ACTG1A Fundamentals of Accounting Theory and Practice 1A I. The Field of Accounting A.

. Meaning And Nature Of Financial Accounting Accounting is a social science. The nature of accounting information has been dictated from time immemorial by the needs of the users of the day. The history of accounting reflects the pattern of social developments and the forces which necessitate the changes in accounting system from time to time. Over the years accountancy has made tremendous progress in the field of commerce and industry. Accounting can be described as being concerned with measurement and management. Measurements of recording transactions and management with the use of data for making decisions are the two fundamental aspects. Accounting is commonly referred to as the language of the business as it is effectively employed to communicate the financial performance of business to various interested parties or stakeholders. It is concerned with the measurement and communicating financial data. Financial Accounting is concerned with the collection, recording, classification and presentation of financial data to serve the purposes of the management, shareholders and stakeholders, such as, creditors, bankers, Government, etc. The nature and purpose of accounting The basic aim of accounting in a business entity is to provide financial information for making decisions on its activities. Managers of an economic entity at various levels require analyzed financial information for planning and programming, for controlling expenditure, for ascertaining the extent of profitability or otherwise of a department even of each production item for undertaking new jobs, etc. Financial information in tabular forms and with graphs and charts are also required by the outsiders, namely, bankers, financial institutions, creditors, investors, government agencies and even by the labor unions and the general public who have some interest in the particular business concern. Accounting: Historical Perspectives With the establishment of the first English colonies in America, accounting or bookkeeping, as the discipline was referred to then, quickly assumed an important role in the development of American commerce. 200 years, however, would pass before accounting would separate from bookkeeping, and nearly 300 years would pass before the profession of accounting, as it is now practiced, would emerge. For individuals and businesses, accounting records in Colonial America often were very elementary. Most records of this period relied on the single-entry method or were simply narrative accounts of transactions. As rudimentary as they were, these records were important because the colonial economy was largely a barter and credit system with substantial time passing before payments were made. Accounting records were often the only reliable records of such historical transactions. The Emergence of Accounting Prior to the late 1800s, the terms bookkeeping and accounting were often used interchangeably because the recording/posting process was central to both activities. There

was little need for financial statements (e.g., income statements) because most owners had direct knowledge of their businesses and, therefore, could rely on elementary bookkeeping procedures for information. Although corporations (e.g., banks, canal companies) were present in the United States prior to the early 1800s, their numbers were few. Beginning in the late 1820s, however, the number of corporations rapidly increased with the creation and expansion of the railroads. To operate successfully, the railroads needed cost reports, production reports, financial statements, and operating ratios that were more complex than simple recording procedures could provide. Alfred D. Chandler, Jr. (1977), noted the impact of the railroads on the development of accounting in his classic work, The Visible Hand, when he stated "after 1850, the railroad was central in the development of the accounting profession in the United States" (p. 110). With the increase in the number of corporations, there also arose a demand for additional financial information that A.C. Littleton (1933/1988) in his landmark book, The Rise of the Accounting Profession, called "figure" knowledge. With no direct knowledge of a business, investors had to rely on financial statements for information, and to create those statements, more complex accounting methods were required. The accountant's responsibility, therefore, expanded beyond simply recording entries to include the preparation, classification, and analysis of financial statements. As John L. Carey (1969) wrote in The Rise of the Accounting Profession, "the nineteenth century saw bookkeeping expanded into accounting" (p. 15). Additionally, as the development of the corporation created a greater need for the services of accountants, the study of commerce and accounting became more important. Although there had been trade business schools and published texts on accounting/bookkeeping, traditional colleges had largely ignored the study of business and accounting. In 1881, however, the Wharton School of Finance and Economy was founded, and two years later, the school added accounting to its curriculum. As other major universities created schools of commerce, accounting secured a significant place in the curriculum. With a separation of management and ownership in corporations, there also arose a need for an independent party to review the financial statements. Someone was needed to represent the owners' interest and to verify that the statements accurately presented the financial conditions of the company. Moreover, there was often an expectation that an independent review would discover whether managers were violating their fiduciary duties to the owners. Additionally, because the late nineteenth century was a period of major industrial mergers, someone was needed to verify the reported values of the companies. The independent public accountant, a person whose obligation was not to the managers of a company but to its shareholders and potential investors, provided the knowledge and skills to meet these needs. In 1913, the responsibilities of and job opportunities for accountants again expanded with the ratification of the Sixteenth Amendment to the Constitution, which allowed a federal income tax. Accountants had become somewhat familiar with implementing a national tax with the earlier passage of the Corporation Excise Tax Law. Despite the earlier law, however, many companies had not set up proper systems to determine taxable income and few were familiar with concepts such as depreciation and accrual accounting.

As tax rates increased, tax services became even more important to accounting firms and often opened the door to providing other services to a client. Accounting firms, therefore, were often engaged to establish a proper accounting system and audit financial statements as well as prepare the required tax return. Thus, in contrast to bookkeeping which often had been considered a trade, the responsibilities of accounting had expanded by the early twentieth century to such an extent that it now sought professional status. One foundation of the established professions (e.g., medicine, law) was professional certification, which accounting did not have. In 1896, with the support of several accounting organizations, New York State passed a law restricting the title certified public accountant (CPA) to those who had passed a state examination and had acquired at least three years of accounting experience. Similar laws were soon passed in several states. B. The Accounting Environment 1. Economic Activities Economic activities are related to production, distribution, exchange and consumption of goods and services. The primary aim of the economic activity is the production of goods and services with a view to make them available to consumer. "Human activities which are performed in exchange for money or money's worth are called economic activities." In other words, economic activities are those efforts which are undertaken by man to earn Income, Money, Wealth for his life and to secure maximum satisfaction of wants with limited and scarce means. 2. Economic Entities. In generally accepted accounting principles (GAAP) of accounting, an economic entity is an assumption that an organization or a unit is operating a business. For the purpose of ownership and responsibilities, economic entities are classified in three main categories. 1. Proprietorship: A proprietorship is a business owned and operated by one person. It can just be a type of business with one person such as a hair braiding salon or a small convenience store. 2. Partnership: A partnership is a business owned by two or more people who work as an association. 3. Corporation: A corporation is a small, medium, or large company that is registered with the local, state, and federal government with many legal ramifications. The budget is usually considered in terms of stocks held by internal and external entities (people) with the ability to exchange (buy or sell) what they own in the company. The entities that own these stocks (they are called stockholders) do not have personal responsibilities with the company, or they are said to have (to enjoy) limited liability towards the company. 3. E-commerce Electronic commerce or ecommerce is a term for any type of business, or commercial transaction, that involves the transfer of information across the Internet. It covers a range of different types of businesses, from consumer based retail sites, through auction or music sites, to business exchanges trading goods and services between corporations. It is currently one of the most important aspects of the Internet to emerge.

Ecommerce allows consumers to electronically exchange goods and services with no barriers of time or distance. Electronic commerce has expanded rapidly over the past five years and is predicted to continue at this rate, or even accelerate. In the near future the boundaries between "conventional" and "electronic" commerce will become increasingly blurred as more and more businesses move sections of their operations onto the Internet. C. Major Users and Uses of Accounting The following are the USERS of accounting information system: Shareholders of a company: Company's shareholders are the real owners of a business and needs information from those that manage the business on their behalf. Government: It is the duty of government to protect lives and property and in so doing will need information concerning every facet of her jurisdiction. Information from businesses in the form of financial report will help government properly formulate her strategic plan. Suppliers/ Creditors: Suppliers and creditors of a company need information concerning the financial position of a company. They need to be convinced that the company is liquid enough to meet with her obligations upon maturity. General public: The general publics will some time need information about the finance of a company in order to protect their interest. Students: students need information about company's finance to take some decisions that relates to courtesy visit and demand for bursary Employees: Employees and lower cadre managers are only interested in a company's financial statements because they want the safety of their daily bread. They may also want increase in wages and salaries. Management: Management in this are the top level managers and they have similar interest with ordinary managers. The only difference is that management also need this information to make economic decision that concerns the running of the business. Tax authority: They are only concerned about the returns that comes to them in the form of tax revenue. Trade union: Their concern is to seek a fair wage for their members. Knowing what a company is making will give them an insight of what to agitate for as fair wage Professional bodies: Professional bodies need accounting information as a tool that will be used to educate her members. Potential investors: For potential investors to be in a position to make investment decision some analysis has to be made and this can only be made from accounting information. Uses of Accounting Accounting plays important role for correct and satisfied operating of any organization. As a matter of fact, the development of any business is only possible, if we record all business transactions with correct method and analyze them. There are following main uses of Accounting:-

1. Avoidance of the limitation of memorizing power Businessman can not remember all business transactions due to the limitation of human memory. Accounting is helpful for recording all business transaction and when businessman checks the record, he can easily remember it and use it for his business purposes. 2. Compliance of Statutory provisions From accounting point of view, recording of business transaction is compulsory. Hereby, accounting helps to fulfill all statutory provisions. In India, it is compulsory to record of all cash, bank and purchase and sale transaction for joint stock companies. 3. Ascertainment of profit and loss of the business Any business concern is established for the motive of earning profit. Net profit or loss is pure result of business. For correct calculation of business profit, it is necessary to record correctly by adopting the principles of accounting. 4. Ascertainment of financial position of the business At specific date, company finds the knowledge of his assets and liabilities from financial statement. Assets means all sources of business and liabilities means all payable amounts of business. Business can calculate correct financial position, if businessman records all assets and liabilities in accounting. 5. Assessment of Tax - Nowadays, a businessman has to pay many taxes. For example income tax, sale tax, property tax , excise duty , import duty and custom duty etc. Its correct estimation is only possible, if businessman record correctly all his income, production and sale with the help of accounting. If businessman does not keep his record properly, then Assessing officer calculates amount of tax with his own estimation. 6. Knowledge of Debtors and Creditors With accounting, businessman can easily find what amount is due from his debtors and what amount is payable to his creditors. If he maintains the accounting records properly. 7. Determination of sale price of business If businessman wants to sell his active business to other party , then the total sale value of business can easily determine, if businessman records all investments in business. 8. Evidence in the court of law If any disputes are presented between two parties in court. Then books of accounts can show as proofs, court accepts these records as evidence of transaction. 9. Assistance in taking managerial decisions Accounting is helpful for many managerial decisions like calculation the price of goods and services , calculating the product mix and sale mix , purchase decisions , different uses of plants , determination of the productivity of different sources of productions , continue or close of business decisions , replacement of machinery decisions , decision regarding accepting of any specific order , decision regarding tenders etc. 10. Development of nation Nation can also develop with the help of accounting, if all the businessman records correctly. With this, the can not save black money and with huge amount of tax, Govt. can utilize these funds for development programmes of nation. After this development of nation is possible. D. Fields of Accounting Financial Accounting In this type of accounting, receipts and received funds are tracked in chronological order; when a specified time period is up, these losses and gains are analyzed according to a pre-defined format. Net gains and losses are easy

to spot in the organized and efficient reports submitted by accountants to their valued clientele. Cost Accounting This sort of accounting may also be referred to as manufacturing accounting. This business style of accounting is based on the concept that the price of an item or service will directly dictate how much profit it generates. Lower-cost products will increase profit ratio. Accountants perform record keeping and analysis to ensure that ideal pricing is in place, in order to help manufacturers boost their bottom lines. Managerial Accounting In this sort of accounting, financial information is recorded according to the specific requests of a board or directors or management team (or a single manager). Data may be analyzed in different formats, or dimensions, to facilitate business planning and more effective decisions about budgets, pricing, labor costs, and other variable expenses and business issues. E. Generally Accepted Accounting Principles (GAAP) This refers to the standard framework of guidelines for financial accounting used in any given jurisdiction; generally known as accounting standards. GAAP includes the standards, conventions, and rules accountants follow in recording and summarizing, and in the preparation of financial statements. Trend Towards a More Global Perspective GAAP is slowly being phased out in favor of the International Financial Reporting Standards (IFRS)[citation needed] as global business becomes more pervasive. GAAP applies only to United States financial reporting and thus an American company reporting under GAAP might show different results if it was compared to a British company that uses the International Standards. While there is close similarity between GAAP and the international rules, the differences can lead a financial statement user to believe incorrectly that company A made more money than company B simply because they report using different rules. The move towards International Standards seeks to eliminate this kind of disparity. The Basic Principles Principles derive from tradition, such as the concept of matching. In any report of financial statements (audit, compilation, review, etc.), the preparer/auditor must indicate to the reader whether or not the information contained within the statements complies with GAAP. Principle of regularity: Regularity can be defined as conformity to enforced rules and laws. Principle of consistency: This principle states that when a business has once fixed a method for the accounting treatment of an item, it will enter in exactly the same way all similar items that follow. Principle of sincerity: According to this principle, the accounting unit should reflect in good faith the reality of the company's financial status. Principle of the permanence of methods: This principle aims at allowing the coherence and comparison of the financial information published by the company.

Materiality concept: An item is considered material if its omission or misstatement will affect the decision making process of the users. Materiality depends on the nature and size of the item. Only items material in amount or in their nature will affect the true and fair view given by a set of accounts.

An error that is too trivial to affect anyones understanding of the accounts is referred to as immaterial. In preparing accounts it is important to assess what is material and what is not, so that time and money are not wasted in the pursuit of excessive detail. Principle of non-compensation: One should show the full details of the financial information and not seek to compensate a debt with an asset, revenue with an expense, etc. Principle of prudence: This principle aims at showing the reality "as is": one should not try to make things look prettier than they are. Typically, revenue should be recorded only when it is certain and a provision should be entered for an expense which is probable. Principle of continuity: When stating financial information, one should assume that the business will not be interrupted. This principle mitigates the principle of prudence: assets do not have to be accounted at their disposable value, but it is accepted that they are at their historical value. Principle of periodicity: Each accounting entry should be allocated to a given period, and split accordingly if it covers several periods. If a client pre-pays a subscription (or lease, etc.), the given revenue should be split to the entire timespan and not counted for entirely on the date of the transaction. Principle of Full Disclosure/Materiality: All information and values pertaining to the financial position of a business must be disclosed in the records. Principle of Utmost Good Faith: All the information regarding to the firm should be disclosed to the insurer before the insurance policy is taken. International accounting standards and rules Many countries use or are converging on the International Financial Reporting Standards (IFRS), established and maintained by the International Accounting Standards Board. In some countries, local accounting principles are applied for regular companies but listed or large companies must conform to IFRS, so statutory reporting is comparable internationally, across jurisdictions. F. How to Study Accounting Accounting is one of the most versatile fields you can choose to study. This is because the goal of nearly every for-profit business is to make money. No matter what industry youd like to work in, you can be sure that businesses in that industry will require accountants to manage their money. Whether youd like to work in government, healthcare, finance, construction, education or are still undecided, studying accounting is a great way to ensure youll always have job security. Instructions

1. Keep up with the work. Studying accounting is a cumulative process, and every level of accounting study builds upon information taught at the previous level. 2. Understand cash versus accrual basis accounting. Under cash basis accounting, expenses and income are counted when a business actually has the cash in hand. Under the accrual basis, expenses and income are counted as soon as they are committed. 3. Learn basic accounting terminology, and not just the formulas and equations. You should be able to identify, prepare and describe the purposes of the three basic accounting documents, including balance sheets, income statements and equity reports. In addition, those serious about their accounting studies should know key formulas like debt-to-income ratio and liquidity index. 4. Complete your assignments and every sample problem as best as you can so that you will know how to solve these problems on the job. II. Introduction to Financial Accounting and Financial Statements A. Objectives of financial statements Provide support for decision making. Financial management provides managers with the information and knowledge they need to support operational decisions and to understand the financial implications of decisions before they are made. It also enables managers to monitor their decisions for any potential financial implications and for lessons to be learned from experience, and to adapt or react as needed. Ensure the availability of timely, relevant and reliable financial and nonfinancial information. Financial management gives managers the information that either forms the basis for calculating financial information, or is used for management control and accountability purposes. Manage risks. Financial management enables an organization to identify, assess and consider the financial consequences of events that could compromise its ability to achieve its goals and objectives and/or result in significant loss of resources. Financial management is an important component of risk management and needs to be considered with the full range of business risks, such as operational and strategic risks as well as social, legal, political and environmental risks. Use resources efficiently, effectively and economically. Financial management is necessary to ensure that an organization has enough resources to carry out its operations, and that it uses these resources with due regard to economy, efficiency and effectiveness. Strengthen accountability. Financial management is essential for an organization to understand and demonstrate how it has used the financial resources entrusted to it and what it has accomplished with them. Provide a supportive control environment. Financial management contributes to promoting an organizational climate that fosters the achievement of financial management objectives - a climate that includes commitment from senior management, shared values and ethics, communication and organizational learning. Comply with authorities and safeguard assets. Financial management is essential to ensuring that an organization carries out its transactions in accordance with applicable legislation, regulations and executive orders; that spending limits are observed; and that transactions are authorized. It also provides an organization with a system of controls for assets, liabilities, revenues and expenditures. These 8

controls help to protect against fraud, financial negligence, violation of financial rules or principles and losses of assets or public money. B. Underlying Assumptions of Accounting A firm foundation is needed in every structure so that it will not collapse in the future. So as in accounting, a basic notion that is the basis for accounting processes is being formed and created and these are called accounting assumptions. These accounting assumptions serve as the understructure of accounting in order to prevent misunderstanding of the use of the financial statements. Other name for accounting assumptions is postulates that are being used to enhance the understanding and usefulness of the financial statements. There are two major underlying assumptions in accounting and these are accrual and going concern. However included in the basic assumptions of accounting are accounting entity, time period and monetary unit. One by one let us discuss the accounting underlying assumptions. Accrual Accrual accounting is the basis for the preparation of financial statements every accounting period. So what does this accrual accounting means? This means that income is being recognized when earned regardless of when the payment is received and expense is recognized when incurred regardless of when to be paid. As you can see under this basis the effects of the transaction are being recognized when they occur and not when cash is received or paid. The importance of accrual accounting is the recognition of the following accounts: accounts receivable, accounts payable, prepaid expenses, accrued expenses, deferred income and accrued income. Going Concern What is meant by the going concern assumption is an entity is viewed as continuing in operation indefinitely even in the absence of proof to the contrary. In other words the financial statements are being prepared in the sense that the entity will continue to operate till the future. This assumption ignores market value and normally recorded asset at cost. The going concern assumption is also called the continuity assumption and is the very core of the cost principle. Other three basic accounting underlying assumptions Accounting Entity This accounting entity is maybe in a form of proprietorship, partnership or corporation because in financial accounting the accounting entity is the particular business organization. In this assumption it is stated that the entity is separate from its owners, managers and employees. Meaning every transaction of the entity is separate and must not be merged with that of the owner and the other group of people just mentioned earlier. Fair presentation of financial statement is the reason behind this assumption so that the personal transactions of the owner will not distort to the financial statements of the entity. If parent subsidiary relationship exists a consolidated statement must be made for the reason that the parent and the subsidiary is a single economic entity. Time Period Timely information is crucial in an entity for this is needed in every economic decision to be made. Periodic reports of the financial statements must be prepared to comply with the presentation of timely information. The time period assumption is the

subdivision of the life of an entity into the indefinite life of an entity. This division is usually in an equal length. The fiscal or accounting period is one year or 12 months. There are two types of accounting period, the calendar year that is a 12 month period that ends in December 31 and the natural business year that is a 12 month period that ends in any month. Monetary Unit Quantifiability and stability of the monetary unit are two aspects of the monetary unit assumption. Quantiability means that the assets, liabilities, capital, income and expenses should be stated in terms of unit of measure. While the stability of the monetary unit means that the purchasing power of the monetary unit is stable and if ever there are instability it will be just ignored because it is immaterial. C. The Qualitative Characteristics of FS The following are all qualitative characteristics of financial statements: Understandability. The information must be readily understandable to users of the financial statements. Relevance. The information must be relevant to the needs of the users, which is the case when the information influences the economic decisions of users. This may involve reporting particularly relevant information, or information whose omission or misstatement could influence the economic decisions of users. Reliability. The information must be free of material error and bias, and not misleading. Thus, the information should faithfully represent transactions and other events, reflect the underlying substance of events, and prudently represent estimates and uncertainties through proper disclosure. Comparability. The information must be comparable to the financial information presented for other accounting periods, so that users can identify trends in the performance and financial position of the reporting entity. D. Elements of FS 1. Assets, Liabilities & Equity Accounting is fundamentally about Assets, Liabilities and Equity. Beginners will be happy to know that the general day to day meaning of the word 'asset' relates perfectly to the accounting meaning. So when you listen to phrases such as "Mr. X or Miss Y is an asset to the organization" you know that the speaker is implying that these individuals are of value to the company. In the accounting sense, an asset is an item of value owned by a company. Assets may be tangible physical items or intangible items with no physical form. Assets add value to a company, and are important to a company's continued success. As with assets, you may look at the wider world to gain an understanding of what's a liability. No one is particularly pleased when he or she is described as a "liability". This is so because the liability description is a negative one. In accounting, liabilities are obligations of the company to transfer something of value to another party. On a companys balance sheet, a liability may be a legal debt or an accrual, which is an estimate of an obligation. In day-to-day parlance, you may be familiar with the word "equity" if you're a homeowner. Homeowners who make regular mortgage payments will accumulate equity

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value in their property, and will be able to borrow against that equity. Equity is the owner's value in an asset or group of assets. In accounting, equity is usually defined as the value of the assets contributed by the owners. This is added to the total income earned and retained by the company to give the company's total equity value. This description of equity is correct but very simplistic. A more profound description is really that used by the homeowner, that is, equity is the owner's value in an asset or group of assets. As an example, a company with total assets valued at Php1,000, may have debt (liabilities) valued at Php900, in which case the owner's value in the assets is Php100, representing the company's equity. The following is the Equity equation: Total Assets minus Total Liabilities (T - A = E). T - A (or Equity) is also referred to as Net Worth, Capital & Shareholders Equity. GROUPING ASSETS Assets are grouped in order of liquidity, not only because it makes sense but also because liquidity is the lifeblood of a company. Liquidity refers to the ease in which an asset can be converted to cash. Cash is therefore the most liquid of all assets. Assets that are very liquid are shown on the balance sheet as current assets. Current assets are assets that are expected to be converted to cash in 12 months or less. Those assets with convertibility exceeding twelve months are considered to be illiquid and are categorized as fixed or long-term assets. CURRENT ASSETS 1. Cash 2. Short-term investments 3. Accounts Receivable 4. Inventory 5. Prepayments (Prepaid expenses) The assets above represent the current assets that are usually found on the typical balance sheet. As shown, the assets are arranged in descending order in order of liquidity, from cash, which is the most liquid asset, to prepayment, which is the least liquid of the five items above. The management of current assets is fundamental to the operating success of a business. This is where the vital operating assets are found, driving the day-to-day activity of the company. Companies are forced to spend significant sum of money to ensure proper management of current assets. For instance, cash is usually monitored by the company's Treasury department, which focuses on the management of bank accounts, investments, lockboxes etc. Accounts receivable is managed with collections and credit staff, while inventory is managed with an array of staff for purchasing, disbursement and valuation. It's the current assets that provide the fuel for the engine of growth in a company. Inventory is a good example of the importance of current assets. Inventory represents assets being

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held by the company for sale, and the speed of the movement of the inventory through the company is of significant importance to the operating success of the company. Fixed Assets Fixed assets are those assets owned by a company that contributes to the company's income but are not consumed in the income generating process and are not held for cash conversion purposes. Fixed assets are tangible items usually requiring significant cash outlay and lasting for an extended period of time. When an asset is purchased, the value of the asset is not recorded against the company's revenue, but is entered by opening a separate account for the account. This accounting process is known as capitalizing. For accounting purposes, a portion of the value of the fixed asset is charged against profit during each accounting period. This process is called depreciation. Unlike its more parochial meaning, depreciation is not simply a reduction in value. It is a fundamental aspect of accounting as dictated by the Matching principle that ensures that expense is matched against the revenue it helps to generate. Many methods of depreciation calculation exist today, however major corporations usually use one of the following methods: Straight line Declining/Reducing balance a. Sum of years' digits b. Double declining balance While it is not possible to list all fixed assets here, the following are a few that will show up on the typical balance sheet: Machinery Property, Plant and Equipment Motor Vehicles Leasehold Improvements Because of the cash outlay involved, the purchase of most fixed assets is usually preceded by an extended period of cost/benefit analysis by the company's accounting staff. The aim of this analysis is to determine, as best as possible that the asset purchased will add value to the company during its useful life, by generating greater positive cash flow than it cost when it was purchased. ' Fixed assets are usually booked at the acquisition cost. However, in some cases additional costs may be incurred to make the asset useable. This cost should also be included in the cost of the fixed asset. Consider the purchase of a refrigerator by a grocery store. The refrigerator cost Php10,000, however it needed a special thermostat to allow it to operate in the store. Because the thermostat cost the company a Php1,000, the value of the refrigerator will be recorded as Php11,000 (Php10,000 + Php1,000). As the asset is used in the business it may have to be repaired from time to time. The cost of the repair can either be capitalized or expensed, depending on whether the repair resulted in an extension of the asset's life or not. Repairs extending the life of the asset will add to the value of the asset (that is, capitalized), while repairs that merely serve to maintain the life of the asset will be expensed. Generally speaking, the following initial cost of an asset will be capitalized to represent the value of the asset:

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The price of the asset The charge for delivery Charges for installation and other setups.

During the life of the asset, the following costs will be capitalized: Any replacement extending the life of the asset Any significant addition to the asset Any extensive service that will extend the life of the asset Understanding fixed assets is very important to a clear understanding of accounting and should be an area exploited by anyone anxious to learn about the accounting process. Liabilities Companies will borrow from financial institutions, from suppliers or from the any individual, group of individuals or corporation willing to lend. Debt is therefore an everpresent part of a company's financial consideration. At any point in time, the average company will find itself in the following position: It will own assets; it's owners will maintain some value in the company; it will be indebted to creditors/non-owners. Liabilities reflect the level of indebtedness to creditors. Liability is a source of funds for a company, and the company will use the fund (purchasing power) to enhance the business (purchase fixed assets, inventory, pay creditors etc.) Liabilities are contractual obligations and companies are required to honor their liability contracts or face legal suits. The content of a liability contract may be extremely simple or very complex. Some creditors may request that the borrowing company pay interest on its debt, as well as maintain certain accounting ratios, a specific cash balance or a certain level of net worth, while another credit may simple require repayment of the principal at a particular time. Current Liabilities Current liabilities may be viewed as the flip side of current assets, and requires similar managerial attention as current assets. Current liabilities represent the amount owed to creditors due for payment within 12 months. Current liabilities are usually amount owed for operating expenses, dominated by accounts payable. However in many cases, current liabilities also include Current Portion of Long Term Debt, which is the amount of long-term debt due for payment in less than 12 months. Managing current liabilities is very important to a company's cash flow process and extended viability. Failure to appropriately manage current liabilities will result in working capital issues, which could lead to operating failures. Current liabilities are ideally settled using current assets, necessitating the combined management of the two. Current assets less current liabilities is called working capital. The following are a few of the current liabilities you may see on the typical balance sheet: Accounts Payable Notes Payable Short-term portion of long-term debts Income Tax Payable

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Wages Payable Accruals/accrued expenses Accounts payable represents trade debts and is usually due within 30 days. Many companies are able to negotiate trade debt terms longer than 30 days, improving their cash position for as long as payment is delayed. Notes payable represents intermediate debt borrowed for a period greater than 2 but less than 10 years. The amount included among current liabilities is the amount due in less than twelve months. The amount due after 12 months is reflected on the balance sheet as long-term debt. A significant amount of a company's long-term debt is repaid over many years. Amount will fall due on a yearly basis and that portion is shown on the balance sheet as current liabilities in the form of "Current Portion of Long-term Debt". Failure to pay this amount when due may result in a loan default, which could have serious negative repercussion for the company. Income tax payable is the amount of tax owed to the government based on the accounting profit earned. Wages payable represents amounts owed to employees. Accrued expenses represent operating expenses incurred but not paid for. Accrued expenses may be analyzed as the flip side of prepaid expenses. While prepaid expenses represent amount for services/goods not yet received, accrued expenditure represents services used/goods received but not yet paid for.

Long-Term Liabilities Long-term liabilities are debt obligations of the company that is not due for repayment within the next 12 months. Most companies will hold both short and long-term debt, with no limit on how "long-term" the debt may be. So while there are a minimum number of months for a liability to be considered long-term, there is no maximum time period. Long-term liabilities are usually much larger in value than short-term liabilities and are usually non-trade debt. There are many differences between the two groups of debt (current and long-term), however most of the differences are not unique to any one group, but are instead more often used in one group and not the other. Collateral is a good example of a debt requirement often associated with long-term debt. This is not to say that a creditor offering short-term loans is prevented from requesting collateral, however this is usually more popular for debt with a life of more than one year. The same is true of covenants and convertibility. Unlike short-term liabilities, long-term liabilities are often an important part of the capital structure of a company. It provides fund for the purchase of long-lived assets used to generate revenue over many years, and from which cash flow is not immediate. This source of fund can provide significant benefits to a company, but can also lead to significant problems. Many companies are forced into bankruptcy because of the difficulties in financing long-term debt and the heavy burden the interest charges bring to bear on the companys operating cash flow and bottom line. There are numerous types of long-term liabilities, with companies and creditors having the flexibility to negotiate hundreds of different variations of loans/debentures/bonds. A new type of long-term debt is maybe created everyday,

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however, the following are the ones you will probably find under the Long-Term Liabilities section of the next balance sheet you peruse: Debt to Financial institutions Bonds Debentures Mortgages Each loan will have some kind of agreement for repayment, including the due dates and the specific amount. The loan contract may also include the following: Any applicable interest rate, a default clause, a listing of the collaterals being held by the creditor, any covenants associated with the loan and a convertibility clause. Prudent management will seek to understand the content of the loan contract before accepting the loan, and will continue to adhere to the contract throughout the life of the loan. Failure to do so may activate the default clause, which could result in a demand for immediate repayment for the entire debt by the creditors. Equity Businesses need to be financed, and although this financing is not necessarily required to come from the owners, most companies will have a portion of its financing fund coming from those owning the business. This funding that is supplied to the company by the owners is called "equity". Equity is also provided when the company generates profit and retains that profit in the business. This is reflected on the balance sheet as Retained Earnings. By the same token, a company generating losses will reduce its equity by the value of the loss. Equity by definition indicates the value of the company to its owners. It is therefore possible for the owners to contribute equity to the business but lose that equity during the life of the business. You will from time to time observe balance sheets with negative equity balances. Of course, business owners commit their funding to companies mainly to increase their wealth with the operating success of the company; it is therefore possible for owners to increase their equity significantly without actually contributing new funding to the business. Just so you know, some writers do describe liability as the equity of creditors, a description that doesn't sit well with many, as it seems to transform the true meaning of the word "equity". The description is correct if equity is taken to mean, "rights to property", which is what the creditors have. Generally speaking, equity speaks to the property rights held by the owners of a business in the business they own. Equity (also referred to as Capital, Shareholder's equity, Net Worth) can be mathematically stated as the difference between Total Assets and Total Liabilities. This difference is also known as Net Assets. Positive equity therefore implies that the sum of the company's assets is greater than the sum of its liabilities, while negative equity implies that the sum of its assets is less than the sum of its liabilities, in which case the business is completely "owned" by the creditors. Not a pleasant situation for any company to be in! The Shareholders' Equity section of the balance sheet can be very crowded and it can also be sparse. A balance sheet with a sparse shareholders' equity section will probably only show the following: Preferred Stock Common Stock

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Retained Earnings A more complex balance sheet will show a more crowded section on shareholders' equity. It may look something like this: Preferred Stock Common stock, par value Php1: a. Authorized shares b. Issued shares Additional Paid-In Capital Retained earnings Treasury stock Foreign currency translation adjustment Preferred stock Preferred stock is usually defined as a hybrid between debt and equity. It's a hybrid because it maintains the dividend-paying characteristic of common stock, as well as the fixed interest payment of debt. Unlike common stockholders, preferred stockholders are usually not given voting rights. Common stock Common Stock has no predetermined dividend payout rate or time, but the holders maintain the rights to vote and the right to share in the residual value of the company upon liquidation. Additional PaidIn Capital Additional Paid-In Capital represents the excess paid for the company's stock above the par value. Treasury stock Treasury stock, which is always a negative value, represents the company's purchase of its own stock.

INCOME 1. For corporations, revenues minus cost of sales, operating expenses, and taxes, over a given period of time. Income is the reason corporations exist, and are often the single most important determinant of a stock's price. Income is important to investors because they give an indication of the company's expected futuredividends and its potential for growth and capital appreciation. That does not necessarily mean that low or negative earnings always indicate a bad stock; for example, many young companies report negative income as they attempt to grow quickly enough to capture a new market, at which point they'll be even more profitable than they otherwise might have been. also called earnings. 2. For individuals, money earned through employment and investments. EXPENSE In accounting, expense has a very specific meaning. It is an outflow of cash or other valuable assets from a person or company to another person or company. This outflow of cash is generally one side of a trade for products or services that have equal or better current or future value to the buyer than to the seller. Technically, an expense is an event in which an asset is used up or a liability is incurred. In terms of the accounting equation, expenses reduce owners' equity. The International Accounting Standards Board defines expenses as ...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 CAPITAL MAINTENANCE

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Accounting concept that a profit can be realized only after capital of the firm has either been restored to its original level (called 'capital recovery') or is maintained at a predetermined level. It is necessary, therefore, to determine the value of capital before the amount of profit can be computed.

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