REVENUE)
Unearned Revenue (deferred revenue) is . . .
– A liability recorded when a company receive collections
from customers before it earns the revenue.
ACCRUAL OF UNRECORDED EXPENSES
Accrue means to accumulate a receivable or payable during
a given period, even though no explicit transaction occurs.

– Because customers have already paid in advance for

merchandise or services . . .
Interest expense Employee wages
– An obligation exists to deliver merchandise or service or
refund the customers’ deposits if the goods or services
are not delivered.

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ADJUSTMENT TYPE IV: ADJUSTMENT TYPE IV:

ACCRUAL OF UNRECORDED REVENUES
– The recognition of revenues that a company has earned
but has not yet recorded in its accounts is
– …..the mirror image of the accrual of unrecorded
expenses.
ACCRUAL OF UNRECORDED REVENUES
Summary of accruals of expenses and revenues (in the
columns) and the timing of the accrual compared to the
cash flows (in the rows).

Interest Revenue

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DIVIDENDS AND RETAINED EARNINGS
– Dividends are distributions of assets to stockholders that
reduce retained earnings.
– Cash dividends are distributions of cash rather than
some other asset.
– The distribution reduces both assets and owners’ equity
and is made possible by profitable operations.
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RETAINED EARNINGS
– Stockholders’ equity represents the claims of owners arising
out of their initial investment (paid-in capital) and
subsequent profitable operations (retained earnings).
– Retained earnings and paid-in capital represent a general
claim against, or undivided interest in, total assets, not a
specific claim against any asset.
– Retained earnings and paid-in capital result from profitable
operations. Equity is not a pot of cash awaiting distribution
to stockholders.
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DIVIDENDS AND RETAINED EARNINGS
– Dividends reduce retained earnings, But they are not
expenses.
– Companies do not deduct dividends from revenues when
measuring income because they do not help generate
sales or conduct operations.
RETAINED EARNINGS
– Retained earnings and paid-in capital result from
profitable operations. Equity is not a pot of cash awaiting
distribution to stockholders.
– Do not confuse retained earnings and cash. Cash can
increase while retained earnings decreases, and vice
versa. There is no direct relationship between retained
earnings and available cash.
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KING HARDWARE COMPANY BALANCE SHEET

King Hardware Company
Balance Sheet as of April 30, 20X1

– Select relevant items from a set of data and assemble

them into a balance sheet and an income statement.

– The balance sheet uses totals from the asset, liability,

and stockholders’ equity columns

– The income statement uses the revenue and expense

entries in the retained earnings column.

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INCOME STATEMENT CHANGES IN RETAINED EARNINGS

King Hardware Company Income Statement King Hardware Company Changes in Retained Earnings for the
for the Month Ended April 30, 20X1 Month Ended April 30, 20X1

This statement shows the linkage between the balance sheet

and income statement. It starts with the beginning balance,
adds net income for April, and deducts cash dividends, to
arrive at an ending balance.

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END
Thank you!!

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