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GFI CPA REVIEW THEORY OF ACCOUNTS Mahalaleel S. Malayo, CPA

ACCOUNTING, ACCOUNTANCY and the CPA PROFESSION 1. ASC s definition: Accounting is a service activity. Its function is to provide quantitative information, primarily financial in nature, about economic entities, that is intended to be useful in making economic decision. AICPA s definition: Accounting is the art of recording, classifying and summarizing in a significant manner and in terms of money, transactions and events which are in part at least of a financial character and interpreting the results thereof. AAA s definition: Accounting is the process of identifying, measuring and communicating economic information to permit informed judgment and decision by users of the information. a. Identifying the recognition or nonrecognition of accountable events i. Internal events economic events involving the entity only ii. External events economic events involving one entity and another entity. b. Measuring the process of assigning Peso amounts i. Historical cost past purchase exchange price ii. Current cost current purchase exchange price iii. Realizable value current sale exchange price iv. Present value future exchange price c. Communicating the preparation and distribution of FS to the users. i. Recording or journalizing the process of systematically maintaining a record of al all business transactions ii. Classifying grouping of similar items (done by posting to the ledger) iii. Summarizing preparing and distribution of financial reports 2. Purpose of accounting. To provide quantitative financial information about the business . 3. R.A 9298 a.k.a Philippine Accountancy Act of 2004 is the law regulating the practice of accountancy in the Philippines. 4. BOA is the body authorized to promulgate rules and regulations affecting the practice of the accountancy in the Philippines. 5. The SEC shall not register any corporation organized for the practice of public accountancy. 6. Areas where CPAs generally practice their profession. a. Public accounting practitioners render independent and expert financial services to the public such as auditing, taxation and MAS. b. Private accounting CPAs are employed in business entities, its objective is to assists management is planning and controlling the entity s operations. c. Government accounting involves the accounting of receipt and disposition of government funds and property. 7. GAAP represent the rules, procedures, practice and standards followed in the preparation and presentation of FS. Developed on the basis of experience, reason, customs, usage and practical necessity. (Like laws that must be followed in financial reporting). 8. ASC (now FRSC) promulgates accounting standards (GAAP) and the approved standards are previously called SFAS but currently known as PAS and PFRS. 9. FRSC s function is to establish and improve GAAP. It is composed of 15 members (including the chairman) 10. PIC prepares interpretations of PFRS and provide guidance on Financial accounting issues not specifically addressed in current PFRS. Interpretations are intended to give authoritative guidance on standards that do not provide specific and clearcut rules and guidance. CONCEPTUAL FRAMEWORK OF ACCOUNTING 1. The Conceptual Framework sets out the concepts that underlie the preparation and presentation of financial statements for the common needs of a wide range of users. (Concerned with General-purpose FS, including consolidated FS). 2. Special purpose Financial reports (e.g. prospectus, computations prepared for taxation purposes) are outside the scope the Framework. 3. The Framework is promulgated by the IASB and adopted by the local FRSC. 4. The Conceptual Framework is NOT PAS and PFRS nor it overrides any PAS and PFRS. In case of conflict, PAS and PFRS prevails over the Framework. 5. The purpose of the Framework is to: A) Assist FRSC in developing GAAP and its review and adoption of existing IAS. B) Assist preparers of FS in applying the standards and in dealing with issues not yet covered by GAAP. C) Assist auditors in forming an opinion as to whether FS conforms to GAAP. D) Assist users in interpreting the FS. E) Provide interested parties with information about PAS/PFRS formulation by FRSC. 6. The scope of the Framework covers the following: A) CAPITAL CONCEPTS: The concepts of capital and capital maintenance Page 1 of 4

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GFI CPA REVIEW THEORY OF ACCOUNTS Mahalaleel S. Malayo, CPA

B) OBJECTIVE: the objective of FS C) QUALITATIVE CHARACTERISTICS: the qualities or attributes that make accounting information useful to the users thereof D) ELEMENTS: the definition, recognition and measurement of the elements of FS 7. Two CAPITAL CONCEPTS: Financial (most common) and Physical concept (based on productive capacity). 8. Under the financial capital maintenance, a profit is earned and only if the financial amount of ending net assets exceeds beginning net assets, EXCLUDING distribution to and contribution from owners during the period. 9. Under the physical capital maintenance, a profit is earned only if the physical productive capacity (operating capability) at the end of period exceeds the same capacity at the beginning of period, excluding any distribution to and contributions from owners during the period. This requires the adoption of the CURRENT COST basis of measurement. 10. The principal difference between the two concepts of capital maintenance is the treatment of the effects of changes in the prices of assets and liabilities of the enterprise. 11. Four theories of accounting: A) Entity theory p A = L + C _proper income determination income statementa B) Proprietary theory p A L = C _proper valuation of assets balance sheeta C) Residual entity theory p A L Preferred SHE Common SHE {proper valuation of assets} D) Fund theory p cash inflows cash outflows = fund {government entities} 12. The management of an enterprise has the primary responsibility for the preparation and presentation of FS. Management has the ability to determine the form and content of such additional information in order to meet its own needs. The reporting of such information, however, is beyond the scope of Framework. 13. The framework is concerned with general-purpose financial statements (including consolidated financial statements) of all commercial, industrial, and business reporting public or private enterprises. 14. Special Purpose financial reports (e.g., prospectuses and computations prepared for taxation purposes) are outside the scope of this framework. 15. Accounting assumptions are the basic notions or fundamental premises on which the accounting process is based. These include: (1) Accrual (2) Going Concern (3) Accounting Entity (4) Time Period (5) Monetary Unit. {the Framework mentions (1) & (2); (3), (4), & (5) are implied} 16. A complete set of FS normally includes the (1) B/S, (2) I/S, (3) statement of comprehensive income, (4) statement of changes in equity, (5) statement of cash flows (6) Notes to FS 17. The users of financial statements include present and potential investors, employees, lenders, suppliers and other trade creditors, customers, governments and their agencies and the public. 18. The OBJECTIVE of FS is to provide information about the: A) Financial position Balance Sheet (As to its liquidity, solvency, financial structure, and its capacity to adapt). B) Performance Income Statement and statement of comprehensive income (As to its profitability and capacity to generate cash flows) C) Cash Flows (as to investing, financing and operating activities) D) Other necessary information Notes and Supplementary Schedules The FS also shows the results of the stewardship of management the accountability of management for the resources entrusted to it. 19. The QUALITATIVE CHARACTERISTICS of FS: C Comparability pIntracomparability; Intercomparability PRESENTATION U Understandability R - Relevance p Predictive value; Feedback value; Timeliness CONTENT Ry Reliability p Faithful Rep n; Substance over form; Neutrality; Prudence or Conservatism & Completeness 20. Constraints on relevant and reliable information: Timeliness, Cost-benefit, Materiality and Balance between Qualitative Characteristics. 21. The ELEMENTS of FS: A) Balance sheet elements: Assets, Liabilities and Equity B) Income statement elements: Income (includes revenue and gains) and Expense (includes expenses and losses) 22. An item that meets the definition of an element should be recognized (recorded) if: A) It is probable that any future economic benefits associated with the item will flow to or from the enterprise AND B) The item has a cost or value that can be measured with reliability. 23. Four different measurement bases are employed to measure the elements of FS: A) Historical cost (most common) B) Current cost Page 2 of 4

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GFI CPA REVIEW THEORY OF ACCOUNTS Mahalaleel S. Malayo, CPA

C) Realizable (settlement) value D) Present value 24. Other revenue recognition principles include: a. Installment method (used in installment sales) proportionate revenue is recognized at the point of collection. {GPR x collection} b. Cost recovery or sunk cost method revenue is recognized at the point of collection after recovery of its cost. c. Cash method revenue is recognized when received regardless of when earned. d. Percentage of completion method (used in construction contracts). e. Production method (applicable to agricultural, forest and mineral products) revenue is recognized at the point of production. 25. Matching Principles include: a. Cause and effect association principle expense is recognized when the revenue is recognized b. Systematic and rational allocation principle expense is recognized over a period of time c. Immediate recognition principle expense is recognized outright 26. Accounting Process or accounting cycle {AJ PTA FC PoRe} a. Analyzing is the process of determining accountable events, the effect on the elements of FS, and determining the debits and credits. i. Accountable events are the transactions that affect the Elements of FS. ii. Elements of FS and their normal balances. 1. Assets DR 2. Liabilities CR Real Accounts 3. Capital CR 4. Income CR Nominal Accounts 5. Expenses DR iii. Debit the left side of an account iv. Credit the right side of an account v. Source documents these are the original materials evidencing a transaction (e.g. sales invoices, purchase invoices, official receipts, debit and credit memorandum, check stubs and minutes of book) b. Journalizing the recording of transactions to the journal. i. Simple entry consists of one debit and one credit. ii. Compound entry consists of two or more debits or credits. iii. General Journal (or simply journal ) is a chronological record of transactions. If special journals are used, transactions that cannot be recorded in the special journal are recorded in the general journal. (Adjusting, Closing and Reversing) iv. Special Journal includes and transactions to be recorded: a. Cash receipts journal (CRJ) all transactions involving cash inflows. b. Cash disbursement journal (CDJ) all transactions involving cash outflows. c. Sales Journal (SJ) all sales on account d. Purchase Journal (PJ) all purchases on account (including purchase of merchandise, equipment and other assets on account) v. Voucher system is a system of IC over all cash disbursements. a. Voucher is a written authorization for every cash disbursements. b. Voucher register is a journal where all vouchers are recorded in a numerical sequence. (entry: Dr: non-cash assets or expenses or appropriate account ; Cr: vouchers payable) c. Check register is a journal where all checks issued for payment of are recorded. (entry: DR: Vouchers payable; CR: CIB) d. Unpaid vouchers file is a subsidiary of a vouchers payable account. e. Paid vouchers file a file where all paid vouchers are placed. c. Posting the process of transferring information from the journal to the ledger i. Journal book of original entry ii. Ledger book of final entry iii. Chart of accounts listing of all accounts in a systematic form. iv. Subsidiary ledger is the device used in storing the details of certain General Ledger account. v. Nominal or temporary accounts those accounts that are being closed at the end of the period (Income and Expenses). They are not accumulated from period to period. vi. Real or permanent accounts these accounts are accumulated from one accounting period to another. (Assets, Liabilities & Equity) vii. Mixed accounts are those accounts consisting real and nominal elements.

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GFI CPA REVIEW THEORY OF ACCOUNTS Mahalaleel S. Malayo, CPA

viii. Contra accounts are offset accounts or those that are deducted from the related account. ix. Adjunct accounts are those that are added from the related account. d. Trial Balance preparation is a list of general ledger accounts with their respective debit or credit balance. It provides evidence that the total debits equals total credits. e. Adjusting entries preparation are made to update and correct account balances at the end of the accounting period. Item that needs adjustments Adjusting Entries i. Ending Inventory (Periodic) Inventory-end xx Income Summary or COS xx ii. Doubtful accounts (recognition of Doubtful accounts xx expense) Allowance for Doubtful Accounts xx iii. Depreciation Depreciation xx Accumulated Depreciation xx iv. Prepaid Expenses (originally recorded using): 1.) Asset Method Expense xx Prepaid Expense xx 2.) Expense Method* v. Accrued Expenses* vi. Deferred Income (originally recorded using): 1.) Liability Method Prepaid Expense xx Expense xx Expenses xx Accrued Expenses xx

Deferred Income Income

xx xx

2.) Income Method* vii. Accrued Income* viii. Errors

Income xx Deferred Income xx Accrued Income xx Income xx *depends on the entry made and the correct entry.

Kinds of errors: a. Transposition {1,234 was recorded as 2134} b. Transplacement {11,000 was recoded as 1,000} c. Error of omission a transaction was not recorded d. Counter balancing error failure to detect and correct the error in the current period and the next period will result to a correct balance sheet in the next accounting period. {ESPPADA} e. Non-counter balancing error failure to correct the error will always result to a misstated balance sheet not until it will be discovered and corrected. {depreciation} f. FS preparation a worksheet is a tool commonly used by accountant in compiling and summarizing the information necessary for the preparation of the FS. g. Closing Entries preparation nominal accounts are being closed because they are just a measure of activities for a given period only. Therefore, it is logical to closed temporary accounts so not to misstate the performance of the company in the next accounting period. The accounts that are being closed include: {Sales/Revenues, Cost and Expenses, also temporary accounts such as income summary, drawing accounts, & dividends declared } h. Post-closing Trial Balance preparation (optional) consists entirely of real or permanent accounts. i. Reversing Entries preparation this done beginning of the next accounting period to simplify recording of certain kinds of recurring transactions. *The adjustments related to items that the company normally recorded using cash basis of accounting requires reversing entries. These include: a. Accrued expenses b. Prepaid expenses, if originally recorded using expense method. c. Accrued income d. Deferred income, if originally recorded using income method.

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